Self-directed Individual Retirement Accounts are popular with investors because they offer a great deal of latitude in how you invest your money. That latitude also gives you the ability to unintentionally abuse your self-directed IRA. Given that the Internal Revenue Service's penalty for abusing your IRA can be to cancel it and make it taxable, staying on the right side of the law is wise.
Use a self-directed IRA custodian that follows IRS rules. While working with one that is fastidious about compliance may require more paperwork, it's a small price to pay to stay out of trouble with the IRS.
Choose a self-directed IRA account that does not have a checkbook feature. Some self-directed IRAs set up an LLC, then give you control of the LLC's checkbook so that you can effectively invest your own funds. Unfortunately, the IRS considers this abuse. A traditional self-directed IRA, in which the custodian holds the funds, will help you sidestep the potential for abuse.
Indicate that any precious metals you purchase through your self-directed IRA be sent to your custodian's depository instead of to you. The IRS won't let you hold your own IRA assets.
Avoid any self-dealing or earning of indirect benefits. If you buy investments for your IRA that you or an immediate family member own, it's considered self-dealing. Using IRA funds to buy stock for yourself or to underwrite a mortgage for your granddaughter is also self-dealing. The IRS ban on indirect benefits prevents you from getting any use from your IRA investments. For instance, if you buy a vacation home as an IRA investment and stay in it, it would be considered an indirect benefit. Borrowing money from your IRA or having your IRA pay you for work that you do for its benefit is also an indirect benefit. All of these can invalidate your IRA.
Avoid buying prohibited investments. In addition to the limitations that come from the self-dealing and indirect-benefit rules, the IRS specially bans three types of investments -- stock in "S" corporations, life insurance policies and collectibles. The collectible ban applies not only to cars and wine, but also to coins that some precious-metals investors purchase.
Use leverage in your self-directed IRA carefully. If you earn money from debt in your IRA, it can be subject to the IRS' Unrelated Business Income Tax. For example, if you use leverage to buy a rental property and you make more money on it after paying the loan than you would have by buying a smaller property without a loan, you'll be subject to UBIT on the difference.
- The IRS' rules and regulations could change at any time, so it's always wise to confirm the self-directed IRA requirements that apply to you with your custodian or accountant.
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- Equity Trust Company: UBIT (Unrelated Business Income Tax)
- Equity Trust Company: Prohibited Transaction FAQs -- What Investments Are Not Allowed in my IRA?
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