In the world of self-directed investing, one wrong move can put you in hot water with the IRS. From prohibited transactions to prohibited assets, your plan can be disqualified for improper use of your account. While it is impossible to list out all of the prohibited IRA practices to avoid, there are some common IRA mistakes, IRA owners make that could have been easily avoided.
The following situations provide some examples of common self-directed IRA mistakes IRA owners have made:
- IRA’s Purchase of a Personal Residence for the Benefit of Disqualified Persons
The use of an IRA to purchase a house to be used personally by the IRA owner or another person disqualified to the IRA is prohibited. Although the Department of Labor has given numerous individual exemptions for transactions involving the sale of real estate between a plan and a party in interest, these typically require an independent fiduciary to approve of the transaction. A transfer of encumbered property by a disqualified person to an IRA is also considered a sale/exchange for purposes of the prohibited transaction rules. Thus, a sale of property subject to a mortgage or deed of trust which the IRA assumes is prohibited. Similarly, the use of IRA property by an IRA owner or other disqualified person would also be a prohibited transaction.
- Loans Between the IRA and a Disqualified Person
The IRA owner cannot borrow from the IRA. The IRA owner may lend IRA assets to a corporation or person who is not a disqualified person. This would include all classes of loans, including traditional extensions of credit, seller financing arrangement, secured and unsecured lending.
- Collateral and Guarantees
Neither an IRA nor its assets may be used as collateral by the IRA owner. Similarly, an IRA owner cannot personally guarantee any debt of the IRA. Both of these scenarios would constitute Prohibited Transactions.
- IRA’s Purchase of Life Insurance
An IRA may not be invested in life insurance as life insurance is one of the listed restricted investments for IRAs. Thus, a life insurance contract distribution from a qualified plan may not be rolled over into an IRA.
We know that your retirement nest egg is important to you. You, as the IRA owner, are ultimately responsible for directing what you can or cannot do with your retirement account. It is for this reason that we recommend that you always consult a qualified CPA or tax advisor on any transactions made with your retirement account.
Do you still have a few questions about Prohibited Transactions & Disqualified Persons? The IRS has put together a few of the most frequently asked questions, which can be accessed here: Retirement Plan Investments FAQs
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