Jeff Dixon, MBA, CISP, SDIP
Our account holders say self-directed accounts allow them to make any investment they want. That is not entirely accurate. It is true you choose the investments made, but the IRA custodian also has to agree to hold the asset. As a result, every custodian has the right to refuse to hold a specific asset. The IRS has their own rules. uDirect IRA Services wants to help you avoid prohibited transactions so read on…
IRS Limitations
Because Prohibited Transactions can cause your account to be disbursed to you as a taxable event, avoiding them is crucial. it is important to understand what these disallowed actions are and how to avoid them. You can read on the IRS website how Prohibited Transactions generally include the following:
- A disqualified person’s transfer of plan income or assets to, or use of them by or for his or her benefit.
- A fiduciary’s act by which he or she deals with plan income or assets in his or her own interest.
The general rule of thumb – A prohibited transaction is a transaction between a plan and a disqualified person that is prohibited by law.
Disqualified Parties
Disqualified parties are people the IRA funds cannot personally benefit. It is the account holder, their spouse, if they are married, and their lineal ascendants and descendants, like parents, grandparents, children, grandchildren and their spouses. Also, anyone the account holder has a fiduciary relationship with. What that means is while an IRA could buy real estate, you cannot buy real estate from yourself or these other people. You could not rent to these people or make a loan to these individuals. You cannot invest in your own business or any business of these people. What about a Fiancé, In-Laws, Step-Children or Step-Parents? While the IRS does not specifically mention them, it is a grey area and it may be an issue the IRS could take exception to.
You can take a personal loan from a Solo 401k. The maximum loan is $50,000 or 50% of the cash available, whichever is less. That loan must be paid back with regular payments in 5 years. Otherwise, it would be considered a distribution and you would pay taxes for the distributed amount. If under age 59 ½, a 10% penalty for an early distribution would also be incurred.
Indirect Violation Rule
This means you cannot sell property you own to a non-prohibited party and then use your Self-Directed IRA to buy that same property from them. You cannot make a loan to non-prohibited party who then makes a loan to a prohibited party of yours. We had a client who wanted to make a loan to a sister-in-law. That seemed fine. However, he then wanted her to invest in his business. That would have been prohibited.
Quid Pro Quo
The definition of a Quid Pro Quo is a favor or advantage granted or expected in return for something. That is not permitted in IRA transactions. For example, two IRA account holders could not agree to loan each other money from their IRAs. You could not make a loan to a business because it agreed to hire the account holders child or spouse. These would be prohibited.
Prohibited Assets
Your IRA has so many options when it comes to asset classes. Still, there are a few assets the IRS does not allow you to invest in. Those include life insurance contracts or collectibles. Collectibles like vehicles, guns, art, wine and gold coins. There are a few exceptions to gold coins. You can read about these exceptions HERE. Your self-directed account cannot invest in a S-Corp. However, the plan can make a loan to an S-Corp, as long as it is not a business of a prohibited party.
Providing Goods, Services or Facilities to the IRA
The IRS does not allow the account holder or a prohibited party to provide Goods, Services or Facilities to the IRA. For example, if you are a real estate agent, a property manager or have a construction business, you cannot use them for assets the IRA will acquire. If you are an attorney, you cannot provide legal services to the IRA. It does not matter if you would pay market value for the work provided or to do it for free. You cannot get a referral fee. You cannot be professionally involved in these IRA deals.
If wanting to use an IRA owned LLC, you cannot create the LLC because you cannot provide that service to the IRA.
Keep things arm’s length. Don’t do any physical work yourself on real estate the IRA is holding. Absolutely do not use any personal funds for the assets the IRA is holding. All expenses of IRA-owned assets must be paid for by the IRA. You cannot use personal funds to pay the property taxes for a property the IRA owns or to repay a loan an IRA has taken out. when it comes to a “personal guarantee” to a loan the IRA has taken out, you can use a non-disqualified person to provide this, but not you yourself. Using personal funds for the IRA account fees, like the annual IRA account fee is acceptable, however.
Investing in Your Own Business
Can you invest in a deal/ project/ fund for the company you work for? It depends on the position you have with the business. If you are in management or have ownership interests, it could be considered self-dealing. If you do not, it should be acceptable to invest with them. You should discuss this with a tax attorney or CPA.
Personal Benefit
The IRS does not allow you to get personal benefit from the IRA investments. An example of this can be buying real estate in close proximity to real estate you own personally. As the value of the IRA owned property grows in value, that can positively impact the value of the real estate you own personally.
It might be argued by the IRS that making a loan to a parent-in-law or step-child provides personal benefit to you since it could make your spouse happy.
Personal benefit is a difficult issue as that can be different for every individual.
What happens if a prohibited transaction occurs?
If a prohibited transaction occurs, the entire IRA is distributed to the account holder. They will receive a 1099-R of the amount of the distribution. They will pay taxes going back to when the prohibited transaction occurred. If under age 59 ½, there would be a 10% penalty for early distribution. It would not impact other IRAs you have, that were not involved in the prohibited transaction.
Final Thoughts:
uDirect IRA Services, LLC is not a fiduciary and does not render tax, legal, accounting, investment, or other professional advice. If tax, legal, accounting, investment, or other similar expert assistance is required, the services of a competent professional should be sought.
Consulting a tax or legal professional when deciding between retirement plans (or any decision regarding a retirement account) is a very good idea. Feel free to contact us if you have questions about this or any IRA-related topic. We can send you information on how the retirement plan makes these investments. You can reach us at (866) 706-2798 or info@uDirectIRA.com. Get started today by completing an online application HERE.
