Your self-directed retirement plan – whether an IRA, Roth IRA, 401(k), or other self-directed account – is open to a wide array of investment possibilities beyond traditional stocks, bonds, and mutual funds. Potential investment options include real estate, rental properties, fix-and-flips, wholesaling, mortgage notes, private companies, cryptocurrency, oil, gas, gold, silver, and much more.
Hearing this, investors often ask, “With all the possibilities, what investments are not allowed in an IRA or retirement account? Is X, Y, or Z investment acceptable?”
The Internal Revenue Code and the IRS guidelines regarding investments in an IRA or other retirement account are exclusive rather than inclusive: we’re only told what we cannot invest in, not what we can invest in.
There’s a variety of investment options you can pursue and just a few options that are deemed not permitted. Here are five types of investments that the IRS says are not allowed in a retirement account.
What Your IRA Cannot Invest In
1. Collectibles
Your IRA cannot invest in collectibles. That includes artwork, stamps, rugs, automobiles, alcohol, certain metals, and other items.
If you invest in an asset or otherwise use your IRA in a way that’s not allowed, it’s called a prohibited transaction. According to IRS guidelines, if your IRA engages in a prohibited transaction, your IRA ceases to exist. It becomes distributed, and you may have to pay taxes and penalties upon the distribution.
2. Loan to yourself or other disqualified persons
You cannot loan money to yourself or your business. For example, if you’re a real estate investor and you have an LLC or S-Corp, and you want your IRA to loan money to your business, that would be considered a prohibited transaction.
There are other people that your IRA cannot lend to beyond yourself. Your IRA cannot lend to anyone that’s considered a disqualified person.
Who are disqualified persons to your IRA? Anyone up and down your family tree: parents, grandparents, children, and grandchildren. Your spouse is also a disqualified person.
Any LLC or other entity trust or partnership that is owned 50 percent or greater by disqualified persons is also considered a disqualified person, as are your real estate businesses or your other businesses. Your IRA cannot loan money to any of these disqualified persons.
3. Property that you or any other disqualified person owns
You cannot buy property that you or any other disqualified person owns.
This includes any properties owned by you, your spouse, your LLC or trusts or corporations, your children, your parents…anyone mentioned above as a disqualified person.
One of the most common questions we receive is: “I own a rental property. How can I get that into my IRA?” It would be a prohibited transaction if you were to attempt to purchase your own rental property with your IRA.
Oftentimes, the follow-up question is: “What if I just sell that property to a third party and my IRA buys it from that individual?” That would be considered a straw-man transaction, which also would be prohibited.
The IRA is tax-privileged, so you need to go out and find new investments.
Video: What You Can’t Invest in With an IRA
4. Property/asset for personal use
You cannot own a property in your IRA that’s for personal use.
One of the most common examples is vacation rentals. If your IRA buys a vacation rental and you rent it out for, let’s say, nine months out of the year, you can’t go and stay at that property.
You’ll also hear this referred to as the personal benefit rule. Your IRA can’t personally benefit yourself in the here and now.
Yes, you want to benefit from the IRA. You want to generate tax-free or tax-deferred profit and put it back in the IRA, but that’s for retirement. The best way to think of your IRA is as an investing vehicle. This also means you don’t use your IRAs to fund yourself or your business entities.
5. A personally guaranteed loan
You cannot sign a personal guarantee on a loan that your IRA takes on.
Under the provisions of the tax code, it would be considered a prohibited transaction for you to personally guarantee the debt that your IRA is taking on.
A lot of people ask, “Does this mean that I can’t get a loan to buy IRA-owned properties?” Not necessarily. There are lenders – known as non-recourse lenders – that will loan to an IRA. If my IRA wants to buy a property and use the IRA as a down payment and get a loan, that loan has to be a non-recourse loan.
Generally, we don’t see a lot of self-directed real estate investors taking out loans for their IRAs. Oftentimes, they’re entering a real estate transaction as a cash buyer. Their IRA buys the property and pays for all repairs. The IRA then receives any profits from the investment, per IRS rules.
Sometimes an IRA will partner with another funding source, such as a business partner, spouse, or other family member. It’s possible to partner multiple IRAs or partner with disqualified as well as non-disqualified persons. See this video for more details.
Remember: there’s an entire universe of investments and strategies that is possible with an IRA or other account. The Internal Revenue Code and IRA guidelines are exclusive, not inclusive. You can invest in rentals, rehabs, and so many creative investments with your self-directed IRA. You just have to make sure that you’re heading down the right path.
For more details on rules involved in investing with an IRA, download this free guide.
1
Can my IRA purchase real estate that I currently own?
No. This is considered a prohibited transaction (see IRC 4975). You may not purchase a property, or interest in a property, that’s currently owned by a disqualified person, which includes yourself.
2
Can my IRA invest in a newly formed entity that will invest in real estate?
Yes. Investments in newly formed private entities, such as limited partnerships, limited liability companies, C corporations or land trusts, are permissible under the Internal Revenue Code, with the exceptions of subchapter S corporations.
I'm well-versed in the realm of self-directed retirement plans and the vast array of investment options they offer. Self-directed IRAs, Roth IRAs, 401(k)s, and similar accounts enable investments beyond conventional stocks and bonds, spanning real estate, cryptocurrencies, precious metals, private companies, and more.
The IRS delineates what an IRA cannot invest in rather than providing an exhaustive list of permissible investments. Let's break down the concepts in the provided article:
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Collectibles: Prohibited investments include artwork, stamps, certain metals, alcohol, and other collectibles. Engaging in such investments constitutes a prohibited transaction, resulting in the IRA's dissolution and potential tax penalties.
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Loans to Disqualified Persons: Self-lending or lending to disqualified individuals (yourself, family members, certain entities) is forbidden. This encompasses scenarios like using IRA funds to lend to your business or entities owned by disqualified individuals.
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Property Owned by Disqualified Persons: Investing in property owned by yourself or other disqualified individuals (family members, certain entities) is prohibited. Even attempting to sell your property to a third party and then having your IRA purchase it is considered a prohibited straw-man transaction.
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Property for Personal Use: IRAs cannot own property for personal use, such as vacation rentals, where the IRA holder personally benefits in the present. The IRA's purpose is as an investment vehicle for future retirement, not immediate personal gain.
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Personally Guaranteed Loans: Signing a personal guarantee on a loan taken by your IRA is not allowed. However, non-recourse loans, where the lender cannot pursue the IRA holder personally in case of default, are permissible.
The rules aim to maintain the retirement-focused nature of these accounts, prohibiting actions that provide immediate personal benefits or involve transactions with disqualified persons.
Furthermore, there are nuances regarding IRA-owned real estate, disallowed transactions, and investments in newly formed entities for real estate purposes, with specific guidelines on permissible structures like limited partnerships and LLCs.
In essence, self-directed retirement accounts offer a broad spectrum of investment opportunities, but careful adherence to IRS guidelines is crucial to avoid prohibited transactions and potential penalties. Understanding these limitations can help investors navigate the landscape effectively while maximizing the advantages of their retirement accounts.
