Before opening a self-directed IRA, it’s important to know the rules that are in place. Failure to understand, to partake in prohibited transactions, or deal with disqualified persons can have serious implications like the disqualification of your self-directed IRA, which may lead to penalties and taxes.
The good news is that it’s pretty easy to avoid prohibited transactions and investments by familiarizing yourself with the self-directed IRA rules and regulations that the IRS has put into place.
The people that are disqualified from conducting activity, or directly benefiting through your self-directed IRA investments include:
- The IRA holder (you cannot directly benefit from your IRA, the money that’s earned must go back into your SDIRA)
- The IRA holder’s spouse
- The IRA holder’s ancestors and lineal descendants (children, grandchildren)
- Spouses of the IRA holder’s lineal descendants
- Investment managers and advisors
- Anyone providing services to the IRA, such as the IRA trustee or custodian
- Any corporation, partnership, trust, or estate in which the IRA holder has a 50% or greater interest
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However, it is acceptable to conduct activity within your self-directed IRA with aunts, uncles, siblings, cousins, and friends. For more information on disqualified persons, go to IRS.gov.
- Borrowing money from a self-directed IRA (known as self-dealing, which means loaning yourself money from your IRA)
- Using the self-directed IRA as security for a loan
- Selling personal assets to the self-directed IRA
- Buying property in the self-directed IRA for personal use
- Purchasing property from a disqualified person (see above)
- Issuing a mortgage on a disqualified person’s residence
People who own real estate often make the most common prohibited transactions, like paying for expenses out of their own pocket instead of from funds in their IRA. Anything associated with the IRA-owned property (taxes, bills, and HOA fees, so on) should be paid out of the IRA directly.
Types of investments
Self-directed IRAs are known as such an attractive option because of the wide-range of investments that someone can make. One thing that everyone should be aware of though, is that there are types of investments that are not allowed within your self-directed IRA.
The prohibited investments include life insurance, because life insurance is meant to benefit your heirs, who are disqualified persons, and collectibles, and they are not allowed as it is difficult to determine a true value. Examples of collectibles:
- Metals other than gold, palladium and silver
- Works of art
- And alcoholic beverages (although, note that investing in a winery or brewery IS allowed, just not the direct ownership of alcoholic beverages, such as a wine collection)
Remember, your IRA is meant to benefit you once you choose to retire, so vigilant and responsible dealings and investments are what you want to help your IRA grow and prosper. So if you’re considering making alternative investments in your self-directed IRA, do so with a full-range knowledge of the ins and outs of all the self-directed IRA rules.