The Internal Revenue Code does not describe what a Self Directed IRA can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain type of transactions. The purpose of these rules is to encourage the use of IRAs for accumulation of retirement savings and to prohibit those in control of IRAs from taking advantage of the tax benefits for their personal account.

Who is a “Disqualified Person”?

The IRS has restricted certain transactions between the IRA and a “disqualified person”. The rationale behind these rules was a congressional assumption that certain transactions between certain parties are inherently suspicious and should be disallowed.

The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest. In essence, under Code Section 4975, a “Disqualified Person” means:

• A fiduciary (e.g., the IRA holder, participant, or person having authority over making IRA investments),
• A person providing services to the plan (e.g., the trustee or custodian),
• An employer, any of whose employees are covered by the plan (this generally is not applicable to IRAs but dos include the owner of a business that establishes a qualified retirement plan),
• An employee organization any of whose members are covered by the Plan,
• A 50 percent owner of C or D above,
• A family member of A, B, C, or D above (family members include the fiduciary’s spouse, parents, grandparents, children, grandchildren, spouses of the fiduciary’s children and grandchildren (but not parents-in-law),
• An entity (corporation, partnership, trust or estate) owned or controlled more than 50 percent by A, B, C, D, or E. Whether an entity is a disqualified person is determined by considering the indirect stockholdings/interest which would be taken into account under Code Sec. 267(c), except that members of a fiduciary’s family are the family members under Code Sec. 4975(e)(6) (lineal descendants) for purposes of determining disqualified persons.
• A 10 percent owner, officer, director, or highly compensated employee of C, D, E, or G,
• A 10 percent or more partner or joint venturer of a person described in C, D, E, or G.

Note: brothers, sisters, aunts, uncles, cousins, step-brothers, step-sisters, and friends are NOT treated as “Disqualified Persons”.

Prohibited Transactions

Pursuant to Internal Revenue Code Section 4975, an IRA is prohibited from engaging in certain types of transactions. The types of prohibited transactions can be best understood by dividing them into three categories: Direct Prohibited Transactions, Self-Dealing Prohibited Transactions, and Conflict of Interest Prohibited Transactions.

Direct Prohibited Transactions

Subject to the exemptions under Internal Revenue Code Section 4975(d), a “Direct Prohibited Transaction” generally involves one of the following:

4975(c)(1)(A): The direct or indirect Sale, exchange, or leasing of property between an IRA and a “disqualified person”

Example: 1: Steve sells an interest in a piece of property owned by his IRA to his son

Example 2: Jane leases real estate owned by her IRA to her daughter

Example 3: Ted uses his IRA funds to purchase an LLC interest owned by his father

4975(c)(1)(B): The direct or indirect lending of money or other extension of credit between an IRA and a “disqualified person”

Example 1: Mark lends his wife $50,000 from his IRA

Example 2: Lisa personally guarantees a bank loan to her IRA

Example 3: Ben uses IRA funds to lend an entity owned and controlled by his mother $35,000

4975(c)(1)(C): The direct or indirect furnishing of goods, services, or facilities between an IRA and a “disqualified person”

Example 1: Steve buys a piece of property with his IRA funds and hires his son to work on the property

Example 2: Kelly buys a condo with her IRA funds and personally fixes it up

Example 3: Jane owns an apartment building with her IRA and hires her mother to manage the property.

Indirect Prohibited Transactions

4975(c)(1)(D): The direct or indirect transfer to a “disqualified person” of income or assets of an IRA

Example 1: Ryan is in a financial jam and takes $5,000 from his IRA to pay his rent

Example 2: Dan uses his IRA to purchase a rental property and hires his friend to manage the property. The friend then enters into a contract with Dan and transfers those funds back to Dan

Example 3: Melissa invests in a real estate fund and then receives a salary for managing the fund.

Self-Dealing Prohibited Transactions

Subject to the exemptions under Internal Revenue Code Section 4975(d), a “Self-Dealing Prohibited Transaction” generally involves one of the following:

4975(c)(1)(E): The direct or indirect act by a “Disqualified Person” who is a fiduciary whereby he/she deals with income or assets of the IRA in his/her own interest or for his/her own account

Example 1: Karen who is a real estate agent uses her IRA funds to buy a piece of property and earns a commission from the sale

Example 2: Rick wants to buy a piece of property for $90,000 and would like to own the property personally but does not have sufficient funds. As a result, Rick uses $60,000 from in his IRA and $30,000 personally to make the investment.

Example 3: Jen uses her IRA to funds to invest in a real estate fund managed by her father. Jen’s father receives a bonus for securing Jen’s investment.

Conflict of Interest Prohibited Transactions

Subject to the exemptions under Internal Revenue Code Section 4975(d), a “Conflict of Interest Prohibited Transaction” generally involves one of the following:

4975(c)(i)(F): Receipt of any consideration by a “Disqualified Person” who is a fiduciary for his/her own account from any party dealing with the IRA in connection with a transaction involving income or assets of the IRA.

Example 1: Ted uses his IRA funds to loan money to a company in which he manages and controls but owns a small ownership interest in

Example 2: Rachel uses her IRA to lend money to a business that she works for in order to secure a promotion

Example 3: Anthony uses his IRA funds to invest in a fund that he manages and where his management fee is based on the total value of the fund’s assets.

Statutory Exemptions

Under Internal Revenue Code Section 4975(d), Congress created certain statutory exemptions from the prohibited transaction rules outlined under Internal Revenue Code Section 4975(c). For these certain transaction, Congress believed there is a legitimate reason to permit them. For these transactions, Congress has issued a blanket statutory exemptions permitting these transactions assuming that certain requirements specified are satisfied.

Below is a list of some of the statutory exemptions found in Internal Revenue Code Section 4975(d) that apply to IRAs:

• Any contract with a disqualified person for office space, legal, accounting or other services necessary for the operation of the IRA as long as reasonable compensation is paid. Note – this exemption does not apply to an IRA fiduciary (the IRA holder) as per Treasury Regulation Section 54.4975-6(a)(5).
• The provision of ancillary services to an IRA by a bank trustee
• Receipt by a disqualified person of any benefit to which he may be entitled as a participant or beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries;
• Life Insurance and Certain Collectibles

In general, a Self-Directed IRA Real Estate cannot Invest in life insurance contracts or collectibles defined below:

• Any work of art
• Any metal or gem
• Any alcoholic beverage
• Any rug or antique
• Any stamp
• Most coins

Types of Collectibles That may be Purchased Using IRA Funds

• one, one-half, one-quarter or one-tenth ounce U.S. gold coins (American Gold Eagle coins are the only gold coins specifically approved for IRAs. Other gold coins, to be eligible as IRA investments, must be at least .995 fine (99.5% pure);
• one ounce silver coins minted by the Treasury Department;
• any coin issued under the laws of any state;
• a platinum coin described in 31 USCS 5112(k) ; and
• gold, silver, platinum or palladium bullion (other than bullion that is made into a coin) of a certain fineness that is in the physical possession of a trustee that meets the requirements for IRA trustees under Code Sec. 408(a).

S Corporation Stock

Because of the shareholder restrictions imposed on “S” Corporations, an IRA cannot own stock in an S Corporation.

Note: an IRA can own stock in a “C” Corporation.

For additional information on the advantages of using a Self-Directed IRA with “checkbook control” to make investments, please contact one of our IRA Experts at 800-472-0646.

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