Don't Go To Jail, Collect Your $200

Don't Go To Jail, Collect Your $200 by Bill Roberts

I received an email the other day from an ActiveRain member asking about using his Self-Directed IRA to buy a house that he could "rent" to his son.  I want to respond to this by saying that a Self-Directed IRA should be your very best investment vehicle for providing for your retirement BUT you need to follow the rules.

You may invest in just about anything from within your IRA but there are specific things that you CANNOT do:

Prohibited transaction.   A prohibited transaction is any direct or indirect:

1. Sale or exchange, or leasing of any property between a plan and a disqualified person; or a transfer of real or personal property by a disqualified person to a plan where the property is subject to a mortgage or similar lien placed on the property by the disqualified person within 10 years prior to the transfer, or the property transferred is subject to a mortgage or similar lien which the plan assumes.
2. Lending of money or other extension of credit between a plan and a disqualified person.
3. Furnishing of goods, services, or facilities between a plan and a disqualified person.
4. Transfer to, or use by or for the benefit of, a disqualified person of income or assets of a plan.
5. Act by a disqualified person who is a fiduciary whereby he or she deals with the income or assets of a plan in his or her own interest or account.
6. Receipt of any consideration for his or her own personal account by any disqualified person who is a fiduciary from any party dealing with the plan connected with a transaction involving the income or assets of the plan.

Exemptions.   See sections 4975(d), 4975(f)(6)(B)(ii), and 4975(f)(6)(B)(iii) for specific exemptions to prohibited transactions. Also see section 4975(c)(2) for certain other transactions or classes of transactions that may become exempt.

And just for the record, a Disqualified Person is:

Disqualified person.   A disqualified person is any person who is:

1. A fiduciary.
2. A person providing services to the plan.
3. An employer, any of whose employees are covered by the plan.
4. An employee organization, any of whose members are covered by the plan.
5. Any direct or indirect owner of 50% or more of:
1. The combined voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of a corporation,
2. The capital interest or the profits interest of a partnership,
3. The beneficial interest of a trust or unincorporated enterprise in a, b, or c, which is an employer or an employee organization described in 3 or 4 above. A limited liability company should be treated as a corporation, or a partnership, depending on how the organization is treated for federal tax purposes.
6. A member of the family of any individual described in 1, 2, 3, or 5. A member of a family is the spouse, ancestor, lineal descendant, and any spouse of a lineal descendant.
7. A corporation, partnership, or trust or estate of which (or in which) any direct or indirect owner holds 50% or more of the interest described in 5a, 5b, or 5c of such entity. For purposes of 7, the beneficial interest of the trust or estate is owned directly or indirectly, or held by persons described in 1 through 5.
8. An officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10% or more shareholder or highly compensated employee (earning 10% or more of the yearly wages of an employer) of a person described in 3, 4, 5, or 7.
9. A 10% or more (in capital or profits) partner or joint venturer of a person described in 3, 4, 5, or 7.
10. Any disqualified person, as described in 1 through 9 above, who is a disqualified person with respect to any plan to which a section 501(c)(22) trust applies, that is permitted to make payments under section 4223 of the Employee Retirement Income Security Act (ERISA).

And if you fail to comply then the IRS has a special plan for you:

Line 16. Section 4965-Prohibited Tax Shelter Transactions.   For tax years ending after May 17, 2006, if an entity manager of a tax-exempt entity approves or otherwise causes the entity to be a party to a prohibited tax shelter transaction during the year and knows or has reason to know that the transaction is a prohibited tax shelter transaction, then the entity manager must pay the excise tax under section 4965(b)(2).

  For purposes of section 4965, plan entities are:

• Qualified pension, profit-sharing, and stock bonus plans described in section 401(a);
• Annuity plans described in section 403(a);
• Annuity contracts described in section 403(b);
• Qualified tuition programs described in section 529;
• Retirement plans described in section 457(b) maintained by a governmental employer;
• Individual retirement accounts within the meaning of section 408(a);
• Individual retirement annuities within the meaning of section 408(b);
• Archer medical savings accounts (MSAs) within the meaning of section 220(d);
• Coverdell education savings accounts described in section 530; and
• Health savings accounts within the meaning of section 223(d).

  An entity manager is the person who approves or otherwise causes the entity to be a party to a prohibited tax shelter transaction.

  The excise tax under section 4965(a)(2) is $20,000 for each approval or other act causing the organization to be a party to a prohibited tax shelter transaction.

  A prohibited tax shelter transaction is:

1. A Listed transaction within the meaning of section 6707A(c)(2). Listed transactions are reportable transactions that are the same as, or substantially similar to, any transactions that have been specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011.
2. A prohibited reportable transaction is:

If this is too much to deal with then you really need an "advisor" for your taxes and investments. Shift the responsibility to an "expert" so that you maximize your returns without jeopardizing your future. A good CPA or Attorney with specific tax knowledge is worth his (or her) weight in gold. And a good retirement investment advisor is also indispensable. 

Most of this information is directly from the IRS website. I hope you noticed the penalty for engaging in a prohibited transaction. They will assess you an "excise" tax of $20,000 per violation. You may read that as a fine in addition to disallowing the investment in your plan, which could have even more devastating consequences.

BE VERY CAREFUL WITH SELF-DIRECTED IRA INVESTMENTS.

Because if you are not you will not pass GO, you will not collect $200, and you may very well go directly to jail.