The phrase "prohibited transactions" may seem threatening and cause worry among Self-Directed IRA investors seeking to stay out of trouble with the IRS. In reality, it is quite simple and painless to avoid any penalty that comes with a prohibited transaction. The penalty incurred from a prohibited transaction is an immediate distribution of the asset accompanied by a harsh tax. To avoid this happening to you, there are essentially four rules regarding prohibited IRA transactions to follow in order to keep yourself on the straight and narrow in the eyes of the IRS.
First, know what you can't invest in with your Self-Directed IRA. It's easier to think of it this way because there are only three assets on the Self-Directed IRA prohibited transactions list: collectibles, life insurance, and S-Corporation Stock.
As long as you are not investing in these two prohibited investments, then you have the green light.
Next, you are not allowed to purchase a property you already own with your Self-Directed IRA. This falls under what is called the rule of self-dealing, which also finds it impermissible to purchase a property that you once owned but sold to someone else. That would still be off-limits. If you were the owner of the property at any point, then you cannot invest in it with your Self-Directed IRA.
The second category of the rule of self-dealing makes up our third rule, which is that even if you've never owned the property before, you can't make personal use of it once it's owned by your IRA. For example, a Broad Financial client once wanted to buy a ski lodge in Colorado. If he stopped right there, this would have been absolutely permissible and very possibly quite lucrative except he insisted on skiing there himself one weekend a year. Even that one weekend a year is enough to make this action prohibited and therefore trigger the penalty. As the IRA owner, you can't get any personal use out of your investment properties.
The final rule governing Self-Directed IRA-prohibited transactions revolves around people who are considered disqualified persons. These are the individuals who you are not permitted to transact with your IRA. The list is not a particularly lengthy one, but it is nonetheless important to know:
A purchase or sale that benefits any of the people in this list in the present is considered a withdrawal from your retirement account and is subject to taxes and penalties. Because your retirement funds are being set aside on a tax-deferred basis to benefit you in the future, they cannot be used to benefit you or anyone close to you today.
Be sure to follow these four rules and you will never encounter any opposition from the IRS regarding your Self-Directed IRA. Hopefully, this should alleviate any concerns over possibly complex regulations resulting in an inadvertent violation and penalty.
Schedule a call with one of our Self-Directed Specialists today to get answers to your questions and find the investment vehicle that's right for you.
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