Let us get this out of the way: A Self-Directed IRA can be a great way to invest. It allows investors to seek out nontraditional retirement assets. It allows investors to determine their own strategies for retirement, decoupling from the traditional pathway of using stocks and bonds through an employer-sponsored plan. In other words, a Self-Directed IRA is one of those tools that makes it possible for an investor to take over the financial reins. They then get to invest on their terms.
But that does not mean Self-Directed IRAs are 100% percent free. The tax benefits they come with also mean there are rules and regulations to which investors have to pay attention. If you want to not only use your Self-Directed IRA the right way, but to avoid these common pitfalls, listen to the words of warning we have put together:
Warning: Do not Use a Self-Directed IRA for Prohibited Transactions
Prohibited transactions within a Self-Directed IRA are direct violations of the rules. If you want to retain your tax protections, you have to know the rules.
What is a prohibited transaction? We cannot point to one specifically, but we can use an example to illustrate. Let us say you purchased an asset within an IRA such as a piece of investment real estate property. If you were to then use this property to rent to someone you know—someone known as a “disqualified person” for IRA contexts, such as a spouse or a family member—then this would be a prohibited transaction. Because you are seeking out immediate personal benefits from the retirement account, the IRS would argue that it is no longer a retirement account.
Keeping this rule in mind is a good way to look at your IRA investments. You need to consider them long-term investments for retirement and separate from investments you may personally benefit from now.
Take the example of a Traditional IRA. In a Traditional IRA, you can deduct contributions from your taxable income from the year. This means that you are putting in “before-tax” money into the retirement account. Since the IRS only wants to allow investors to put that money into a retirement account, putting that money into an IRA and engaging in a prohibited transaction means the money should have been taxed. And therefore, the assets could not be retirement assets.
Avoid Working with People You Know When Handling Retirement Assets
One of the key points here? Not using retirement assets for your personal benefit, or the personal benefit of those around you. In the example above, we talked about the possibility of using a retirement asset for someone you know, such as renting out an investment property to a son or a daughter. This is a prohibited transaction that you should absolutely avoid. But in understanding why you should avoid it; you will find some key insights into how you should proceed as a rule of thumb.
In short, only transact retirement assets with people you do not know, such as finding a new renter who is a stranger. This means creating a layer between you and your retirement assets, just as the government intended. These retirement assets are then separated from your personal benefit, allowing you to realize the tax protections that you want to realize when building a retirement portfolio.
Once you get a sense of what these rules are, why these rules are in place, and how to proceed from there, you are ready to work with a Self-Directed IRA administration firm. Interested in learning more about Self-Directed IRAs? Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation. Download our free guides or visit us online at www.AmericanIRA.com.