Self-Directed IRA investing has tremendous advantages for the right investors: It allows you to concentrate your efforts in market niches and asset classes where you have the most expertise; it helps you diversify your overall portfolio, it can help save you money compared to high AUM fees and expense ratios from traditional Wall Street investment companies, and it gives you personal control over your money.
But liberty always brings with it an element of danger. In this case, the danger is that a Self-Directed IRA investor may accidentally run afoul of the so-called “indirect benefit rule.”
This can potentially cause significant problems for a Self-Directed IRA owner – and even lead to the entire account being disallowed. If this happens, the IRS could force you to distribute the entire amount in the account – and generate ordinary income taxes and possible early withdrawal penalties.
The Indirect Benefit Rule
The ‘indirect benefit rule’ restricts your use of assets in an IRA or other tax-advantaged retirement account to retirement security. You can’t use assets you own within an IRA as your personal plaything or use it to benefit yourself or certain family members.
Under Internal Revenue Code Section 4975(c)(1)(E), Congress forbids certain transactions, called ‘prohibited transactions, defined as “any direct or indirect . . . act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account.”
Now, if the indirect benefit is simply that the action or transaction will generate a profit that will someday benefit the IRA owner, and there is no other benefit to you or certain family members that could reasonably be expected to ensue, then there is no rule against the transaction. But if the IRA, or an entity within the IRA engages in transactions that will line your pockets now, or prior to retirement, or benefit your spouse, children, grandchildren, parents, grandparents, stepchildren of your current spouse, step-grandchildren of your current spouse, or your spouse’s parents or grandparents, or any entities they control, then that action would likely run afoul of the indirect benefit rule against prohibited transactions.
Here are some examples of actions that can – and have – landed Self-Directed IRA owners in trouble in tax court:
- The IRA owner renting a home owned within the IRA to his or her child.
- An IRA owner staying overnight in a home owned by the IRA – even though they paid a market rate rent.
- Using a ski boat owned within the IRA.
- The IRA owner starting an LLC within the IRA and then hiring himself as manager and paying himself a salary or commission.
- Commingling IRA and non-IRA funds in a single IRA account
- Causing an IRA to sell or lend to – or buy or borrow from – a prohibited counterparty.
- Pledging assets within an IRA as collateral for a personal or business loan outside the IRA.
American IRA, LLC specializes in working with investors who use Self-Directed IRAs and other retirement accounts. We ensure all transactions are properly executed and recorded, and help our clients remain in compliance with the rules governing Self-Directed IRAs.
To schedule a no-obligation consultation and review, call us today at 866-7500-IRA(472), or visit us online at www.americanira.com.
We look forward to working with you.