When it comes to engaging in transaction with retirement funds, such as an IRA, the IRS and the Internal Revenue Code do not describe what a Self Directed IRA or retirement funds can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain type of transactions that the IRS believes will directly or indirectly benefit the IRA holder or a close family member.
In general, when it comes to making real estate transaction with IRA funds, the IRS generally prohibits one from engaging in any transaction with a “disqualified person”. Pursuant to Internal Revenue Code 4975, an IRA transaction should not involve a “disqualified person”. The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest. The prohibited transaction rules outlined in Internal Revenue Code Section 4975 are centered around one using IRA funds in a transaction that directly involves or benefits, directly or indirectly a disqualified person. In other words, if the IRA transaction does not involve a disqualified person you will very likely not run afoul to any of the IRA prohibited transaction rules under IRC 4975. Or said another way, an IRA transaction should not directly or indirectly involve a disqualified person, including himself or herself.
Therefore, the IRS rules would prohibit one from using IRA funds and purchasing a second home or vacation home and using it. The reason behind this rule is the IRS believes is that if one is able to personally benefit from the use of IRA funds, they should have to pay tax (and penalty, if applicable) just like if they would have taken a cash distribution.