What to Watch out For in Self Directed IRA Transactions

by | BiggerPockets.com

Considering investing in real estate with your IRA?  Sounds great and there are a number of companies who actively promote real estate investing through a “Self Directed IRA”.  For a fee, you can roll over an existing IRA or 401k from a previous employer and gain control over how your funds are invested.  The problem as I have seen it, many of these companies do not adequately explain the rules that go along with investing through a “Self Direct IRA”.   I am referring to prohibited transactions?  

Section 408 and 4975 of the Internal Revenue Code explain everything the IRA must be aware of when dealing with his own IRA.  To save you the time of looking up these code sections I will lay out the gist of the rules in English.  Here we go ….

  • Certain transactions with an IRA account are prohibited if a “disqualified person” is involved in the transaction.
  • Disqualified persons include the IRA owner, certain family members, any other fiduciary and certain service providers (among others).
  • Prohibited transactions include the following:
    • a transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person;
    • any act of a fiduciary by which plan income or assets are used for his or her own interest;
    • the receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets;
    • the sale, exchange, or lease of property between a plan and a disqualified person;
    • lending money or extending credit between a plan and a disqualified person; and
    • furnishing goods, services, or facilities between a plan and a disqualified person.
    • If a prohibited transaction occurs, the IRA ceases to be an IRA as of the first day of the tax year in which the transaction took place.

I often see the potential for prohibited transactions when an IRA owner works on the property owned by the IRA or becomes to involved in facilitating an IRA transaction. These problems typically arise because the IRA Owner can not or does not want to wait for the IRA trustee to handle the transaction on behalf of the IRA owner. A solution offered by many Self Directed IRA companies is for the IRA owner to establish a "Checkbook IRA" i.e., set up an LLC that is wholly owned by your IRA but managed by the IRA owner. The Checkbook LLC attempts to solve the "I need to get this deal done ASAP" problem because the IRA owner is in control of the LLC and can enter into transactions on its behalf without involving the IRA trustee.

I bring this to your attention because despite the nature of the transaction, the prohibited transaction rules still apply and the IRA owner must tread carefully lest he risk disqualifying his IRA. Next week I will discuss an alternative to the "Self Directed IRA".


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  1. Charles Bradford on

    Clint — Thank you for the reminder that investing with 401k funds has its advantages, the rules still must be followed. And, as you so aptly pointed out, there are several that can become a landmine if they are overlooked. Thanks for your insight!

  2. Good Post Clint,
    Although Prohibitive Transaction rules still exist, I find that setting up a Solo 401K plan is much better for R.E. Investors. The reason you don’t hear about the Solo K plans from Self Directed Custodians is because the Solo K is not only Self Directed with check book control but It’s also Self Managed (No Custodian needed). It also eliminates the need for a LLC! Either plan of course, still addresses the need to know about Prohibitive Transactions as you have described in your post article. Thanks.

  3. Matt,
    I have a solo 401k and a self directed ira with checkbook control. The solo 401k does have to be opened with a custodian and it is similar in nature as an IRA. It is does require a custodian. It is a single member 401k.

    Not sure where you’re getting this info.

  4. HELP!!! I have a Mutual Fund that expires in June, 2013. Last year, my account representative presented this self-directed IRA stuff to me. I didn’t like it from the start, but I was under the impression I had 1 year and 1 option to either go with it or to get out of it without any loss of money involved. Everytime I talked to her this past year, I would tell her that I wanted out…No other paperwork has taken place. I talked to her last week and she is now telling me that I can’t get out — EVER!!! How can this be? and that the only option I have is to either increase of decrease my monthly income…expected in July of 2015. I need help and fast!! I would have N E V E R signed up for this program had I known that I had no way out of it. They approached me, I didn’t approach them about this program. I go to talk with a group of them on Thursday, January 31, 2013.

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