If you use a Self-Directed IRA, you are aware of the powerful potential that using non-traditional retirement assets in a tax-protected account can have. In many cases, it can mean establishing a strong cash flow for retirement and even exceeding the returns of the stock market.
But it’s not too good to be true, either. There are some prohibited transactions within a Self-Directed IRA that you will need to be aware of, especially if you’re just beginning your retirement journey. Here are five key prohibited mistakes to avoid:
Prohibited Transaction #1: Selling Property to Your Self-Directed IRA
Although your IRA and you and considered separate entities for tax and legal purposes (for example, you won’t be allowed to live within a property that your IRA holds, as this would be investment property and not personal property), it does not mean you can interact with your IRA in any way you want. The IRS prohibits the selling of property to an IRA.
This rule is used to prevent someone from simply loading up their IRA far above the maximum contributions they could make. Selling a property to an IRA is essentially selling it to yourself, which means that you could also charge your IRA rock-bottom prices that aren’t at all realistic to market conditions.
Prohibited Transaction #2: Using a Self-Directed IRA as Security for a Loan
You might think that holding a Self-Directed IRA is a great way to demonstrate that you have wealth. And who wants to know about your wealth more than a lending officer? Unfortunately, because an IRA is not to be accessed except for retirement purposes (without carrying hefty taxes and fees), it should not be used as security in a loan application, either.
That means that while your net worth might suggest that you are capable of paying off a loan, using an IRA for such purposes is a big no-no.
Prohibited Transaction #3: Using a Property for Personal Needs when Held Within a Self-Directed IRA
Let’s say that you purchased a piece of residential real estate with your Self-Directed IRA. You initially intend to rent the house out and generate income from it, all proceeding to the IRA itself. Then, you find that you need a place to stay. Can you live in your investment property?
The IRS prohibits this transaction, wanting to keep a clear line between your investment/retirement property and the real estate you use for your personal needs.
Prohibited Transaction #4: Borrowing Money from Your Self-Directed IRA
Just as was the case with the first prohibited transaction on our list, you cannot view your Self-Directed IRA as “just another” account, like a checking or savings account. Borrowing money from your IRA is another prohibited transaction that’s often misunderstood, because there are rules for borrowing money against a 401(k).
A Self-Directed IRA, however, should not be borrowed from or against.
Prohibited Transaction #5: Allowing a Disqualified Person to Do Any of the Above
“Great,” you might think. “But what if I let a relative stay in my Self-Directed IRA property for a while?”
The IRS has a list of disqualified persons within a Self-Directed IRA, and it usually means that you’re stuck not being able to use your rental property, for example, with someone that you know intimately, such as a family member. For investment purposes, a good rule of thumb is to treat the IRA as a separate business—not something you can use now for your immediate benefit or the immediate benefit of your family/relatives.