Self-directed IRAs are growing more popular among individuals who want to invest in alternative assets like real estate and private equity. Account owners have complete control over investment acquisition for their plan and do not rely on plan administrators, investment bankers, or brokers to make those decisions for them. There is a tremendous amount of freedom plan owners enjoy, but that freedom comes with the responsibility of avoiding self-directed IRA prohibited transactions.
What Are Self-Directed IRA Prohibited Transactions?
When you self-direct, not only are you responsible for choosing your own assets, you’re also in charge of ensuring you invest and treat your IRA in compliance with IRS regulations.
The alternative investment asset class includes a large pool of opportunities available to self-directed IRAs. You can invest in real estate, businesses, LLCs, precious metals, cryptocurrency, private equity, and much more.
If you don’t understand the rules, you may perform a prohibited transaction and not even realize it. These transactions are fully covered in IRC Section 4875, but below are a few examples.
There are two types of actions your IRA must avoid:
- prohibited investments
- dealings with disqualified persons
Examples of prohibited transactions include:
- You or a disqualified person vacationing in or renting a property your IRA owns.
- Disqualified persons (including yourself) buying a property from or selling a property to your IRA.
- Buying precious metals for your IRA and storing the assets at home; you’re required to use an approved depository for storage.
- Not following IRS standards for approved precious metals.
- Investing in collectibles and/or life insurance contracts with your self-directed IRA.
Penalty for Prohibited Transactions
The penalty for committing any transaction that’s prohibited regarding your IRA is harsh. All prohibited transactions, large or small, are treated the same way: Your IRA is disqualified and loses its tax-sheltered status. The assets and/or funds it holds are regarded as distributed to the owner. IRC 4975 has a section regarding taxes levied on disqualified persons who deal with your IRA that is worth reading.
Depending on the size of your retirement account holdings, these penalties can be disastrous. And taxes disqualified persons may face aren’t much fun, either.
The SECURE Act 2.0 Ruling on Penalty for Prohibited Transactions
There is a bit of good news in the way of a clarity delivered in Section 322 of the SECURE Act 2.0. Section 322 clarifies that the above penalties will only impact the IRA involved in the prohibited transaction. This means that if you own multiple retirement plans, if they weren’t involved, they will maintain their tax-sheltered status and not suffer the consequences of the IRA that committed the prohibited transaction. This ruling begins with all taxable years that begin after the date of the enactment of the SECURE Act 2.0.
The Bottom Line
It is critical you understand who disqualified persons are and what prohibited transactions involve regarding your IRA. Doing so will help you maintain your retirement plan in good standing, which has a direct impact on how much you can amass to live on in your golden years.
To learn more about these transactions and how to avoid them, check out these articles: