I would like to take a minute and teach you what you have always wanted to know but were too afraid to ask about self-directed IRAs and prohibited transactions! A prohibited transaction is one that involves a transaction between a disqualified person and an IRA (including Traditional, Roth, SIMPLE, SEP and Coverdell ESA plans). I will cover the two parts of the prohibition-the disqualified person and the transaction.
Disqualified Person: A disqualified person includes you, the investor, and members of your family, including your spouse, lineal ancestors (for example, your parents and grandparents), and lineal descendants (for example, your children, grandchildren, including adoptive children, and their spouses).
If you own more than 50% of a corporation, partnership, trust, or estate directly or indirectly (includes ownership interests over which you have control), the entity is considered a disqualified person.
In addition, any officer, director or shareholder (with more than 10% ownership interest) or highly compensated employee of the entity, where you control 50% or more of that entity, would be considered a disqualified person. Non-lineal relatives-brothers, sisters, aunts and uncles-are not disqualified persons.
Transactions Disallowed: Your IRA cannot have any business with or make an investment involving the disqualified persons mentioned above.
For example, you cannot make an investment in or loan money to the company where you are a 50% or more, owner. You may not provide benefits to any disqualified person. For example, the IRA may not pay excessive salaries to disqualified family members from within your LLC. You may not use the IRA assets for personal benefit, such as living in a house owned by the IRA. You cannot use IRA funds to invest in a property located next to another you own, for the purpose of increasing the value of the first property.
You are not allowed to borrow money from your IRA, or pledge, or assign your IRA to another person or company. You cannot purchase life insurance with your IRA. You cannot invest in collectibles (art works, rugs, antiques, most metals, gems, stamps, most coins, and alcoholic beverages).
The Good, the Bad, and the Penalties: If the IRS finds that your IRA has participated in a prohibited transaction, the IRA stops being an IRA on the first day of the year that the transaction occurred. This means that it is considered a distribution and you will have to pay taxes based on the fair market value of the account. If someone other than you, the owner, caused the prohibited transaction, additional excise taxes may also be imposed.
If you think a transaction may be a prohibited one, do not do it. Check with your legal or tax advisor if you need a specific transaction reviewed. Again, it is always important to stay above board when it comes to investing, and investing your IRA in Real Estate using a self-directed IRA can guarantee you a great return and a strong addition to any retirement portfolio.
Paul R. Whitacre is a managing partner at WealthyIRA.com. Our vision is to teach others to invest their IRAs and 401(k)s in the deepest discounted Real Estate in decades. Check out more at our http://www.WealthyIRA.com blog and follow us on Twitter at http://www.Twitter.com/WealthyIRA
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