October 10, 2016
Joe Fairless

What You Can and Can’t Do with the Self-Directed IRA

We have all wonder what you could and couldn’t do with a self-directed IRA. Fortunately, Kaaren Hall has come to our rescue. Kaaren is the President of uDirect IRA Services, LLC, where she has helped thousands of Americans invest their IRA into assets such as real estate, land, and private notes. In our recent conversation, she outlined the 4 main rules for what you can’t do with a self-directed IRA.

What Can You Do?

One of the pivotal definitions of the self-directed IRA is that one can invest in assets that are outside of the stock market, also known as uncorrelated assets. Therefore, the IRA account can be used to invest in many different types of assets, including:

  • Real Estate
  • Loan someone money to purchase real estate
  • Performing and nonperforming debt
  • Private stock
  • Precious metals
  • Land

What Can’t You Do?

When the IRS came up with the IRA rules back in 1974, they never stated what you could invest in. They only stated what you couldn’t invest in. The types of things you can’t invest in are very important because most of us are used to investing with cash. Self-directed IRA investing is not the same. It is its own little universe and has its own rules. According to these rules, you cannot commit a prohibited transaction. Therefore, it is a game of keep away from prohibited transactions.

1st Self-Directed IRA Rule

The first rule of the self-directed IRA universe is that you cannot have personal benefits from your IRA. For example, you cannot transfer money from your IRA into your personal checking account to buy a flat screen TV. The self-directed IRA is all about saving for later, not for spending today.

2nd Self-Directed IRA Rule

The second rule of the self-directed IRA universe is that you can’t buy, sell, or exchange assets between the IRA plan and people that are disallowed to your IRA. Disallowed people are your ascendants, descendants, and your and their spouses. Below is an example list of disallowed and allowed individuals:

  • Disallowed – parents, grandparents, your spouse, your children, your grandchildren, and all of their spouses
  • Allowed – aunts and uncles, nieces and nephews, brothers and sisters, and cousins

For example, you cannot use an IRA to purchase a property that your daughter will live in. However, there is nothing that disallows your niece from living in the property instead.

3rd Self-Directed IRA Rule

The third rule of the self-directed IRA universe is that you cannot have one of those disallowed people offer goods, services, or facilities to the plan. For example, Kaaren had an account holder bring them a purchase agreement for a property. When reviewing the document, they found that the broker of record was his father. This broke the rule because a disallowed person – his father – is providing services. The father was also asking for a commission. However, whether he would do it for free or charge a commission, a disallowed person cannot offer services and cannot benefit from the IRA.

4th Self-Directed IRA Rule

The final rule of the self-directed IRA universe is that you can’t invest in collectables or life insurance policies. Examples of collectables are fine wines, baseball cards, art, collectable coins, diamonds, etc.

Consequences of Committing a Prohibited Transaction

If the IRS says that you have committed a prohibited transaction, you will face financial Armageddon. This means that your entire IRA balance can be dispersed to you as a taxable event!

The Four IRA Rules Summarized: (1) One cannot personally benefit (2) Cannot sell, buy, or exchange with disallowed persons (ascendants, descendants, an spouses) (3) Disallowed persons cannot offer goods, services, or facilities (4) Cannot invest in collectables of life insurance policies

Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.

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