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Self-Directed IRA Rules
As a retirement investor, it's important to follow the self-directed IRA rules before making an investment. If you don't follow these rules, it can lead to the disqualification of your IRA. In this article, we'll explain what you can and cannot do with your self-directed IRA.
Self-Directed IRA Rules permit the IRA to engage in practically any investment. However, prohibited transaction rules do exist. Your self-directed IRA cannot engage in any “prohibited transactions” or make investments in certain assets, such as 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 all self-directed IRA rules. Additionally, it’s wise to be aware of the specifics of a prohibited transaction.
You know how a self-directed IRA works, therefore you know that prohibited transactions fall under three primary categories:
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.
So, 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. Patty can purchase real estate, however she cannot lease it to her son, as her son benefits from this transaction.
Prohibited transactions exist so individuals don’t directly or indirectly benefit from transactions.
These self-directed IRA rules are primarily in place so investments involving your IRA can benefit from the retirement account, not just the owner. Of course, when you reach retirement age, you will benefit by having an increase of funds in your account.
Again, this transaction involves a situation where an individual uses his or her IRA income or assets for personal gains.
For example, meet Pam:
Now, meet Doug, whose situation is very similar:
These are prohibited transactions because Pam and Doug use their self-directed IRA funds for their personal interests. However, the purpose of an IRA is to increase your retirement funds through tax-free or tax-deferred growth.
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. However, she also manages and controls the daily operations. Francine is the fiduciary, thus has a close connection to the investment.
The Prohibited Transaction rules encourage people to save for retirement, but also prevents them from taking advantage of tax benefits for their personal account.
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:
You can find these prohibited-transaction rules in IRC Section 408. Again, it's important to know the self-directed IRA rules, otherwise you may incur tax penalties.
Here are the following IRC provisions. Each of these rules fall under Internal Revenue Code sections.
Do you still have questions about the self-directed IRA rules that we didn't cover in this article? Contact IRA Financial Group at 800-472-0646. You can also fill out the form to speak with an IRA specialist.
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