Does the IRS Audit a Self-Directed IRA?
Self-directed Individual Retirement Accounts (SDIRAs) allow investors to invest in assets not typically available through traditional retirement accounts, such as real estate, private equity and collectibles. There are specific regulations you must abide by when investing in these types of assets.
One key rule regarding SDIRAs is their prohibition of self-dealing, which stipulates that any transactions undertaken via your SDIRA cannot generate personal benefits for yourself.
What is a Self-Directed IRA?
Self-directed IRAs are retirement accounts designed to allow investors to invest in assets beyond stocks and mutual funds, such as real estate (although there may be certain rules you must abide by), precious metals, secured promissory notes and tax liens.
Purchase of non-traditional assets can be done through a custodian that works exclusively with these investments; however, these custodians are legally prohibited from selling investment products, verifying legitimacy or providing investment advice.
As a result of these limitations, self-directed IRAs typically charge higher fees than traditional IRAs. You could also experience reduced liquidity due to limited financial information being made available about them; many alternative assets aren’t publicly traded either. Furthermore, sometimes custodians provide inaccurate valuations which lead to IRS audits resulting in potentially taxing earnings or capital gains that arises.
How is a Self-Directed IRA audited?
IRS rules outline exactly what can and cannot be done with a Self-Directed IRA account, so any violations could lead to large tax bills and financial penalties.
One of the rules surrounding an IRA is that its assets should not be used personally. That means you can’t buy a beach house with your IRA and then rent it out as part of an illegal transaction to friends or family; otherwise, the IRS would consider this a prohibited transaction and invalidate your entire IRA account.
Under IRS rules, it is forbidden to invest in collectibles, life insurance policies or real estate that you own yourself as this practice is known as self-dealing and cannot result in profiting from something in which you own or have control.
What are the penalties for a Self-Directed IRA audit?
Self-directed IRAs come with their own set of intricate tax rules that must be observed. Failing to do so could result in extra taxes, financial penalties and even loss of the account’s tax-deferred status.
Investors who utilize SDIRAs generally appreciate their potential for higher returns and diversifying their portfolios through investments not available via traditional retirement accounts, yet have certain reservations regarding them. However, investors also express reservations.
Concerns surrounding investments include lack of liquidity, fees and potential fraud. Signs that fraud might be occurring include completely new investment companies with no track record; unrealistically high return claims; or no third-party oversight.
Concerns surrounding prohibited transactions include heavy IRS fines and the possibility of account disqualification. Prohibited transactions could include purchasing real estate that you personally reside in, lending money to an IRA-owned entity, or conducting business with disqualified people (e.g. family).
What are the options for a Self-Directed IRA audit?
SDIRAs offer investors access to unique investment options not available through traditional retirement accounts, including real estate, promissory notes or tax liens that may provide higher returns than would otherwise be achievable with traditional or Roth IRAs. There are certain rules you must abide by with these accounts though; such as avoiding prohibited transactions and reporting the fair market value of investments annually.
Chase Insogna, president of InsognaCPA in Austin, Texas emphasizes the importance of working with a trusted financial adviser and constantly verifying account statements for alternative assets, particularly when investing in them. Such investments tend to be difficult and illiquid investments, leaving fraudsters the perfect opportunity to exploit unwary investors.
Prohibited transactions involve any activity that benefits either an IRA owner, beneficiary, or “disqualified person”, such as a fiduciary. Common examples of prohibited transactions include investing in rental properties owned by the IRA that will then be rented out to disqualified people; or providing equity or debt capital investment to companies owned by disqualified people.
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