Prohibited Transactions

How to Steer Clear of Prohibited Transactions in a Self-Directed IRA

Using a Self-Directed IRA gives you a lot of freedom. It gives you the freedom to choose your own retirement investments. It gives you the freedom to invest in nontraditional retirement assets like real estate, precious metals, private notes, and more. But that freedom has limits. Even a Self-Directed IRA has to work under the rules of a retirement account if you’re going to maintain the tax protections you want.

One of the keys to making sure you steer well within the regulations of a Self-Directed IRA is understanding what a “prohibited transaction” is. In a prohibited transaction, you will have to avoid making an investment with who is known as a “disqualified person,” including a spouse or son/daughter.

How do you know who to avoid transacting with? It starts with a definition of who a “disqualified person” is as it relates to your Self-Directed IRA. Here is what you will need to know.

Who is a Disqualified Person in a Self-Directed IRA?

When it comes to your IRA, a disqualified person refers to just about anyone that you know, who can possibly give you a personal benefit from an investment that’s designed to be separate from your personal accounts. Here are a few examples of who might count as a disqualified person:

  • Family members, including spouses, ancestors, or lineal descendants.
  • Parties that have authority or control in managing your IRA.
  • Your IRA custodian.
  • Entities (such as companies) of which you/other disqualified individuals own at least 50%.

These are just a few examples, but they give you an idea of the lay of the land.

Let us say you were planning on purchasing a piece of real estate within your Self-Directed IRA and then renting that property to someone you know, such as a daughter. In a personal investment, this is not prohibited. But with retirement funds, this would be a major no-no. The reason these tax protections exist is so you can put aside money specifically for retirement, and blending your retirement funds with your personal, short-term benefit is exactly what the IRS is looking to avoid.

What Qualifies as a “Transaction,” Anyway?

If we are going to make further sense of this, we have to dig deeper into what qualifies as a transaction with your IRA. Certainly, there is no reason someone in your family could not look at your retirement property as they drive by it.

The IRS notes the following four examples as types of transactions that you would want to avoid with an IRA and a disqualified person:

  • Borrowing money from the account. For example, you would not be able to loan your wife a hundred thousand dollars from a Self-Directed IRA; doing so would be an obvious problem that people would exploit for their personal gain.
  • Selling property to your IRA. Buying an IRA investment such as real estate from someone you know would be another way of merging the personal with the retirement investment—not a good idea.
  • Using an IRA as security for a loan.
  • Buying property for personal use, using IRA funds.

These are all to be avoided if you have a Self-Directed IRA, or any IRA for that matter. But it is of special relevance to people with a Self-Directed IRA, because they’ll be making their own investment decisions.

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