When it comes to making an investment with self directed IRA funds, it is important to have a good grasp of the self directed IRA rules as well as the prohibited transaction rules as outlined in Internal Revenue Code Section 4975.
The IRS and the Internal Revenue Code do not describe what a Self Directed IRA can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits self directed IRA 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.
When it comes to using IRA funds to make non-traditional investments such as real estate, tax liens, precious metals, it is important that one works with a tax professional that specializes in the IRS prohibited transaction and Disqualified Person rules. The reason for this is that the penalties for engaging in a prohibited transaction are severe (entire IRA will be treated as a distribution subject to tax plus a penalty may be imposed).
When it comes to making an investment using retirement funds, there are essentially four types of categories of prohibited transactions. First, pursuant to Internal Revenue Code Section 408, a self-directed IRA should not purchase life insurance contacts. Second, pursuant to Internal Revenue Code Section 408, a self-directed IRA should not purchase collectibles. Collectibles is defines as antiques, rugs, stamps, certain coins, etc. Note – there are exceptions for pure gold, silver, and palladium bars (99.99% pure), as well as American eagle and other coins minted by the Government. Third, a self-directed IRA should not purchase S Corporation Stock, since only individual may purchase stock in a S Corporation and an IRA is a trust. Fourth, a self directed IRA should not engage in any transaction with 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. In essence, one should not engage in any transaction involving a disqualified person or that directly or indirectly personally benefits a disqualified person.
The prohibited transaction rules are extremely broad and the penalties extremely harsh. Therefore, it is crucial that a tax professional be consulted prior to making an investment using IRA funds.