Self-Directed Account Rules and Regulations

A self-directed IRA lets you invest retirement funds in alternative assets like real estate, cryptocurrency, and tax liens. With that flexibility comes a short list of rules. Follow them, and your account keeps its tax advantages. Break them, and the IRS can treat the whole IRA as distributed.

This guide covers the seven rules that matter most, what counts as a disqualifying mistake, and what the IRS does when one happens. None of it is complicated. It just rewards a little care.

The list

Seven rules that keep your IRA compliant.

Read each one before you invest. Most disqualifications come from one of these.

1. Do your due diligence

Research every alternative investment before you fund it. Accredited investors can put money into deals that are not registered with the SEC, but the lighter regulation is exactly why the burden of vetting falls on you. Use a provider experienced with the asset class, and bring in legal and tax help when the deal is complex.

A workable due-diligence checklist.

• Inspect tangible assets in person.
• Vet potential business partners.
• Understand the associated taxes and fees.
• Learn the rules specific to your asset type.
• Research the prospective investment thoroughly.
• Get input from experienced investors you trust.

2. Avoid prohibited transactions

A prohibited transaction is any improper use or transfer of money out of the IRA by a disqualified person, such as the account holder, a beneficiary, or a fiduciary. Congress added these rules to the Employee Retirement Income Security Act in 1974 to stop people from using retirement accounts for personal benefit before retirement.

A common example is borrowing from your own IRA or buying property you plan to use yourself. The IRA also cannot transact directly with immediate family or other close entities. It can only deal with third parties, whether the asset is real estate, a private loan, or anything else. If you (or a beneficiary) cause a prohibited transaction, the entire IRA is treated as distributed on January 1 of that year. See the consequences section below for what that means in practice.

3. Do not take indirect benefits

The same logic that bans direct self-dealing also bans indirect benefits. If a transaction quietly puts money or value back into your pocket before retirement, it disqualifies the account. Three common examples.

• Paying out of pocket. Personally covering an expense the IRA should pay (a property repair, a closing cost) is an indirect benefit.
• Living in an IRA-owned property. Even briefly. Personal use disqualifies the account.
• Loaning IRA funds to yourself. Lending to a disqualified person and being paid back is still self-dealing.

4. Understand the tax rules

Know what you may owe today and at distribution.

• Unrelated business income tax (UBIT). Triggered when your IRA earns active business income, like profits from running a business or developing real estate to sell. Passive rent, interest, and capital gains are usually not subject to UBIT.
• Traditional self-directed IRA. Contributions are usually tax-deductible and tax-deferred. You pay tax when you take qualified withdrawals in retirement.
• Roth self-directed IRA. Contributions are made with after-tax dollars, so growth and qualified distributions come out tax-free.

5. Know who counts as a disqualified person

The IRS lists specific people and entities that are prohibited from doing business with your IRA. The bright-line rule is simple. Your IRA cannot transact with you or your closest economic relations.

• The account owner.
• The account holder’s spouse.
• Beneficiaries of the IRA.
• Lineal descendants (children, grandchildren, and their spouses).
• Lineal ascendants (parents, grandparents, and great-grandparents).
• Entities you own 50% or more of.
• Anyone providing services to your IRA assets, such as a fiduciary or advisor.

An entity can be an LLC, a business partner, a corporation, a trust, or an estate that you own 50% or more of. Routing money through one of those entities still violates the rule.

Some related parties are allowed. Your IRA can do business with people the IRS does not treat as family for these rules.

• Your siblings.
• Your spouse’s parents.
• Your nieces and nephews.
• Friends.
• Stepparents and step-grandparents.
• Aunts, uncles, and cousins.

6. Submit a Fair Market Valuation (FMV)

Each year, every asset in your self-directed IRA needs an updated value. Fair market value is the price the asset would change hands for between a willing buyer and a willing seller, neither under pressure to act. Accuplan, as your TPA, collects the year-end valuation. The custodian, American Estate & Trust, files Form 5498 with the IRS. The account holder is responsible for supplying an accurate value.

7. Stay clear of prohibited investments

Self-directed IRAs are flexible, but the IRS still excludes a few asset classes. There is no master list of allowed investments. There is a clear list of disallowed ones.

• Most collectibles. Artwork, rugs, antiques, gems, stamps, alcoholic beverages, and most coins. Certain U.S.-minted gold, silver, platinum, and palladium coins and bullion that meet IRS purity standards are allowed.
• S-corporations. An IRA cannot be an S-corp shareholder.
• Life insurance. IRAs cannot hold life insurance contracts.

Consequences

What happens if your IRA is disqualified.

When the IRA owner (or a beneficiary) causes a prohibited transaction, the consequences are severe. Under IRC §408(e)(2), the account stops being an IRA on January 1 of the year the violation occurred. The full fair market value of the IRA is treated as distributed to you on that date.

In practice, that means three things.

• Income tax on the entire account balance, at your ordinary income rate for that year.
• A 10% early-withdrawal penalty on top, if you are under age 59½ when the deemed distribution occurs.
• Loss of tax deferral on every dollar in the account, even amounts unrelated to the violation.

If a different disqualified person (not you) deals with your IRA improperly, the IRS instead applies a 15% excise tax to that person and a 100% additional tax if the transaction is not corrected in time. Either way, the financial cost is real and worth avoiding.

Get started

Open a self-directed IRA with Accuplan.

Whether you are new to IRAs or already running one, it pays to talk through your plan with a tax or legal professional. Our self-directed specialists at Accuplan Benefits Services are ready to answer compliance questions and walk you through the setup. If you would rather read first, our resource library covers most of the common ones.

When you are ready, schedule a call or open a self-directed IRA with Accuplan.

Our information shouldn’t be relied upon for investment advice but simply for information and educational purposes only. It is not intended to provide, nor should it be relied upon for accounting, legal, tax or investment advice.