Prohibited Transaction Rules – Self-Directed IRA (SDIRA) LLC
A self-directed IRA can engage in practically any investment, however prohibited transaction rules do exist. Your self-directed IRA cannot engage in “prohibited transactions” or make investments in life insurance or collectibles. Breaking these rules can lead to severe taxes or disqualification of your IRA.
Because of this, it’s important to familiarize yourself with the IRA rules. Additionally, it’s wise to be aware of the specifics of a prohibited transaction.
You know how a self-directed IRA works, so you know that prohibited transactions fall under three primary categories:
1. Direct prohibited transactions
This is a transaction between a disqualified person and his/her retirement account. For example, Mark uses funds from his Self-Directed IRA to purchase an interest in an entity that his father owns. Do you see the problem with this investment? This transaction is between two disqualified persons (Mark, the IRA holder and his father, a lineal descendant). Furthermore, it personally benefits one of the disqualified persons.
Let’s take a look at another example. Patty purchases real estate with her self-directed Roth IRA funds and leases it to her son.
Similar example to the one above, right? Therefore, you now realize why Patty’s purchase is prohibited. Prohibited transaction rules exist so individuals don’t directly or indirectly benefit the Plan participant or any of his/her lineal descendants.
These rules are primarily in place so investments involving your IRA can benefit the retirement account, not just the account owner. Of course, when you reach retirement age, you will benefit by having an increase of funds in your account.
2. Self-dealing prohibited transactions
This transaction also involves a situation where an individual uses his or her IRA income or assets for personal gains. For example, Pam makes an investment with her self-directed Roth IRA funds. She puts the funds into a company she controls, which, in turn, benefits her personally.
Another example is of Doug who uses his self-directed IRA funds to invest in his son’s business that is in financial trouble.
These transactions are prohibited because Pam and Doug are using their self-directed IRA funds for the benefit of their personal interests. Yet the purpose of an IRA is to increase your retirement funds through tax-free or tax-deferred growth.
3. Conflict-of-interest prohibited transactions
This involves a disqualified person who is also a fiduciary and is connected to a transaction that involves the income or assets of the individual’s IRA.
In Francine’s case, she uses her IRA funds to loan money to a company she owns a small interest in. She also manages and controls the daily operations. Francine is the fiduciary, and as you can see, she has a close connection to the investment.
The Prohibited Transaction rules were created to encourage people to save for retirement, but also prevent them from taking advantage of tax benefits for their personal account.
Self-Directed IRA Rules
You now know that with a Self-Directed IRA, you’re able to invest in virtually anything. However, if it engages in prohibited transactions, you may jeopardize the tax-deferred status of your IRA account. The IRS doesn’t tell you what you can do, only what you can’t. For example, you can’t invest in life insurance or collectibles. Other prohibited transactions include:
- Works of art
- Metals or gems
- Alcoholic beverages
- Rugs or antiques
- Most coins
You can find these prohibited-transaction rules in IRC Section 408.
We know you don’t want to make a transaction with your retirement accounts that may trigger a prohibited transaction. Therefore, it’s important to familiarize yourself with the self-directed IRA rules.
Here are the following IRC provisions. Each of these rules fall under Internal Revenue Code sections.
- Prohibiting IRAs from investing in life insurance contracts.
- Referencing tax on prohibited transactions.
- Defining an IRA’s loss of tax-exempt status upon engaging in a prohibited transaction.
- Describing effect of pledging an IRA or any IRA assets as security for a loan.
- Expressing impermissible investment in collectibles.
- Describing unrelated business taxable income.
- Imposing tax on unrelated business income.
- Describing an unrelated trade or business.
- Individual Retirements Arrangements (IRAs)
- Swanson v. Commissioner (1996)
At IRA Financial Group, we understand that a self-directed IRA may seem difficult to establish and to understand the particulars. That’s why we’re here to help. Contact us today for a consultation with an IRA specialist.
Did you know?
You can transact with a sibling with your Self-Directed IRA without triggering a prohibited transaction.