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It’s important that as you approach investing in real estate or lending money that you understand the basic foundational principles of using a self-directed IRA to invest in real estate.

So let’s start with some of the basics:
1. If you own property now personally, or if you own that property in an LLC or corporation or other entity, your IRA cannot buy that property from yourself personally.
2. You cannot take your IRA money and loan it to yourself personally or a business entity that you’re affiliated with. That would also be considered a prohibited transaction.
3. You cannot buy a property or borrow from certain other family members IRAs.

For instance, let’s say your mother or father had a healthily funded IRA or 401k and you wanted them to loan money to you or a business entity that you’re affiliated with and go out and flip properties or buy rentals, that would be considered a prohibited transaction. You also couldn’t buy a property using your IRA money and then lease it to your son or daughter or parents or spouse or yourself personally, that would also be considered a prohibited transaction.

Any of the tax advantage investment accounts that we talk about, follow the same rules associated with disqualified persons and prohibited transactions. You need to understand who disqualified persons are to your IRA or self-directed account, what transactions and how to define those transactions, what transactions will result in a prohibited transaction.

And if your IRA engages in a prohibited transaction, the IRA will cease to exist January one in the year in which that first prohibited transaction occurred, so that IRA would become distributed, the assets would be distributed, you’d have taxes, penalties, and potentially you’d have to amend additional tax returns.

For more info: Internal Revenue Code 4975.

Who are disqualified persons to your IRA? Well, the way 4975 displays this is lineal ascendants, lineal descendants, any fiduciary, which could be a financial adviser and of course should be you to your IRA, spouses, spouses of lineal descendants, and then there’s also something that is referred to as the 50% entity rule.

The idea is and the best way to understand this, the rule of thumb is anyone up and down the family tree is considered a disqualified person to your IRA. And then of course your spouse and then you. So going back to the first segment, if you own property personally, your IRA can’t buy that property from yourself. You can’t take money from your IRA and loan money to your own business entity, going back to this 50% entity rule. Then you have to ask yourself, is there a transaction occurring within the self-directed IRA between a disqualified person in the plan?

The purchase sale, lease or exchange of any asset between the plan and a disqualified person. So, if you own a property personally, your IRA can’t buy it from yourself.

You can’t take your IRA money and make a loan to yourself personally or a business that you own or are affiliated with. Extension of credit. This is why if your IRA borrows money to buy a property or your IRA’s encumbered by debt, it has to be a non-recourse loan, which will state the lender is agreeing to that in the event of a default, the recourse is only against the subject property.

In other words, you personally cannot guarantee that debt and most conventional lenders when loaning money to you are going to ask for a personal guarantee, but if your IRA is borrowing the money, your IRA and you personally cannot sign a personal guarantee, it would be considered a 4975 prohibited transaction.

Next, the furnishing of goods, services, and facilities between the plan and a disqualified person. This means using it in the context of a rule of thumb, you can do the desk work on your IRA on rentals or IRA on a fix and flip transactions, but you can’t do the sweat equity, meaning the physical work.

Lastly, the transfer to or use by or for the benefit of a disqualified person of the income or assets to the plan. This is also known as the personal benefit rule.

To give you an example of this, let’s say you owned a vacation rental and you wanted to stay there a few days out of the year, that would be considered a personal benefit and therefore a prohibited transaction.

Equity Trust Company is a directed custodian and does not provide tax, legal or investment advice. Any information communicated by Equity Trust is for educational purposes only, and should not be construed as tax, legal or investment advice. Whenever making an investment decision, please consult with your tax attorney or financial professional to determine whether an investment product, plan or strategy is right for you. Investing involves risk, including possible loss of principal…(read more)

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