IRAs allow investors to diversify their investments across traditional and nontraditional assets, including real estate and private equity. However, certain restrictions must be kept in mind before investing.
Self-dealing rules pose the largest restriction, meaning you and other disqualified parties cannot personally benefit from transactions within an IRA or pension plan.
Unapproved Assets
Custodians of individual retirement accounts must abide by IRS guidelines which specify which assets an IRA may invest in. Following these rules is generally straightforward for traditional investments like stocks and bonds, while it can become more challenging when investing in alternative asset classes like real estate or collectibles.
Your IRA should never allow for self-dealing or the reaping of personal benefits from its property ownership, including making use of it as your primary residence, performing labor for example fixing a leaky toilet, or paying any non-eligible person to use the property.
No co-investing should take place with disqualified persons, including family, friends and third-party entities you own or work for. However, DOL advisory opinion 2010-10A allows certain transactions that go around these rules as long as certain conditions are fulfilled:
Loans from an IRA
IRS rules prevent your IRA from lending you personal funds (known as prohibited transactions) and using its assets for personal benefit; this is known as exclusive benefit rule. Your IRA should never engage in transactions that provide this exclusive benefit, including purchasing real estate or renting it out or borrowing against its assets.
Relying on an IRA to purchase real estate or startup equity via crowdfunding platforms is forbidden, as is loaning money or guaranteeing debt owed by it to someone. Borrowing against self-directed IRA values or taking advantage of 60-day rollover rule loopholes are examples of prohibited transactions that shouldn’t take place using an IRA.
Under IRS rules, your IRA cannot loan to anyone considered disqualified by law – this includes family members as well as your spouse. One exception exists whereby it borrows for no longer than 60 days per calendar year.
Selling Property to an IRA
Real estate can make an ideal addition to an IRA portfolio, but investors must remain mindful of any transactions the IRS considers prohibited when investing in property.
As an IRA is not intended as a vehicle for self-dealing, such activities as buying property within an IRA and renting it to yourself or family members is considered self-dealing. You also cannot sell property back to yourself, borrow from an IRA directly to yourself or pledge assets as security for outside debts.
Property management, renovation or construction services provided to an IRA-owned property cannot be used for personal purposes such as your children or spouse, which would constitute a prohibited transaction that could lead to its dissolution and result in severe taxes and penalties owed from you to the IRS – that’s why IRAs are called retirement accounts!
Buying Property for Personal Use
IRS rules stipulate that you cannot personally benefit from real estate held within an IRA or alternative asset classes, commonly referred to as the exclusive benefit rule. To prevent any issues, avoid purchasing property you plan on living in yourself, investing in life insurance policies on yourself directly and extending loans from your IRA directly while choosing more mainstream investments such as mutual funds and ETFs instead.
As an example, if you purchase rental property through your self-directed IRA and decide to use it as a vacation home or even just spend one night there for free, this breaches the exclusive benefit rule and creates a prohibited transaction. Furthermore, making improvements on property owned by your IRA – such as fixing leaky faucets or adding fencing – would violate this provision; however a PTE exemption (Exemption 80-26) from the Department of Labor allows limited circumstances whereby personal loans may be extended against said investment property.