A Self-Directed Individual Retirement Account (SDIRA) allows you more investment options than a traditional IRA. However, the IRS prohibits certain types of transactions and investments. You should, therefore, acquaint yourself with the prohibited transactions and restrict yourself from them.
What is a Prohibited Transaction?
When you make any transaction that violates the IRA rules, it corresponds to a prohibited transaction. You can also regard a prohibited transaction as improper use of your SDIRA by you, your beneficiary, or a disqualified person.
Usually, prohibited transactions fall under the following three categories:
You should choose a Self-directed IRA service that is well-versed with such transactions.
What is a Disqualified Person?
Disqualified persons can include your fiduciary and members of your family, including spouse, lineal ascendants or descendants, and their spouses.
Direct Prohibited Transactions
If a transaction involves a disqualified person and his SDIRA, it corresponds to a direct prohibited transaction. An example will perhaps make the concept more clear.
X uses funds from his SDIRA to purchase a stake in a company that his brother owns. It is a transaction between two disqualified persons–X, the SDIRA holders, and his brother, a lineal descendant. At the same time, the transaction benefits one of the disqualified persons.
Self-Dealing Prohibited Transaction
When an SDIRA holder uses the income from his account or assets for personal gains, it becomes a self-dealing prohibited transaction. The IRS prohibits the usage of retirement funds for benefiting the account holder’s personal interests.
For example, Y uses his SDIRA funds to invest in a company which he controls. The transaction will benefit Y personally.
Conflict-of-Interest Prohibited Transaction
A conflict-of-interest prohibited transaction occurs when a disqualified person and also is a fiduciary is involved in a transaction related to the income or assets of the SDIRA.
For example, Z uses his SDIRA funds to loan money to a company in which he owns a stake.
Yes, such transactions are prohibited, and you should avoid them. An SDIRA has many advantages that justify your desire to open one. But, refer to the infographic in this post to know why you should open one.