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.
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.
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:
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:
Generally, IRA investments that can generate UBIT include:
UBIT won’t apply to rental properties.