Self-Directed IRA's by their nature can be more complicated than a standard IRA -- and therefore there exists a better chance of violating IRS rules.
You might be surprised to learn that the Internal Revenue Service does not have a separate IRA category entitled "Self-Directed IRA".
IRS Rules For a Self Directed IRA (Individual Retirement Account)
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Prohibited Transactions - Prohibited Investments
These prohibited transactions are especially important for a self directed IRA.
The prohibited transactions are meant to protect the security and the retirement integrity of your IRA.
If there were no prohibited transactions, people would become careless with investing their IRA assets.
The end result would be a substantial decrease in the value of IRAs.
The term Self-Directed IRA is really just a descriptive name invented for the marketplace. The IRS doesn't really care what you call your IRA -- they only care if you violate the rules that are meant for any type of IRA.
IRS Rules For a Self Directed IRA
In fact, the term self-directed IRA is not even mentioned in IRS Publication 590.
This Publication discusses traditional IRAs, Roth IRAs, including withdrawals, taxes, and penalties -- but never a word about self-directed IRAs.
It is also not mentioned in the actual IRA law enacted by Congress -- Internal Revenue Code Section 408
Investments That Are Not Allowed For Any Type Of IRA
There are only two types of investments that the IRS prohibits from being in your IRA:
- (1) Life insurance contracts
- Sports or entertainment cards and related memorabilia. No Mickey Mantle rookie cards or Michael Jordan signed basketballs.
- Alcoholic beverages. No wine or scotch collections.
- Coins -- The exceptions allowed are certain U.S. gold, silver, and platinum coins minted by the Treasury Department. You may also invest in certain gold, silver, platinum, and palladium bullion that is allowed to be used to settle a Commodities Exchange regulated futures contract.
There are certain transactions, in regard to either a self-directed or standard IRA, that are prohibited by the IRS rules -- IRC Section 4975.
Prohibited transactions are defined as any direct or indirect:
- Sale, exchange, or leasing of any property between your IRA and a disqualified person. You cannot sell your home or summer home to your IRA.
- Lending of money or other extension of credit between your IRA and a disqualified person. Your IRA cannot give you a loan.
- Furnishing of goods, services, and facilities between your IRA and a disqualified person. You cannot personally remodel a rental house that is in your IRA.
- Transfer to, or use by or for the benefit of a disqualified person of the income or assets of your IRA. Your IRA cannot buy a beach home to be used by your daughter and son-in-law.
- Act by a disqualified person who is also a fiduciary whereby he deals with the income or assets of your IRA in his own interests or for his own account. Your investment advisor cannot invest the IRA assets into his own business.
- Receipt of any payment for his own personal account by any disqualified person who is also a fiduciary from any party dealing with your IRA in a transaction involving the income or assets of the IRA. A contractor cannot pay you a fee in regard to remodeling an apartment building that is owned by your IRA.
For purposes of the prohibited transaction rules, both the owner of the IRA and the beneificiary of the IRA are deemed to be disqualified persons. Disqualified persons also include a:
- Fiduciary - A person of trust who administers, or controls the IRA; or who renders investment advice to the IRA.
- Person providing services to the plan.
- Ancestors -- Your parents or grandparents.
- Lineal descendants - Your children and grandchildren.
- Spouses of lineal descendants - Your daughter-in-law or son-in-law.
What Happens If I Violate The IRS Rules?
If you invest in a collectible or participate in a prohibited transaction, you may have to pay income taxes and possible penalties.
When your IRA invests in collectibles, the amount invested is considered to be a distribution in the year the investment was made. The distribution could be subject to income taxes and a 10% early withdrawal penalty depending on your personal circumstances.
If you or your beneficiary are involved in a prohibited transaction, your IRA stops being an IRA as of the first day of that same year. The entire fair market value of your IRA account is now considered to have been distributed to you as of the first day of that year. The income taxes and early withdrawal penalties could be devastating to your retirement future.
Disqualified persons, other than yourself and your beneficiary, are also subject to a 15% tax on the amount of any prohibited transaction. If the prohibited transaction is not corrected, there could be an additional 100% tax.
Things you must consider before you invest your retirement money.... read more » Do the ups and downs of the stock market give you a bad feeling? .... read more »
More investment choices including real estate.
They are complicated but important.
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