When you open a Self-Directed IRA (SDIRA), you unlock the ability to make investment decisions that extend far beyond traditional retirement accounts. 

However, with this freedom comes responsibility. Understanding the IRS rules about prohibited transactions and disqualified persons is crucial to avoid costly penalties and ensure your account complies with regulations.

What Is a Self-Directed IRA?

A Self-Directed IRA (SDIRA) is a retirement savings account that allows you to invest in alternative assets like real estate, private equity, cryptocurrency, and more.

These accounts are managed by a custodian, but the investment decisions are entirely in your hands. Depending on whether you choose a Traditional or Roth SDIRA, they offer tax-deferred or tax-free growth.

Advantages of an SDIRA

• Diversification: Invest in alternative assets to hedge against market volatility.
• Control: You decide where to allocate funds.
• Tax Benefits: Enjoy the tax-deferred growth of a Traditional IRA or tax-free withdrawals with a Roth IRA.

However, with these benefits come strict rules and regulations, particularly around prohibited transactions and disqualified persons. Failing to adhere to these rules could disqualify your account and result in taxes and penalties.

Prohibited Asset Types

Not all investments are allowed in an SDIRA. According to IRS regulations, you cannot invest in:

• Life Insurance Policies
• Collectibles, including:
  • Artwork
  • Rugs
  • Antiques
  • Gems
  • Stamps
  • Coins (exceptions: specific coins minted by the U.S. Treasury)
  • Alcoholic beverages (e.g., wine collections)
  • Tangible personal property
• Certain Precious Metals: Exceptions include specific bullion (e.g., gold, silver, platinum, palladium) that meets IRS purity standards.
• S-Corporations: SDIRAs cannot own stock in S-Corps due to IRS restrictions on ownership structures.

Prohibited Transactions

Prohibited transactions are defined as improper uses of the IRA account by the account owner, their beneficiaries, or any disqualified person (s). These rules are designed to prevent self-dealing, where you personally benefit from your retirement account before reaching retirement age.

Who Are Disqualified Persons?

Disqualified persons include:

• Yourself (the account holder)
• Family members:

• • Spouse
  • Ancestors (parents, grandparents)
  • Lineal descendants (children, grandchildren, and their spouses)
• Service providers (e.g., custodian, CPA, financial planner)
• Entities:

• • Any entity in which you or a disqualified person hold 50% or more ownership.
  • Any entity that is a 10% partner or joint venture with a 50%-owned entity.

Examples of Prohibited Transactions

The following actions are strictly prohibited and could disqualify your IRA:

• Borrowing Money: You cannot take a loan from your SDIRA.
• Selling Property: Selling property you own to your SDIRA is prohibited.
• Using the IRA as Collateral: Pledging your IRA as security for a personal loan is disallowed.
• Buying Property for Personal Use: Purchasing real estate for personal or family use (now or in the future) is not allowed.

Consequences of Prohibited Transactions

If you engage in a prohibited transaction, the IRS will treat your entire IRA as distributed, meaning:

• Immediate Taxation: The fair market value of the account is treated as taxable income for the year the transaction occurs.
• Penalties: A 10% early withdrawal penalty applies if you are under 59½.
• Loss of Tax-Deferred Growth: Your account is no longer eligible for tax benefits.

Examples of Self-Dealing

To better understand prohibited actions, here are common examples of self-dealing:

• Real Estate: Using IRA funds to purchase property you or a family member will use, even temporarily.
• Loans: Lending money from your IRA to yourself or a disqualified person.
• Family Transactions: Granting a family member (e.g., child or parent) a second mortgage for a personal property purchase.
• Private Stock: Purchasing shares in a company where you have a controlling interest.
• Restricted Stock: Buying restricted stock from a disqualified family member.

How to Avoid Prohibited Transactions

• Hire Professionals: Work with knowledgeable custodians, tax advisors, and attorneys who specialize in self-directed accounts.
• Perform Due Diligence: Research investment opportunities thoroughly to ensure they comply with IRS rules.
• Document Everything: Maintain clear records of all transactions to prove compliance in case of an audit.
• Understand the Rules: Regularly review IRS guidelines to stay informed about changes to SDIRA regulations.

