Prohibited Transactions and Investments in IRAs

By Dr. James M. Dahle, Founder of WCI

With an explosion of interest in alternative investments (for better or for worse), it seemed useful to lay out the actual rules about what you can and can’t do with an IRA. As you dive into this world, you’ll find that many retirement plan providers, whether 401(k) plans or IRAs, have significant additional limitations beyond what the IRS actually allows. . This is often to reduce their hassle, reduce their costs and make more money.

For example, if you go to a bank and open an IRA, you may only be allowed to invest in their overvalued actively managed funds in that IRA. Many 401(k)s will not allow you to make Roth contributions or Mega Backdoor Roth IRA contributions or accept IRA rollovers even if the IRS allows it.

So if you want to invest in something or do something unique with an IRA, your first step should be to see if your desired stock/investment is actually prohibited by the IRS, and if not. , look around until you find an IRA provider willing to let go. Naturally, many of these types of things probably shouldn’t be done in the first place, especially if the added costs involved are particularly high. And often it’s just easier to do them using a taxable investment account.

But if all or most of your money is in retirement accounts, it may be worth trying to invest in these alternative investments using your retirement money.

We’re going to go through two lists today — a prohibited investment list and a prohibited transaction list.

Prohibited investments in an IRA

These are investments that cannot be purchased by an IRA.

#1 Life Insurance

You cannot put life insurance in an IRA. You can, however, put it in a 401(k) if the amount is “ancillary amount”. Basically, the premium cannot exceed 50% of the annual employer contribution for a whole life insurance policy or 25% if it is a universal or variable life insurance policy.

#2 Collectibles

Collectibles are also specifically prohibited. This includes art, antiques, furniture, china, liquor (wine), stamps, baseball cards, comic books, Beanie Babies and similar investments.

#3 pieces

Generally, you cannot own physical gold coins in an IRA. There are, however, exceptions to this. Basically, the idea is that if the coin is of very pure quality and not considered a collector’s item, you can invest in it. American Eagle coins are therefore allowed, but not Krugerrands. Basically, the coins should be currency and not collectibles.

#4 Options

You also generally cannot invest in options or derivatives. Technically, only unlimited risk derivatives are prohibited. So you can still invest in covered calls, but not naked call writing.

#5 Personal real estate

You can own real estate in an IRA, but you cannot use it. You cannot put your house or vacation home there. All real estate expenses must go out of the IRA, and all income must go into the IRA. Your IRA cannot buy real estate from you or your family, nor can it sell it to you or your family.

Aside from these restrictions, everything else goes into an IRA if you can find a custodian willing to deal with the hassle and if you’re willing to pay the costs associated with making it happen. This includes investment real estate, cryptocurrencies like Bitcoin, gold ETFs, private companies, hedge funds, oil and gas investments, limited partnerships, and tax lien certificates, in addition to more traditional investments like stocks, bonds, mutual funds, ETFs and CDs. .

Keep in mind that I do not recommend investing in most of these alternative investments at all. i’m just telling you could invest in it if you want. If you’re interested in a self-directed IRA (or 401(k)) that allows you to invest in these types of assets, take a look at our recommended retirement plan providers.

Unrelated business income tax

Charities and other tax-exempt entities (such as IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs) are subject to unrelated business income tax (UBIT). If your IRA invests in a business such as a Master Limited Partnership (MLP) or Limited Partnership (LP), the income from that business will be subject to tax at the corporation tax rate (21% as of December 2021), even if the partner is an IRA. Dividends and interest are generally excluded, but income that appears on a K-1 generally is not. These investments are generally best held in a taxable account.

IRA investors usually get tripped up when investing in real estate. If you invest in a private real estate debt fund or similar, this income is correct since it is interest. But if you invest in a stock syndication or a fund, it becomes a bit more interesting. If the property is financed by debt, only the part of the income attributable to the debt is subject to UBIT. If the property is paid for, it doesn’t matter. If 100% funded, all income over $1,000 is subject to 21% tax. This tax is paid by the IRA — not the IRA owner — and the IRA actually has to make estimated quarterly tax payments if the income is over $1,500.

So while leveraged real estate, small business, and energy MLPs aren’t technically prohibited IRA investments, it’s really not a good idea to have them in your IRA. Do yourself a favor if you really want these investments: put them in a taxable account. You would avoid these hassles and you could also take advantage of the depreciation-related tax breaks that these investments are eligible for.

Prohibited Transactions in an IRA

In addition to prohibited investments, there are also prohibited transactions.

#1 Borrow from the IRA

Unlike a 401(k), you cannot borrow from an IRA at all. A 401(k) will allow you to borrow the lesser of $50,000 or 50% of the account value. Sometimes this amount can be temporarily waived. In 2020, for example, you could borrow $100,000 or 100% of the account value. You can borrow the money for the shorter of five years or until tax day next year. But that’s not an option with an IRA. You can make a withdrawal, but you cannot get a loan.

transactions prohibited investments in ira

#2 Borrow against an IRA

Unlike cash value life insurance, your home, or your car, you can’t pledge an IRA as collateral for a loan.

#3 Buy and sell personal property

As mentioned earlier, your IRA cannot buy your property or that of your family members (and family member is defined broadly enough to include the spouses of your children and even your great-grandparents). You also cannot sell property to yourself or your family members.

#4 You rent a property

You and your family members cannot use IRA-owned property, even if you pay IRA rent for it. So if you bought a building with IRA money, you couldn’t turn around and hire your child as the resident manager of the property.

The penalty for any of these prohibited transactions in an IRA is quite severe. Basically, the following January 1 after you do so, the account ceases to be an IRA. It is considered 100% distributed and you will owe a 10% penalty on all of it. And if it’s a traditional IRA, the entire IRA will be taxable that year. The penalty for prohibited investments is not as severe, but it comes close. The amount placed in the prohibited investment is considered to be distributed from the account.

The theme here is clear. There are a lot of investments you can put into an IRA that you maybe shouldn’t, and there are a lot of investments you can put in an IRA that you maybe shouldn’t. But if you know and follow the rules, you shouldn’t have too much trouble using the money in the retirement account for alternative investments.

What do you think? Do you use the money in the retirement account for alternative investments? Why or why not? If so, how? Comments below!

About Charles D. Goolsby

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