Everything to Know About SDIRA Prohibited Transactions

What types of transactions are prohibited within an SDIRA?

When it comes to retirement planning, Self-Directed IRAs (SDIRAs) can be an attractive option for many investors. These accounts allow investors to take control of their retirement investments, allowing them to choose from a wide range of alternative investments that are not available through other IRAs.

Definition of a Self-Directed IRA

An IRA, or Individual Retirement Account, is a type of retirement savings plan that allows you to invest in various assets with tax-deferred growth. It is designed to help you save for retirement by allowing you to invest in stocks, bonds, mutual funds, and other investments.

There are four main types of IRAs:

• Traditional IRA: IRA holders make contributions to their Individual Retirement Account from their pre-taxed income
• Roth IRA: individuals make contributions from their post-tax savings
• SEP IRA: self-employed or freelancers
• SIMPLE IRA: similar to a 401(k) plan for small businesses

If you are a private equity or venture capital fund manager, you may be interested to know how to accept retirement money from your investors. With a Self-Directed IRA, you can invest in various alternative assets, including real estate. You can also invest in alts like private placements, limited partnerships, and notes.

But with this freedom comes responsibility. SDIRAs are governed by the same IRS rules and regulations as traditional IRAs, so it's essential to understand what types of transactions are prohibited within an SDIRA and to understand these restrictions before investing.

SDIRA restrictions

Here is an overview of the restrictions on investing through an SDIRA. A more detailed description of these restrictions is presented in the next section.

• You cannot engage in any transaction deemed self-dealing by the Internal Revenue Service (IRS).
• You cannot use the funds for personal benefit.
• You cannot purchase collectibles or artwork with your SDIRA funds.
• You cannot use the funds to purchase life insurance, alcoholic beverages, or tangible property.
• You must contribute to your SDIRA within a certain threshold.

Knowing what prohibited transactions can help ensure that your investments remain compliant with IRS regulations and help avoid costly penalties.

A detailed description of SDIRA-prohibited transactions

Here is a closer look at some of the most common prohibited transactions:

1. Transactions with Disqualified Persons:

A disqualified person is someone related to the IRA owner or who has some financial interest in the account. This includes spouses, parents, siblings, and children, the IRA owner's investment advisor, manager, or the IRA trustee or custodian.

It is also important to note that the IRA owner cannot transact through their SDIRA with any entities owned or controlled by the individuals listed above. In other words, no transaction can occur with an entity owned at 50% or more by a disqualified person.

2. Using Funds for Personal Benefit:

An SDIRA is meant for retirement savings, so using funds for immediate personal benefit is strictly prohibited. This includes using funds to purchase items for yourself or your family members, make payments on personal debts, or engage in any transaction that would benefit you personally rather than your retirement savings.

This also means you cannot buy a house or any real estate and then personally use it. You cannot lend money from the IRA to yourself and cannot pay IRA expenses or receive IRA income personally. Additionally, you cannot use your IRA as collateral to get a loan.

3. Prohibited Investments:

Certain types of investments are not allowed by the IRS within an SDIRA due to their high-risk nature or other factors.

• SDIRAS are not allowed to invest in collectibles which include:
  • Artworks
  • Rugs
  • Antiques
  • Metals
  • Gems
  • Stamps
  • Coins
  • Alcoholic beverages
  • Certain other tangible personal property

• Life insurance contracts: SDIRAs cannot invest in life insurance contracts.
• S corporation stock: SDIRAs are not allowed to invest in S corporation stock.
• Businesses that are not qualified: SDIRAs are only allowed to invest in qualified businesses under IRS rules.
• Certain real estate investments, such as flipping houses or raw land speculation, are prohibited investments through SDIRAs.

4. Excessive Contributions:

The IRS limits contributions to SDIRAs yearly based on income level and other factors. Exceeding these limits can result in severe penalties and even disqualification of the account if it is not corrected quickly enough.

An excess contribution is an amount contributed to your traditional IRAs for the year that is more than the smaller of:

• $6,000 ($7,000 if you are age 50 or older), or
• Your taxable compensation for the year.

However, if you catch it before your annual tax return is filed, you can contact your IRA custodian and make them aware of the situation. They will be able to assist you and provide the necessary paperwork for you to withdraw the excess contribution and any amount of earnings to bring your contribution back below your excess contribution threshold.

Sanctions in case of a non-respect of the SDIRA rules

If a person who owns an SDIRA or benefits from the SDIRA does something that is not allowed in connection with the SDIRA account during the year, then the account is no longer considered an IRA as of the first day of that year.

This means the account is treated as if it has distributed back all its assets to the IRA owner at their fair market value on the first day of the year. If the total value of these assets is more than the amount the IRA owner initially invested in the account, then the IRA owner will have to pay taxes on the difference and include it in their annual income.

Always consult an expert advisor when in doubt.

Understanding these rules and regulations is essential for anyone considering investing in an SDIRA since violations can lead to significant penalties from the IRS and disqualify the account itself.

As always, it's essential to consult with a qualified financial advisor before making any decisions about your retirement savings plan to ensure you're making the best decisions possible for your future financial security!

You can refer to the IRS website for the complete source of prohibited transactions.

FAQs

Who is eligible to open an SDIRA?

Anyone who meets the eligibility requirements for a traditional or Roth IRA (e.g., age and income limits) can open an SDIRA.

What types of investments can be made with an SDIRA?

SDIRAs can invest in a wide range of alternative assets, such as real estate, private businesses, precious metals, cryptocurrency, and more. However, some investments, such as collectibles, life insurance, and certain types of debt, are prohibited by law.

Are there any tax benefits to using an SDIRA?

Yes, SDIRAs offer the same tax benefits as traditional and Roth IRAs. This means that contributions to a traditional SDIRA may be tax-deductible and that withdrawals from a Roth SDIRA are tax-free. However, it's important to note that the tax treatment of SDIRA investments can vary depending on the type of asset and the specific tax rules that apply.

Can I use an SDIRA to invest in my own business?

No, you cannot use an SDIRA to invest in your own business, as it would most likely qualify as a prohibited transaction. However, you can have investors investing in your business through their SDIRA if they are not Disqualified, persons.

Can I use an SDIRA to invest in Real Estate?

Yes, you can use an SDIRA to invest in real estate, including rental properties, vacation homes, and raw land. However, you cannot use the SDIRA to buy a property that you or your family members will use personally (e.g., a vacation home or rental property that you will use for your own vacations).

Can I use an SDIRA to invest in cryptocurrency?

Yes, you can use an SDIRA to invest in cryptocurrencies like Bitcoin and Ethereum. However, you should be aware that investing in cryptocurrency carries additional risks, such as price volatility and the lack of regulatory oversight.

Can I use an SDIRA to invest in Private Equity?

It is possible to use a self-directed individual retirement account to invest in a private equity fund. Private equity funds are investment vehicles that invest in private companies, and they can be an option for individuals looking to diversify their investment portfolios.

However, there are some considerations to keep in mind when using an SDIRA to invest in a private equity fund. First, ensuring that the private equity fund is a qualified investment under IRS rules is vital. In general, private equity funds that meet the criteria for qualification will have a written partnership agreement and be managed by a professional investment manager.