You have a Self-Directed IRA, but do you know the rules?
Some of these rules are referred to as IRA Prohibited Transactions. While the IRS has only a few limitations on what an IRA can do, there are still some areas that need to be understood and avoided.
When using a Self-Directed IRA, the account holder runs into the possibility of violating certain guidelines of the IRS, these actions are called Prohibited Transactions. IRA Prohibited Transactions can involve either people or actions. You can read about them HERE.
Some people are prohibited people to the IRA. These people include, the account holder, their spouse, their linear ascendants and descendants and fiduciary’s. Linear ascendants and descendants would be people up and down a family line, like parents, grandparents, children, grandchildren and their spouses. Other family members are not prohibited parties. A spouse’s parents (while not directly considered a prohibited party) can be a grey area. An attorney opinion letter may be needed in transactions involving them.
A fiduciary to the IRA would be someone providing advice or services to the IRA or has discretionary control over the IRA.
Examples of IRA prohibited transactions with a Self-Directed IRA:
- Borrowing money from your Self-Directed IRA
- Selling property you own to it
- Receiving compensation for managing an IRA-Owned property
- Using the retirement account as security for a loan
- Using your IRA to buy property for personal use (present or future) with IRA funds
How does that impact you?
It is a prohibited transaction to rent a property your Self-Directed IRA owns to your children, but you could rent it to a sibling. You cannot buy a property your parents own, but you could buy one that your uncle owns. You could make a loan to a non-prohibited party, but not to yourself or another prohibited party. Could you loan money to a non-prohibited party who then gives it to a prohibited party? No, that is still considered a prohibited transaction as the funds ended up with the prohibited party. This is considered a violation of the Indirect Rule. If you cannot do it directly, you cannot do it by involving a third party.
There is one thing you can do with a prohibited party and that is: buying a new asset together. For example, you and your daughter could buy a property together so long as you do so concurrently. Keep in mind the prohibited rules still apply. You could not buy them out later or let them live in the property. Your IRA can buy the property together with a disallowed person, hold it together and then sell to a non-prohibited party later.
What are the ramifications of a Self-Directed IRA engaging in a prohibited transaction? The entire IRA account can be distributed out to the account holder at fair market value, retroactive to the first day of the year that the prohibited transaction occurred. You will receive a 1099 for this distribution and pay taxes on the distribution. There could also be penalties if you were under 59 ½ when the event occurred. Excise taxes are also a possibility. You can learn more about IRA rules HERE