Pursuant to Internal Revenue Code Section 4975, a Self Directed IRA is prohibited from engaging in certain types of transactions. The types of prohibited transactions can be best understood by dividing them into three categories: Direct Prohibited Transactions, Self-Dealing Prohibited Transactions, and Conflict of Interest Prohibited Transactions.
Direct Prohibited Transactions
Subject to the exemptions under Internal Revenue Code Section 4975(d), a “Direct Prohibited Transaction” generally involves one of the following:
4975(c)(1)(A): The direct or indirect Sale, exchange, or leasing of property between an IRA and a “disqualified person”
Example: Jack sells an interest in a piece of property owned by his IRA to his son.
4975(c)(1)(B): The direct or indirect lending of money or other extension of credit between an IRA and a “disqualified person”
Example: Peter uses IRA funds to lend an entity owned and controlled by his mother $60,000.
4975(c)(1)(C): The direct or indirect furnishing of goods, services, or facilities between an IRA and a “disqualified person”
Example: Sara owns an apartment building with her IRA and hires her father to manage the property.
4975(c)(1)(D): The direct or indirect transfer to a “disqualified person” of income or assets of an IRA
Example: Steve uses his IRA to purchase a rental property and hires his friend to manage the property. The friend then enters into a contract with Steve and transfers those funds back to Steve.
Self-Dealing Prohibited Transactions
Subject to the exemptions under Internal Revenue Code Section 4975(d), a “Self-Dealing Prohibited Transaction” generally involves one of the following:
4975(c)(1)(E): The direct or indirect act by a “Disqualified Person” who is a fiduciary whereby he/she deals with income or assets of the IRA in his/her own interest or for his/her own account
Example: Jessica who is a real estate agent uses her IRA funds to buy a home and earns a commission from the sale.
Conflict of Interest Prohibited Transactions
Subject to the exemptions under Internal Revenue Code Section 4975(d), a “Conflict of Interest Prohibited Transaction” generally involves one of the following:
4975(c)(i)(F): Receipt of any consideration by a “Disqualified Person” who is a fiduciary for his/her own account from any party dealing with the IRA in connection with a transaction involving income or assets of the IRA
Example: Michelle uses her IRA to lend money to a business that she works for in order to secure a promotion.
Under Internal Revenue Code Section 4975(d), Congress created certain statutory exemptions from the prohibited transaction rules outlined under Internal Revenue Code Section 4975(c). For these certain transaction, Congress believed there is a legitimate reason to permit them. For these transactions, Congress has issued a blanket statutory exemptions permitting these transactions assuming that certain requirements specified are satisfied. Below is a list of some of the statutory exemptions found in Internal Revenue Code Section 4975(d) that apply to IRAs:
- Any contract with a disqualified person for office space, legal, accounting or other services necessary for the operation of the IRA as long as reasonable compensation is paid.Note – this exemption does not apply to an IRA fiduciary (the IRA holder) as per Treasury Regulation Section 54.4975-6(a)(5).
- The provision of ancillary services to an IRA by a bank trustee
- Receipt by a disqualified person of any benefit to which he may be entitled as a participant or beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries;
Life Insurance and Certain Collectibles
In general, an IRA cannot Invest in life insurance contracts or collectibles defined below:
- Any work of art
- Any metal or gem
- Any alcoholic beverage
- Any rug or antique
- Any stamp
- Most coins
Types of Collectibles That may be Purchased Using IRA Funds
- one, one-half, one-quarter or one-tenth ounce U.S. gold coins (American Gold Eagle coins are the only gold coins specifically approved for IRAs. Other gold coins, to be eligible as IRA investments, must be at least .995 fine (99.5% pure);
- one ounce silver coins minted by the Treasury Department;
- any coin issued under the laws of any state;
- a platinum coin described in 31 USCS 5112(k) ; and
- gold, silver, platinum or palladium bullion (other than bullion that is made into a coin) of a certain fineness that is in the physical possession of a trustee that meets the requirements for IRA trustees under Code Sec. 408(a).
S Corporation Stock
Because of the shareholder restrictions imposed on “S” Corporations, an IRA cannot own stock in an S Corporation. Note – an IRA can own stock in a “C” Corporation
In general, an IRA can generally make any investment other than the following categories:
- Stock of an S Corporation
- Life Insurance
- Any investment involving a “disqualified person”
For more information and to set up your own self-directed IRA, contact the IRA Financial Group now!