The First Golden Rule of Investing with Self-Directed IRAs: Avoid Disqualified Persons

Investors who understand and follow rules that govern IRAs have one thing in common: They rarely get in trouble with the IRS. 

Why?

Because compliance with the IRS keeps all retirement accounts, including self-directed IRAs, in good standing. Failing to do so can cause heavy penalties, taxation, and even disqualification of IRAs. And, no one wants that. Those who follow the rules have nothing to fear.self directed IRA disqualified persons

The two golden rules that govern IRAs:

  1. Avoid disqualified persons and,
  2. Beware of prohibited transactions

If you use a self-directed IRA, you must personally understand these rules to achieve success in controlling your retirement account. The two rules cover various restrictions applicable to all retirement plans (self-directed or not) that must be avoided when investing with retirement funds. Each rule has significant bearings on the other—because if you commit a prohibited transaction with a disqualified person, you’re looking for trouble from the IRS.

Advanta IRA understands these rules can be complex in some areas. So, we are going to break them down for you in a series of two articles. This article explains the first golden rule: Your IRA may not conduct business with disqualified persons.

But first, a short explanation for those wondering, “What is a self-directed IRA?

Self-Directed IRAs Give You Great Freedom to Invest in What You Know Best 

Self-directed retirement plans offer almost endless possibilities for you if you want control over how your account grows wealth. When you self-direct, you do not rely on a retirement plan custodian or investment broker to make decisions for you. Instead, you choose assets you personally know and understand. And, you aren’t stuck with the ordinary choices of stocks, bonds, and mutual funds, either.

You can invest in a totally different class of assets called alternative investments. That’s the reason people choose to self-direct IRAs—to gain the freedom and flexibility to choose assets they believe have the potential to grow income at a faster pace than traditional investments do.

Every day, more people are discovering they can invest in real estate, mortgages and notes, tax liens and certificates, LLCs & LLPs, oil and gas options, timberland, checkbook IRAs, and much more.

The list of alternative investments is so extensive that the IRS doesn’t have one. Instead, they list the few things not permissible  in these plans: life insurance contracts and collectibles. Other than that, your IRA can invest in just about any asset imaginable

Great responsibility comes with the freedom of choosing your own investments.

The freedom of choosing your own assets is exhilarating. You get to put your own expertise to work for you in building retirement wealth. But, that freedom comes with the responsibility of fully understanding the regulations that govern investing with retirement funds.

And, here’s that first golden rule we mentioned:

Your IRA May Not Conduct Business with Disqualified Persons

The IRA owner must ensure the plan does not perform transactions with the following persons or entities. These people are deemed disqualified persons by the IRS and as such are prohibited from doing business with your plan.

  • The IRA holder (you)
  • The IRA holder’s spouse
  • The IRA holder’s lineal descendants and their spouses (children, grandchildren etc.)
  • The IRA holder’s lineal ascendants (parent, grandparent etc.)
  • Investment advisors and managers
  • Those providing services to the IRA
  • Any corporation, trust, partnership, or estate where the disqualified person has 50 percent or more interest

This means your IRA can’t purchase an investment from your mom. You can’t sell property you already own to your IRA. And, your IRA can’t extend private mortgages to your kids or anyone else on this list. These are a few examples prohibited transactions, which are covered in detail in part two of our golden rules for IRAs articles (coming soon). 

For now, concentrate on familiarizing yourself with disqualified persons in your life that are prohibited from dealing with your IRA. Know exactly who these people and/or entities are minimalizes mistakes you might make in your self-directed IRA.

If you have any questions about this article, please feel free to contact Advanta IRA. We don’t give investing advice or sell investments, but we are able to fully educate you on disqualified persons and prohibited transactions.