A Self-Directed Real Estate IRA is simple: you keep real estate within the IRA, allowing you the tax protections of an IRA while a property manager collects rental income. But because the real estate is put under the umbrella of the IRA, there are additional rules that govern what kinds of transactions you can take on. When real estate is not a personal investment, but a retirement investment, the IRS wants to be sure that you are treating this real estate as a legitimate investment and not as a way to benefit what they call “disqualified persons.” Here’s a guide to understanding how it works.
Understanding the “Disqualified Persons” Tag
At the core of understanding your limits as a Self-Directed IRA or Real Estate IRA investor is this term: disqualified persons.
In the context of an IRA, a disqualified person can include you, your spouse, your employer, your direct descendants and their spouses, and people providing plan-related services, such as a Self-Directed IRA custodian. Other entities (such as an LLC you own) in which you own at least 50% could also be considered disqualified.
These rules are in place to make sure that you separate your retirement investments from your personal life. Once you grasp that basic rule, you will find the next section much more intuitive.
What are Prohibited Transactions in a Self-Directed Real Estate IRA?
Once you know who a disqualified person is, then you will easily understand where prohibited transactions occur. These are any transactions your assets within an IRA have with a disqualified person, including:
- Selling, exchanging, or leasing property. That means that even if you know someone who could really benefit from renting out your investment property, you can’t come to this kind of arrangement if you hold the property within an IRA. The same is true for sales and exchanges. When it comes to real estate property you hold in an IRA, keep it away from disqualified persons.
- Lending money or extending credit. Just as you would not enter a business transaction with a disqualified person—such as leasing out a property to them—you wouldn’t include a private loan to a disqualified person within a Self-Directed IRA. This means that there is no way of using loans to “get around” these rules, as the loans themselves would also be prohibited.
- Furnishing goods, services, or facilities. “Well,” you might think— “if the IRS won’t let me do those things where money is transacted, maybe I can simply use my retirement investments to furnish goods or services directly.” Not so. Opening your retirement assets to a disqualified person in any way would be a prohibited transaction.
- Acts of fiduciary. “Any act of a fiduciary,” notes the IRS, “by which he or she deals with plan income or assets in his or her own interest” is prohibited.
- Benefitting a disqualified person within a Self-Directed Real Estate IRA. The IRS prohibits “a transfer of plan income or assets to or use of them by or for the benefit of, a disqualified person.”
For a rule of thumb, it’s simple: do not allow your IRA’s assets to interact with a disqualified person. If that seems limiting, remember that a disqualified person can essentially be many of the people you know—but your Self-Directed Real Estate IRA will still be open to interacting with tenants and others who are strangers to you.