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The Basics of Self-Directed IRA Prohibited Transactions

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  |  By Christopher Orr, SDIP

Using a self-directed IRA to invest in alternative assets (such as private equity or real estate) can be an appealing and potentially lucrative retirement strategy. These tax-advantaged accounts allow people the freedom to use their retirement dollars to invest in a wide range of assets that are unavailable in a conventional IRA. However, there are some limitations – specifically, what the IRS deems to be “prohibited transactions.”And not knowing the rules around prohibited transactions can result in investor frustration, penalties and loss of investments.

This doesn’t diminish the benefits of self-directed IRA investing, but like anything in life it’s very important to understand the rules of the game before you play. For self-directed IRA prohibited transactions, this can largely be summed up as the WHO (disqualified parties) and the WHAT (disqualified assets). Once you gain an understanding of these two categories, it’s easier to discern what’s possible within your self-directed IRA.

Let’s take a closer look at these:

The Who: Disqualified Parties
One of the basic tenets of self-directed IRA investing is that you and your family can’t personally benefit from the assets you invest in. So for example, if you own an investment property in your SD IRA, you can’t stay there yourself. If you want to invest in your son’s startup, you’ll have to do it outside of your IRA. These rules are designed to prevent a conflict of interest known as “self-dealing.”

Examples of disqualified parties include:

  • You
  • Your spouse
  • Your “lineal ascendants” (parents, grandparents, their spouses, etc.)
  • Your “lineal descendants” (children, grandchildren, their spouses, etc.)
  • Your fiduciary (anyone who exercise discretionary authority or control in managing your IRA and/or provides investment advice to your IRA for a fee)
  • Any corporation, partnership, trust or estate in which disqualified persons have a 50% or greater interest

The What: Disqualified Assets
There are some investment types that the IRS prohibits in any tax-deferred account or plan, including self-directed IRAs. These prohibited asset types include but are not limited to:

  • Collectibles, such as art, antiques, stamps, gems, rugs, or anything the U.S. Treasury Department deems to be a collectible.
  • Life insurance
  • Viatical settlements
  • S Corporations
  • General Partnerships
  • Auction transactions (including real estate transactions)

Most prohibited transactions are related to one or both of these categories, so knowing them can help you discern whether your potential SD IRA investment is feasible. For example, any time there is a disqualified party involved in the IRA asset or transaction, you can probably guess that the IRS might consider it self-dealing. This is where a self-directed IRA custodian like PENSCO can be a huge help, because if you’re not sure you can always ask. We spend all day every day working with clients to help investors figure out what’s possible.

The PENSCO blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.