Prohibited Asset Types
IRS regulations prohibit IRA investments in
life insurance and in collectibles such as
artwork,
rugs,
antiques,
metals (there are exceptions for certain kinds of bullion),
gems,
stamps,
coins (there are exceptions for certain coins minted by the U.S. Treasury),
alcoholic beverages, and certain other
tangible personal property.
Prohibited Transactions
IRS regulations prohibit transactions that are an improper use of the value in the account or annuity by the account owner, the account owner's beneficiary, or any other disqualified person. These rules are generally designed to prevent
self-dealing. Disqualified persons include your fiduciary and members of your family, such as your spouse, ancestor, lineal descendant (e.g. children), and any spouse of a lineal descendant). In addition, other disqualified persons include:
- Service providers of the IRA (e.g., custodian, CPA, financial planner);
- An entity (such as a corporation, partnership, limited liability company, trust or estate) of which 50% or more is owned directly or indirectly or held by a fiduciary or service provider;
- An entity that is a 10% or more partner or joint venturer of with an entity that is 50% or more owned directly or indirectly or held by a fiduciary or service provider;
- Additionally, in the case of a SEP or SIMPLE IRA:
- The Employer;
- 50% or more owner of the Employer;
- Officers, directors, 10% or more shareholders, and highly compensated employees of the Employer;
- An entity 50% or more owned by the Employer;
- 10% or more partner or joint venturer of the Employer.
The following are prohibited transactions with an IRA:
- Borrowing money from it.
- Selling property to it.
- Receiving unreasonable compensation for managing it.
- Using it as security for a loan.
- Buying property for personal use (present or future) with IRA funds.
If the account owner or beneficiary engaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market values on the first day of the year in which the transaction occurred. The distribution would be subject to any taxes or penalties associated with an early distribution. Generally, a 10% early withdrawal penalty and treatment of the distribution as ordinary income for the purposes of income taxes.
Examples of self-dealing include:
- Having your IRA purchase real estate that you own or use.
- Issuing a mortgage on a relative’s new residence purchased by a family member who is a disqualified person as listed above.
- Granting a child a second mortgage for the down payment on his or her first home.
- Buying stock from the account owner involving IRA funds and a disqualified person.
- Purchasing stock in a closely held corporation in which the account owner has a controlling equity position.
- Purchasing restricted stock from a family member who is a disqualified person listed above.
Common Permitted Investments
Some of the additional investment options permitted under the regulations include
real estate,
stocks,
mortgages,
franchises,
partnerships,
private equity and
tax liens. Real estate may include residential and commercial properties (U.S. & Internationally), farmland, raw land, new construction, property renovation, development, and passive rental income. Real estate purchased in a self-directed IRA can have a mortgage placed against the property, thus lowering the amount of total cash needed for a purchase; however, neither the IRA nor the account owner of the IRA can have personal liability on the mortgage. Business investments may include partnerships, joint ventures, and private stock. This can be a platform to fund a start-up business or other for-profit venture that is managed by someone other than the account owner of the IRA. Other alternative investments include: commodities, hedge funds, commercial paper, foreign stock, royalty rights, equipment & leases, American depository receipts, and U.S. T-bill
Limited liability company structured IRA
In an effort to reduce fees, paperwork, and processing delays, some self-directed IRA investors choose to employ a
Limited Liability Company (LLC) IRA structure. In such a structure the account holder directs his IRA custodian to invest into a limited liability company that the account owner manages himself. The account owner can then execute transactions on the LLC level without the involvement of the IRA custodian, thus reducing fees and eliminating custodian transactional fees and delays. The profits of the LLC pass through to the IRA with nearly identical tax favorable treatment. Some claim that this IRA LLC strategy has been legitimized through a tax court case: Swanson v. Commissioner, 106 T.C. 76 (1996). Others disagree on the validity of the court case.
[1] Some refer to this structure as "checkbook control" because the IRA account holder often has sole signing authority for the LLC and its bank accounts.
Although Swanson v. Commissioner doesn't directly relate to a single member IRA LLC, but instead merely sets a precedence that an individual can control an entity owned by an IRA or IRAs that they are a disqualified person to, there are other cases, private letter rulings and IRS Memorandums that collaborate the validity of the IRA LLC and Checkbook Control over an IRA. To quote a few:
Ancira v. Commissioner 119 T.C. No. 6 (2002)- Ancira acted as a conduit for her self directed IRA custodian
DOL Advisory Opinions 97-23A and 2005-03A - The Department of Labor takes the position that if an asset is owned 100% by a plan, that asset becomes the plan
IRS Field Service Advice 200128011 - IRS Confirms: "The type of investment that may be held in an IRA is limited only with respect to insurance contracts, under section 408(a)(3), and with respect to certain collectibles, under section 408(m)(1").
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