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Increasingly, Self-Directed IRA (SDIRA) owners are looking at alternatives to traditional stocks and bonds for their retirement accounts. Growing investor sophistication is driving many in the direction of Real Estate, Private Stock, non-public Hedge Funds and other investments traditionally excluded from their current retirement portfolios. Alternative investment transactions through a SDIRA, may provide greater transparency and control over retirement assets. Additionally, a Traditional SDIRA allows taxes on assets held inside the IRA account to be deferred or postponed until the money is withdrawn from the account, presumably after the age of 59 ½. Alternative investments may allow account owners to take a proactive approach to improving investment returns because they choose asset classes that are not correlated to their current portfolios.

When working with SDIRA’s, it is important to be familiar with the prohibited transaction and disqualified person sections of the Internal Revenue Code (IRC). Failing to understand Prohibited Transactions, or to find an advisor or professional that does, may lead to the disqualification of your SDIRA, resulting in possible taxes and penalties. This article will outline the importance of disqualified person(s), prohibited transaction(s), and common scenarios SDIRA owners should avoid with their SDIRA.

The prohibited transactions rules are intended to ensure that the assets of a plan are invested in a manner that benefits the SDIRA itself and not the SDIRA owner. This is intended to prevent a person, such as the IRA holder, from using the assets of their SDIRA for personal benefit. It is incredibly important that the IRA holder not engage in any ‘transaction’ with his or her IRA. Consequently, transactions involving the SDIRA must be “arms-length” and free from any direct exploitation by the SDIRA owner.

Disqualified Person(s)
An IRA owner may not invest in property that he/she, a relative, or his/her business, already owns. Prohibited transactions are transactions that occur between the SDIRA and disqualified person(s). The following are, generally, considered disqualified persons.

Penalties
When an IRA is involved in a transaction that is considered ‘prohibited’, the IRA loses its tax-exempt status and the IRA holder is deemed to have received a distribution on the first day of the tax year in which the prohibited transaction occurred. The value of the IRA is treated as if was distributed to the IRA holder and must be included in the IRA holder’s income for that year. Unless the IRA holder has reached age 59½ or is disabled, this distribution is subject to the 10 percent penalty tax on early distributions. These are hefty penalties that can rapidly diminish the benefits of the self-directed IRA.

Conclusion
Individuals who consider making, or have made, alternative asset investments in their SDIRA must be vigilant and responsible for each action they take. Becoming aware of the prohibited transaction and disqualified person rules will help them avoid tax consequences by not tripping over these fundamental rules. Individuals should contact a knowledgeable self-directed IRA custodian, attorney, CPA, or financial advisor, with a track record of working with SDIRA’s, for more details.