Investors with Individual Retirement Accounts have many choices available to them, from Wall Street stocks and bonds to gold coins, real estate investments and derivatives. But certain investments cannot be held within an IRA due to IRS restrictions.
Engaging in prohibited transactions may incur account penalties; here are five of the most prevalent.
Collectibles
The IRS imposes stringent rules regarding what can and cannot be invested in an IRA, such as life insurance policies, collectibles and certain precious metals. They also prohibit certain derivative trades with unlimited risk and ratio spreads.
Your IRA cannot lend money directly to yourself or any disqualified persons; these include spouses, children and grandchildren as well as parents, grandparents and in-laws. Furthermore, lending money to businesses generating unrelated business taxable income (UBTI) would cause its tax-exempt status to be lost.
However, an IRA may co-invest in limited partnerships according to ERISA Opinion 2000-10A. When seeking alternative assets such as real estate and precious metals investments for your IRA account, finding a custodian who supports and charges higher fees is vital – many traditional trustees aren’t capable of supporting this service while there are custodians that specialize in these specific investments.
Real estate
Holding nontraditional assets in an IRA triggers complex rules regarding prohibited transactions and unrelated business income tax, potentially leading to disqualification and assets becoming taxable as well as early withdrawal penalties.
Real estate investment with an IRA presents some serious restrictions that should be kept in mind, including not being able to live there and incurring costs related to repairs and upgrades from outside sources, rather than your IRA itself paying the expenses.
Additionally, when dealing with real property in your IRA account directly, a custodian that specializes in self-directed IRAs should handle the necessary paperwork and IRS reporting for this transaction. Furthermore, you cannot finance it using funds from your IRA account and must refrain from lending money to disqualified people such as your spouse, lineal ascendants/descendants, their respective spouses and anyone who might cause severe IRS penalties – those transactions are prohibited transactions that must not take place unless properly documented with all necessary forms and documents being completed accurately by them before proceeding further with this action.
Insurance
IRAs and other retirement accounts must adhere to strict investment rules in order to remain tax-exempt, with any transactions that don’t comply with the Internal Revenue Code considered unlawful transactions and subject to penalties of up to 50% of its value or an early withdrawal penalty of 10% from the IRS.
CPAs should familiarize themselves with the types of investments allowed within an IRA so they can provide adequate advice to clients. Investors should generally focus on Wall Street investments such as stocks, mutual funds and bonds that adhere to purity standards – rather than collectibles such as collectibles or real estate or precious metals that do not.
Other popular IRA investment options include rental property, startup equity and foreign investments. Before making their decisions on any investments they plan to put their IRA savings towards, investors should carefully research each asset being considered for an IRA investment account. Traditional trustees may not be willing to act as trustees for nontraditional assets so the account owner must find an independent trustee who will manage these investments on his or her behalf.
Investments with disqualified persons
The rules governing an IRA investment stipulate that you and other disqualified parties cannot engage in self-dealing with funds in your retirement account. This means you cannot invest in your own rental property, buy a house that you will reside in as part of the “personal residence exception”, invest in yourself or buy stock in companies you work for; nor can they co-invest with parties related to the IRA and control decisions related to it (for instance negotiating equipment purchases or loan extensions), nor receive fees in return.
If you violate these rules, the IRS treats it as an unlawful transaction and imposes severe penalties. Therefore, it’s advisable to consult a knowledgeable Self-Directed IRA expert prior to investing in unconventional assets; risks can be substantial; even one misstep could cost thousands in taxes and penalties.
