The Individual Retirement Arrangement, or IRA, is a tremendously flexible financial vehicle that offers investors a wide range of investment options for diversification and potentially better returns. But there are a few restrictions, which are particularly important for Self-Directed IRA owners to understand. While violations are relatively rare, a few Self-Directed IRA owners have incurred severe penalties and tax consequences for wittingly or unwittingly violating these rules with their Self-Directed IRAs. Before you make any moves with a Self-Directed IRA, make sure you understand Congress’s prohibited transaction rules.
Self-Directed IRA Prohibited Transaction Laws
The relevant laws prohibiting certain transactions in Self-Directed IRAs can be found in Internal Revenue Code Sections 408 and 4975. While at first glance some of these rules may seem arcane, Self-Directed IRA owners can better understand them by keeping in mind that Congress granted special tax advantages to these retirement accounts for a specific and limited reason: To enhance the financial security of their owners in their retirement years in a transparent and straightforward way.
Most of the prohibited transaction rules are aimed at preventing IRA owners from abusing the tax privileges of the account by using their accounts to enrich themselves prior to retirement, or to enrich family members in the short-term. Generally, you cannot use your Self-Directed IRA for the purposes of self-dealing. The IRA must always serve its Congressionally-appointed purpose of enhancing your financial security in retirement.
There are two kinds of restrictions on IRA transactions: Prohibited investments and disqualified persons.
Congress restricts IRAs from owning certain types of assets:
- Life insurance
- Gold and precious metal coins and bullion of insufficient or inconsistent purity. (Some coins are allowed, other coins are prohibited. Call American IRA at 866-7500-IRA for more information before buying precious metal coins or bullion if you aren’t sure).
- Art and collectibles such as rugs, antiques and coins
- Alcoholic beverages
- S-corporation stocks
- Gemstones and jewelry
Your IRA is prohibited from conducting transactions directly with certain family members and a few other individuals. That means your IRA cannot buy from or sell to, or borrow from or lend to any of the following persons or entities:
- You and your spouse
- Your Ascendants
- Your Direct Descendants
- Your Direct Descendants’ Spouses
- Certain Fiduciaries (CPAs, Attorneys, Financial Planners, etc.)
- IRAs held by Disqualified Persons
- Entities owned or controlled by Disqualified Persons
In practice, this means that you cannot use assets in your Self-Directed IRA to rent or lease to anyone on this list. Indeed, they are not allowed even to stay overnight on a rental property. You also cannot hire your son or daughter as a property manager or landscaper for property in your IRA, for example nor may anyone on this list earn a commission as a result of sales involving your IRA. Failure to observe these restrictions could result in the IRS or the courts disallowing your entire IRA, with all the resultant taxes and penalties.
Note that current law does not disqualify all family members. Siblings, siblings-in-law, nieces and nephews, cousins, aunts and uncles are not disqualified by law.