Self-Direction Part 3 of 4



Previously, we discussed retirement accounts in general and how to turn them into self-directed accounts. Once you’ve gone that far, you’re ready to invest. You can use those funds in the exact same way you’d use your personal cash to do any deal. There really is no limit to the kinds of investments you can make. However, “how” you make those investments IS a big deal and can get you into trouble.

NOTE: Self-direction is an advanced real estate investing technique with a lot of nuances. This blog is meant as general information and not legal, tax or investing advice. You will certainly need more education and advice to truly understand this amazing technique.

If you do what is called a “prohibited transaction” you could face the possibility of incurring penalties, which for an IRA could be add up to the entire amount of your IRA. So this is a very important topic. And not one that can fully be explained in a short blog. This is meant to bring your attention to the issue. I always recommend seeking legal counsel if you are unsure about a certain investment.

At it’s core, the IRS does not want you to unlawfully make a contribution to or take a distribution from your retirement account. There are rules about making contributions and taking distributions. So, if you do something that does, or even looks like you are “benefiting” your retirement account or your retirement account is “benefiting” you, then there’s probably a prohibited transaction.

For example, if you’re a real estate agent and act as such on a property that your IRA is buying, and you receive a commission on that sale, you just benefited from something your IRA did. That’s a prohibited transaction.

If you do the remodel work on a flip project that your IRA owns, your IRA in benefiting from your work. It received something of value from you. And if you were paid, you just received something of value from your IRA. Those are also prohibited transactions.

The IRS takes a BROAD view of the word “benefit.” Money, and even services, do not have to change hands. And not only does it apply to you, but it also applies to your spouse, your parents, your grandparents, etc., your children and their spouses, your grandchildren and their spouses and etc. It can also apply to businesses that you own or manage, or other people who might be a fiduciary of you. So, there are a number of persons and entities that your retirement account cannot benefit from or provide a benefit to. These are all “DISQUALIFIED” persons or entities that cannot, in any real way, interact with your retirement account. I refer to them as DQs.

A general rule of thumb (that should be discussed with legal counsel if it’s questionable) is that you (or any prohibited person/entity) can only be the brains and not the brawn when dealing with your retirement account. You can make decisions about what investments to make or who to hire. But you cannot put in any real work. Again, this is good starting point for guidance, not an IRS rule. In fact, the IRS hasn’t really said a lot about prohibited transactions. In fact, the only guidance is the following types of transactions your retirement account cannot do with a DQ.

  1. Buying from or selling to
  2. Lending to or borrowing from
  3. Furnishing goods or services
  4. Transfer, use or benefit from any retirement account asset (you can’t even spend the night in a rental owned by your IRA)
  5. Receive consideration (like a commission) from a transaction involving your retirement account
  6. Fiduciaries (like CFPs, CPAs, attorneys, etc.) cannot benefit or provide benefits

There are a number of other ways to engage in a prohibited transaction. But if you understand the generalities above, you’re at least familiar with the certain things you cannot do. For everything else, consult legal counsel. You don’t want to lose your money! And it is REALLY easy to avoid all of this and sleep well at night. But when you start thinking of ways to get around these rules, that’s when you’re going to run into problems. And trust me, the IRS knows every game in the book. They will catch you.

In the next blog we’ll discuss the UBIT tax.

Jeffrey S. Breglio, Esq.
Breglio Law Office and REI Mastery U
(801) 560-2180


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