Self-Directed IRA Rules

If you don’t follow rules for self-directed IRAs, you can risk the tac-deferred status of your account. This could lead to the disqualified of the IRA and result in servee tax consequences. But don’t worry, the rules aren’t complicated.

Here is what you need to know:

Prohibited Transactions and Investments

A prohibited transaction can bring into question the tax-deferred status of your account, potentially resulting in the disqualification of your SDIRA and tax consequences.

The IRS defines a prohibited transaction as follows:

“Generally a prohibited transaction is any improper use of your IRA account or annuity by you, your beneficiary or any disqualified person. Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of lineal descendant).”–Source IRS Publication 590

Publication 590 indicates that, in addition to prohibited investments, the IRS prohibits certain transactions within IRAs. Prohibited transactions include investments with disqualified individuals (as defined by IRC 4975), “self-dealing” and receiving indirect benefits.

The IRS does not provide guidance on what is permitted, but dictate only what is NOT permitted. Examples of prohibited IRA investments include collectibles (such as artwork, stamps, rugs, antiques and gems), certain coins and life insurance. See IRS Publication 590 for more information about prohibited investments.

Disqualified Individuals

Your IRA may not buy an investment from or sell an investment to a disqualified person as defined by Internal Revenue Code Section 4975.  To do so is known as “self dealing”.

Additionally, investments made with self-directed IRA funds must be at arms length, which is most often defined as a willing buyer and willing seller coming together with no undue influence from outside sources.

Disqualified persons are individuals or entities between whom or which an IRA is prohibited (absent a special exception) from engaging in any direct or indirect sale or exchange or leasing of any property; lending of money or other extension of credit; furnishing goods, services or facilities; or transferring to or permitting the use of IRA income or assets.

  • Fiduciaries (which in the case of a self-directed IRA includes you, as the IRA owner).
  • The following family members of the IRA owner:
    • Spouse;
    • Parents;
    • Grandparents and Great-Grandparents;
    • Children (and their spouses);
    • Grandchildren and Great-Grandchildren (and their spouses).
  • Service providers of the IRA (e.g., IRA custodian, CPA, financial planner).
  • An entity (such as a corporation, partnership, limited liability company, trust or estate) of which 50% or more is owned directly or indirectly or held by a fiduciary or service provider; also a partner which holds 10% of a joint ventur of such entity.
[NOTE: The term “disqualified person” under the Internal Revenue Code does not include siblings (brothers and sisters) or aunts, uncles and cousins of the IRA owner.]

Indirect Benefits

The purpose of the IRA is to provide for your retirement in the future. It is considered an “indirect benefit” if your IRA is engaged in transactions that, in some way, can benefit you personally today.

The following are just a few types of indirect benefit transactions that are NOT allowed in an IRA:

  • Personally using property held in the IRA: Using real estate purchased through your IRA— as an office, personal residence, vacation home or retirement home.
  • Receiving personal benefits from your IRA: Lending yourself money from your IRA or paying yourself, or a company that you own, to do work on a home purchased by your IRA
  • Using your IRA funds to buy a vacation home that you or your family will use.

UBIT (Unrelated Business Income Tax)

If your IRA owns an asset or interest that produces unrelated business taxable income (UBIT), your IRA may be subject to an unrelated business income tax (UBIT) pursuant to Section 511 of the Internal Revenue Code.

UBIT applies if ALL of the following are true:

  • Income is derived from “trade or business” activity (i.e., sale of goods and services).
  • Business activity is not substantially related to exempt status.
  • Business is regularly carried on by organization.

Generally, IRA investments that can generate UBIT include:

  • Limited Partnerships (LPs),
  • Limited Liability Companies (LLCs), and
  • Any investment that incurs debt financing and/or is involved in an unrelated business.

UBIT won’t apply to rental properties.