At Accuplan Benefits Services, we pride ourselves on our knowledge of IRS rules and regulations within alternative investments so investors can maintain the tax-advantaged status of their individual retirement account.
One aspect of investing with a self-directed IRA is that the account holder must perform their due diligence. Since a self-directed investor does not generally consult with advisors or fiduciaries, it is up to them to perform all checks and balances. Lest they wittingly or unwittingly break IRS laws and disqualify their self-directed IRA.
It’s important to note that the IRS does prohibit some asset types and transactions, and there are restrictions on how some investments are used. Breaking these rules could result in tax-related consequences.
Self-Directed IRA Rules:
Prohibited Transactions
A prohibited transaction is any improper use of an IRA account or annuity by the account holder, beneficiary, or disqualified person. For example, borrowing money from the self-directed IRA (known as self-dealing, which means loaning themselves money from their IRA) or buying a property with funds from the self-directed IRA for personal use would be a prohibited transaction.
What is an Indirect Benefit?
As the IRA account holder, to personally benefit today from a self-directed account violates IRS rules and guidelines. Retirement plans are designed to replace income upon retirement, so the IRS has set rules to define an Indirect Benefit or improper use of these tax-advantaged accounts.
In other words, any time the account holder benefits from their IRA other than ways that the IRS has stipulated is considered an indirect benefit and could disqualify the retirement account.
Indirect Benefit Examples
Here are a few examples of what the IRS could consider prohibited indirect benefit transactions within an IRA:
- Living in IRA-owned property: The IRA owner may not live in a property that the IRA owns. But if they use that property for personal use, it could be disqualified.
- Paying out of pocket: IRA holders cannot personally pay for expenses that their IRA should be paying.
- Loaning IRA funds: Account holders cannot loan funds to an unrelated party and then have that person turn around and lend the funds back to them.
Disqualified Persons
The following people are prohibited from conducting business within your self-directed IRA.
- The account owner
- The beneficiary of the IRA
- The account holder’s spouse
- Lineal ascendants of the IRA holder
- Lineal descendants and their spouses
- Plan fiduciaries, including all advisors, custodians, and administrators
- Any entity where the IRA owner has 50% or more interest
The same goes with business partners or entities that are 50% or more owned by a disqualified person. So if you loan money out to your business partner who is half owner of the company, even though you aren’t doing it directly through the company, you’re still violating the IRS rules on disqualified persons.
The same goes for retirement plans that you might own, whether it’s a 401K or some other retirement plan. If you’re not allowed to borrow money from your IRA plan, then you shouldn’t be able to loan out money through your IRA either.
It’s important to note that under IRS laws, not all related persons are disqualified. For instance, here are some examples of IRS-approved persons that an IRA can do business with:
The following people are eligible to conduct business with your self-directed IRA.
- Brother or sister of the IRA account owner
- Cousin of the IRA account owner
- Spouse’s parents (in-laws of the account owner)
- Stepparents or step-grandparents of the IRA account owner Aunt or Uncle of the IRA account owner
- Niece or Nephew of the IRA account owner
- Friends of the IRA account owner
Due Diligence
Some self-directed investors don’t know that there is an added element of responsibility called due diligence, where you have to vet your assets, have complete familiarity with the rules of that asset, and the applicable taxes.
What proper due diligence looks like:
- Thorough research of a prospective investment
- Vetting of potential business partners
- Gaining knowledge of the rules that are specific to your asset of choice
- Seeking advice from successful and trusted investors
- Inspecting tangible assets when possible
- Thorough understanding of the associated taxes
Your IRA provider doesn’t vet these investments, and it’s up to you as the account manager to be sure these alternative investments aren’t too good to be true.
Fair Market Valuation (FMV)
Fair Market Value (FMV) is an IRS requirement to report an asset’s value or selling price annually.
The IRA owner submits the fair market value annually to the IRS to indicate the change of the value of their assets in a self-directed IRA. Accuplan Benefits Services requires the valuation annually to certify the accurate tax reporting to the Internal Revenue Service as of December 31 of each year.
More Common Self-Directed IRA Rules
Self-Directed IRA Contribution Limits and RMDs
Annual contribution limits on self-directed IRAs can range depending on the account holder’s age, income, and account type.
Required Minimum Distributions, RMDs, dates vary depending on the type of IRA. Some start at 59 1/2 and others at age 71 1/2.
Go to the individual account to see the rules for distributions or RMDs for the type of account.
Learn morePersonal Use of Property
The IRA holder cannot personally benefit from their IRA investments before distributions are taken upon retirement. To personally benefit can be interpreted in a couple of ways. It can mean that the IRA holder cannot store IRA-purchased gold at home, and it can mean that the IRA holder cannot use IRA-owned real estate. Violating this rule can result in the IRS disqualifying the account and penalty fees.
Self-Directed IRA Tax Rules:
Traditional Self-Directed IRA Taxes
Traditional SDIRA contributions are tax-deferred, so no taxes are paid until retirement. Contributions to a Traditional IRA are also tax-deductible.
Roth Self-Directed IRA Taxes
All contributions made to a Roth IRA are with pre-taxed dollars, so all growth made within an IRA stays tax-free. Thus all distributions are tax-free.
Form 5498
They are filed to the IRS by the chosen custodian. No taxes are due or paid as a result of Form 5498.
UBIT
If an IRA incurs Unrelated Business Income Tax (UBIT), the IRA must file a tax return, and taxes paid must come from the IRA account.
Learn moreWhat Happens if an IRA is Disqualified?
The IRS states, that if a disqualified person were to engage in a prohibited transaction, a penalty fee of 15% of the amount involved is to be applied to the IRA. If the disqualified person does not correct the transaction within the stated taxable period, there is an additional tax of 100% of the amount involved.
Both taxes are payable by any disqualified person who participated in the transaction.
Upon the violation of IRS laws, the self-directed IRA runs the risk of a full mandatory distribution.