When it comes to making investments with a Self Directed IRA, there are only a handful of IRS rules that govern. The Internal Revenue Code does not describe what a Self Directed IRA can invest in, only what it cannot invest in. The rules are often categorized as the IRA prohibited transaction rules.
In general, Internal Revenue Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain type of transactions. The purpose of these rules is to encourage the use of IRAs for accumulation of retirement savings and to prohibit those in control of IRAs from taking advantage of the tax benefits for their personal account. In other words, the IRS does not one an IRA holder to personally benefit in anyway from the use of his or her IRA, directly or indirectly, without paying tax and penalty, if applicable. In essence, the IRS prohibited transaction rules are designed to protect the integrity of the IRA distribution rules.
The Self Directed IRA Prohibited Transaction rules are outlined in two sections of the Internal revenue Code – sections 408 and 4975.
Pursuant to Internal Revenue Code Section 408(m), an IRA may not invest in life-insurance contracts and certain collectibles, such as: any work of art, any metal or gem, any alcoholic beverage, any rug or antique, any stamp, and most coins. However, the prohibited transaction rules do include an exemption for certain types of precious metals that satisfy the following elements:
- one, one-half, one-quarter or one-tenth ounce U.S. gold coins (American Gold Eagle coins are the only gold coins specifically approved for IRAs. Other gold coins, to be eligible as IRA investments, must be at least .995 fine (99.5% pure);
- one ounce silver coins minted by the Treasury Department;
- any coin issued under the laws of any state;
- a platinum coin described in 31 USCS 5112(k) ; and
- gold, silver, platinum or palladium bullion (other than bullion that is made into a coin) of a certain fineness that is in the physical possession of a trustee that meets the requirements for IRA trustees under Code Sec. 408(a).
Putting aside life insurance and collectibles, the bulk of the IRA prohibited transaction rules governing Self Directed IRAs can be found in Internal Revenue Code Section 4975. Internal Revenue Code Section 4975 outlines the rules governing the relationship between a “disqualified person” and an IRA or retirement plan. In general, the prohibited transaction rules were designed to restrict the IRA holder from recognizing any personal benefit from the income or assets of his or her IRA without taking a distribution and paying tax and penalty if applicable (a tax and penalty may not apply in the case of a Roth IRA).
Pursuant to Internal Revenue Code Section 4975(c) prohibited transactions include but are not limited to any direct or indirect – a) sale or exchange, or leasing, of any property between a plan and a disqualified person; b) lending of money or other extension of credit between a plan and a disqualified person; c) furnishing of goods, services, or facilities between a plan and a disqualified person; d) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan.
Internal revenue Code Section 4975(e)(2) defines a disqualified person as essentially you (IRA holder), fiduciary, any members of your family including spouse, ancestor, lineal descendant, and any spouse of a lineal descendant. Note: siblings, cousins, aunts, uncles and other family members are not considered disqualified persons.
Although the IRA prohibited transaction rules are quite limited, it’s important to seek the assistance of a tax professional before making an investment, such as real estate, with an IRA or retirement plan. However, as a tip, as long as you don’t use IRA funds to purchase life insurance, collectibles, S Corporation stock, or engage in any transaction with a disqualified person, you will likely not be in violation of any of the prohibited transaction rules.