What to Watch out For in Self Directed IRA Transactions

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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".

 

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.