What Assets Cannot Be Held in an IRA?
An Individual Retirement Account (IRA) allows you to invest your pre- and post-tax dollars in various assets; however, certain items are prohibited by tax laws.
Prohibited transactions include purchasing property that you are not allowed to use and lending funds to an “S” corporation – acts which could incur hefty tax bills in the future if violated.
Collectibles
IRS rules generally prohibit individual retirement accounts (IRAs) from investing directly in collectibles; however, self-directed IRAs may invest indirectly through funds which own collectibles. It is crucial for owners of IRAs to understand these regulations so as to avoid engaging in prohibited transactions or engaging in self-dealing practices.
One example of an illegal transaction would be renting property owned by your IRA to yourself or any direct relative, in violation of the exclusive benefit rule. Another is providing credit to disqualified people.
Thankfully, there are many other ways to circumvent prohibited transactions. An IRA can invest in real estate and private equity but transactions must be structured carefully to exclude disqualified persons from being involved. Thanks to Swanson vs Commissioner court case where an IRA was allowed to purchase initial stock from companies it had incorporated; this ruling has served as the foundation for many startup businesses across America and is considered the most significant case concerning IRA investments.
Real estate
If you own an investment property within an IRA, any use for personal gain is forbidden and subject to significant tax penalties. For instance, docking your boat on lakefront property owned by your IRA would constitute an unlawful transaction, or performing “sweat equity” activities like painting or cleaning cannot take place either.
Renting property to disqualified persons such as your spouse, children, parents and siblings – or fiduciaries such as an IRA custodian – is prohibited as well as borrowing against or lending money against it.
However, as long as you abide by the rules and avoid prohibited transactions, investing in real estate with your retirement account can be done successfully. Always consult a self directed IRA company that specializes in alternative investments to ensure all transactions and associated paperwork comply with compliance.
Investments
Congress created these regulations so IRA funds will be invested appropriately so they will be available for retirement. They also serve to prevent their use for anything else or for anyone other than account owners; any violation could constitute an illegal transaction and result in prosecution.
Typically speaking, investments that fall under the categories of collectibles, coins (other than Treasury Department-minted one-ounce gold and silver coins), art works, gems, rugs or stamps are prohibited from being held in an IRA; however they can still be purchased via a qualified custodian.
Capital investments in an S corporation cannot be completed using an IRA due to self-dealing and sweat equity regulations; however, an exception exists to this rule.
Loans to disqualified persons
Although most professionals believe that the Swanson decision permits IRAs to invest in entities initially capitalized by disqualified persons using personal funds without engaging in prohibited transactions, this doesn’t always work that way. If, for example, your IRA invests in a warehouse to be leased to another entity but at the time of purchase you own 50% of it, this may constitute engaging in an illegal transaction and should therefore be avoided.
Reason being, any investment made for the benefit of an IRA must only benefit that fund and cannot provide you with any direct or indirect gains (such as leasing the property back).
IRAs cannot purchase or sell property already owned by you or other disqualified parties such as spouses, lineal ascendants and descendants, related trusts and their related trusts. They also cannot buy or lend money to family members; or hire family members to perform services (such as maintenance on real estate properties) for them, while accepting compensation in return.
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