Monday, November 26, 2012

An Overview of "Prohibited Transactions" in a Self Directed IRA


IRAs were created in 1975 as a way for citizens to take control over their retirement savings. They were established in response to ERISA, The Employee Retirement Security Act, which was passed in 1974 to put the responsibility of retirement savings into the hands of employees.

IRAs are a wonderful retirement savings tool. They provide an abundance of tax benefits and can make saving for retirement safe and relatively secure. However, they do come with a set of rules and regulations. Self Directed IRAs, which provide the most investment opportunities, also come with a list of "Prohibited Transactions." It's important to understand what's prohibited to make sure you don't incur penalties.

What is a Prohibited Transaction?

The IRS prohibits certain transactions within an IRA. Any activity that improperly uses the account's funds is considered a prohibited transaction. These prohibited transactions center around two key terms:

Self Dealing

Self dealing is defined as "The conduct of a trustee, an attorney, or other fiduciary that consists of taking advantage of his or her position in a transaction and acting for his or her own interests rather than for the interests of the beneficiaries of the trust or the interests of his or her clients." (Source: http://legal-dictionary.thefreedictionary.com/Self-Dealing )

It means that you cannot make a transaction that directly benefits you. For example, you can't borrow money from your IRA. You also can't use it as security for a loan nor can you buy personal property with it.

Disqualified Person

A disqualified person is anyone who is directly related to you or to the account. Your spouse, dependents, and the fiduciary of your account are all disqualified people. Additionally, if someone owns more than 50% of a business or estate that is held by the fiduciary, they too are a disqualified person. This means you cannot use your IRA to their benefit.

Common Prohibited Transactions

Here's a short list of the most common prohibited transactions. You cannot:

Borrow money from your Self Directed IRA Sell property to it. Receive compensation for managing it. Use it as security for a loan. Use it to purchase real estate that you use. Use it to issue a mortgage on a relative's new residence. Buy stock in a closely held corporation or from a disqualified member.

It's important to make sure you understand the terms disqualified person and self dealing. Make sure you don't break the rules! If you engage in a prohibited transaction the account is treated as distributing all its assets to you at their fair market value. The distribution is then subject to taxes and penalties.

So What Can You Do With Your Self Directed IRA?

The possibilities for permitted investments are virtually endless. In addition to being able to make traditional investments like stocks and bonds you can also:

Invest in real estate including farm land, developments and rental properties Issue a mortgage Issue a loan Buy a franchise Invest in private equity Invest in tax liens Almost any other than life insurance or collectibles

A Self Directed IRA provides you with an abundance of investment opportunities. The good news is that if you're concerned about prohibited transactions a good custodian can be your facilitator and educator.

Types of 401(K) Contributions   



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