When establishing a Self Directed IRA with “Checkbook Control” it is important to be aware of the disqualified person and prohibited transaction rules found in Internal Revenue Code Section 4975.
The IRS has restricted certain transactions between the IRA and a “disqualified person”. The rationale behind these rules was a congressional assumption that certain transactions between certain parties are inherently suspicious and should be disallowed.
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, under Code Section 4975, a “Disqualified Person” generally means, the IRA holder and his or her grandparents, parents, spouse, children daughter-in-law, or in son-in-law and any entity controlled by such persons. Interestingly, brothers, sisters, aunts, uncles, cousins, step-brothers/sisters, and friends are NOT treated as “Disqualified Persons”.
The Internal Revenue Code does not describe what a Self Directed IRA can invest in, only what it cannot invest in.
The IRS only describes the type of investments that are prohibited, which are very few.
Pursuant to Internal Revenue Code Section 4975, a Self Directed IRA is prohibited from engaging in certain types of transactions. In general, a prohibited transaction involves any transaction with an IRA holder’s IRA and a “disqualified person”. The types of prohibited transactions can be best understood by dividing them into three categories: Direct Prohibited Transactions, Self-Dealing Prohibited Transactions, and Conflict of Interest Prohibited Transactions.
Direct Prohibited Transactions
A “Direct Prohibited Transaction” generally involves the direct or indirect sale, exchange, leasing or property, lending of money, extension of credit, the furnishing of services, or the transfer of the income or assets of an IRA to a “disqualified person.” For example, an individual lends his spouse IRA funds.
Self-Dealing Prohibited Transactions
A “Self-Dealing Prohibited Transaction” generally involves a “disqualified person” dealing with the income or asset of the IRA for his or her own interest. For example, an individual uses his or her IRA funds in a way that personally benefits such individual.
Conflict of Interest Prohibited Transactions
A “Conflict of Interest Prohibited Transaction” generally involves a “disqualified person” dealing with the income or asset of the IRA for his or her own account. For example, an individual invests his or her IRA funds in order to secure a personal benefit.
Under Internal Revenue Code Section 4975(d), Congress created certain statutory exemptions from the prohibited transaction rules outlined under Internal Revenue Code Section 4975(c). For these certain transaction, Congress believed there is a legitimate reason to permit them.
Life Insurance and Certain Collectibles
In general, a Self-Directed IRA cannot Invest in life insurance contracts or collectibles defined below:
- Any work of art
- Any metal or gem
- Any alcoholic beverage
- Any rug or antique
- Any stamp
- Most coins
Types of Collectibles That may be Purchased Using IRA Funds
The IRS does permit a Self-Directed IRA to own certain gold coins (American Gold Eagle coins or coins 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 of a certain fineness that is in the physical possession of a financial institution.
S Corporation Stock
Because of the shareholder restrictions imposed on “S” Corporations, an IRA cannot own stock in an S Corporation. Note – an IRA can own stock in a “C” Corporation.
The Self Directed IRA Rules rules are extremely broad and the penalties extremely harsh (immediate disqualification of entire IRA plus penalty). Thus, an individual using a Self Directed IRA to make investments should be aware and cautious of the disqualified person and prohibited transaction rules.