Prohibited Transactions with SEP and SIMPLE IRAs

Special rules apply to SEP and SIMPLE IRAs, particularly for employers or entities involved. Disqualified persons include:

• The employer who sponsors the plan.
• 50% or more owners of the employer.
• Officers, directors, and 10% shareholders of the employer.

2025 Updates: Changes to Keep in Mind

Enhanced Scrutiny

The IRS continues to tighten its oversight of SDIRAs due to their rising popularity. For 2025, expect increased audits and stricter enforcement of prohibited transaction rules. It’s more important than ever to work with a knowledgeable custodian, maintain detailed records, and ensure compliance with all IRS regulations to avoid penalties.

Updated Contribution Limits

For 2025, the contribution limits for various retirement accounts have increased to reflect cost-of-living adjustments:

• Traditional & Roth IRAs: $7,000 annually ($8,000 for individuals aged 50+).
• SEP IRAs: The lesser of $70,000 or 25% of compensation.
• SIMPLE IRAs: $16,500 annually, with an additional $3,500 “catch-up” contribution for individuals aged 50+.

Focus on Alternative Investments

• Cryptocurrency: With growing investor interest, regulatory scrutiny has intensified. Custodians are now required to report crypto holdings more transparently.
• Real Estate Crowdfunding: Investments in crowdfunding platforms must meet compliance standards. Ensure these assets are properly titled under the SDIRA to avoid prohibited transaction issues.
• Private Equity: Increased popularity has drawn attention from the IRS. Valuation accuracy and proper documentation are critical for compliance.

New Reporting Requirements

Starting in 2025, custodians are now required to file additional reports to the IRS for alternative investments, including fair market valuations of non-traditional assets. This reporting emphasizes the importance of accurate valuation and proper documentation to avoid penalties.

Revised RMD (Required Minimum Distributions)

For account holders turning 73 in 2025, RMD requirements remain in effect, but future changes could raise the age to 75 by 2033 under the SECURE 2.0 Act. Roth IRA accounts remain exempt from RMDs during the account holder’s lifetime.

Increased Penalties for Noncompliance

Penalties for engaging in prohibited transactions or failing to comply with required reporting have increased in 2025:

• Prohibited Transactions: The IRS now imposes stiffer fines, including disqualification of the entire account and a higher excise tax rate.
• Missed RMD Penalties: Reduced from 50% to 25% under SECURE 2.0, and reduced to 10% if the correction is made within 2 years.

Maximizing SDIRA Benefits Without Violations

While the rules for SDIRAs may seem complex, understanding and adhering to them can help you leverage the full potential of this investment vehicle. Here’s how to stay on track:

• Focus on Permitted Assets: Invest in assets like real estate (for investment purposes), private equity, and cryptocurrency that comply with IRS guidelines.
• Leverage Professional Guidance: Custodians and advisors can help you navigate complex regulations and avoid pitfalls.
• Plan Long-Term: Avoid short-sighted decisions that may inadvertently violate IRS rules.

Take Control with Confidence

Self-Directed IRAs offer unparalleled investment flexibility and opportunities to grow your retirement savings. However, staying informed about the rules and avoiding prohibited transactions is essential. Consult a trusted custodian, like Horizon Trust, to help you navigate the complexities of SDIRA investing and achieve your financial goals.

By adhering to these guidelines, you can confidently take control of your retirement portfolio and enjoy the benefits of alternative investments while staying compliant with IRS regulations.

FAQs

Can I live in a property purchased through my SDIRA?

No, you cannot use SDIRA-owned property for personal use. It must be solely an investment property.

What happens if I engage in a prohibited transaction?

Your entire SDIRA may be disqualified, resulting in immediate taxation and penalties.

Can I use my SDIRA to invest in a family member’s business?

No, investments involving disqualified persons (like family members) are prohibited.