Self-Directed IRA Rules by IRA Financial Group
By using a Self-Directed IRA, you can make both traditional investments and alternative asset investments. Alternative assets include real estate, notes and tax liens. You can establish a Self-Directed IRA at one of many IRA custodians dealing with self-directing, like IRA Financial Trust. It’s best not to go through a traditional bank or financial institution. This is because, Self-Directed IRA custodians don’t sell investment products, like mutual funds. Additionally, they offer no investment advice. In other words, with a Self-Directed IRA custodian, you have more flexibility to make investments you want, and control over your IRA.
A Self-Directed IRA custodian is essentially a non-fiduciary facilitator of IRA investments into alternative assets. Most Self-Directed IRA custodians simply charge a flat annual fee for their administrative services.
Two Important Self-Directed IRA Rules
Self-Directed IRA investors must focus on two main rules:
Prohibited Transaction Rules
The Internal Revenue Code doesn’t tell IRA investors what they can invest in. However, the IRC does say what investments you cannot make. These investments are very few. In general, your IRA cannot invest in life insurance or collectibles, like stamps. Additionally, there are transactions you can’t make with certain people – these are called “disqualified persons.” The definition for a disqualified person varies. However, it typically includes you (the IRA holder) and ancestors or lineal descendants of the IRA holder. It also includes entities in which the IRA controller or other disqualified persons hold an equity or manage interest.
In other words, you can’t use your IRA to invest in transactions directly or indirectly involving yourself or a parent, child, spouse, daughter/son-in-law. Again, this includes entities these persons are affiliated with.
It’s important to understand the IRS prohibited transaction rules. If you don’t, you may be hit with penalties for triggering the prohibited transactions, which are steep. Such transactions can lead to the disqualification of the Self-Directed IRA and a penalty that can go as high as 100%.
In addition to understanding the prohibited transaction rules, IRA investors seeking to use a loan associated with real estate or to invest in an active business a passthrough entity operates, you must be aware of the UBTI rules.
Most passive investments that a Self-Directed IRA may invest in are exempt from UBTI. This includes:
- Capital gains
- Rental income
However, several forms of income a Self-Directed IRA generates may trigger unrelated business taxable income rules. These include:
- Income from the operations of an active trade or business through a passthrough entity, such as an LLC.
- Use of a nonrecourse loan to purchase a property (there’s an except for a 401(k) plan).
- Using a margin on a stock purchase.
A Self-Directed IRA can be an attractive way to invest in alternative assets in a tax advantageous account. However, you must be aware of Self-Directed IRA rules before you make investments.
Q for You:
How well do you know the Self-Directed IRA rules, such as UBTI and prohibited transactions?
Author, Adam Bergman is the founder of the IRA Financial Group & IRA Financial Trust Company. For more information on this topic please call 800-472-0646 or fill out the form at IRA Financial Group.