Prohibited Transactions in Self Directed IRAs

When you invest your IRA offshore, you become responsible for ensuring your transactions follow all the US rules. Yes, even when you invest abroad, you still must worry about prohibited transactions in self directed IRA. Here’s everything you need to know about prohibited transactions in self directed IRAs if you’re going to take your retirement account offshore.

First, let’s talk about investing your IRA offshore. There are two ways to invest your retirement account abroad and earn higher returns. You can ask your custodian to make the investment as a self directed account or you can form an offshore IRA LLC.

The benefit of using an offshore IRA LLC is that you are in total control. You write the checks and manage the investments. The negative in using an offshore IRA LLC is that you’re in total control. You write the checks and have all the risk… with none of the training and experience a qualified custodian has.

With an offshore IRA LLC, your custodian invests in the LLC and you take it from there. With a self directed account, you direct the custodian to make certain investments and he or she generally follows your direction. If the investment will violate a rule, or the custodian isn’t comfortable, they can refuse.

We generally recommend those new to money management, and those who plan to make 2 to 5 international investments in the first year, to start with a self directed account. Those who plan to actively trade their accounts should consider an offshore IRA LLC. In most cases, those who will invest in cryptocurrencies and ICOs should use an IRA LLC.

Whether you set up a self directed account or an offshore IRA LLC to make international investments with your retirement account, you need to understand the prohibited transaction rules. If you violate these rules, even inadvertently, you risk having your entire account revoked (a forced distribution) and incurring big time taxes and penalties.

The IRS defines a prohibited transaction as follows:

“Generally a prohibited transaction is any improper use of your IRA account or annuity by you, your beneficiary or any disqualified person. Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of lineal descendant).” IRS Publication 590

Prohibited transactions in a retirement account generally include the following transactions:

A disqualified person’s transfer of plan income or assets to, or use of them by or for his or her benefit
A fiduciary’s act by which he or she deals with plan income or assets in his or her own interest
A fiduciary’s receipt of consideration for his or her own account in a transaction that involves plan income or assets from any party dealing with the plan
Any of the following acts between the plan and a disqualified person
- Selling, exchanging, or leasing property
- Lending money or extending credit
- Furnishing goods, services or facilities

Publication 590 indicates that, in addition to prohibited investments, the IRS prohibits certain transactions within IRAs. Prohibited transactions include investments with disqualified individuals (as defined by IRC 4975), self-dealing and receiving indirect benefits.

The IRS doesn’t tell us what is permitted, only what’s NOT allowed. Examples of prohibited IRA investments include collectibles (such as artwork, stamps, rugs, antiques and gems), certain coins and life insurance.

And these examples make sense… at least to an IRS mind. Collectables aren’t permitted because you will get some benefit from owning them. You might hang a painting on a wall or flip through your stamp collection and get joy from them. (Is stamp collecting still a thing?) So, these are prohibited transactions.

Investors using self directed IRAs are most at risk from the inappropriate benefits rules. You should be managing your IRA for the benefit of the retirement account. In that capacity, you must treat the account just as a professional investment advisor would.

An inappropriate benefit would be borrowing from the account, paying yourself a salary to manage the account, paying personal expenses with IRA money, or staying in a property you purchased with retirement money.

The last of these, staying in a property you purchased with IRA money, is the most common problem we see offshore. I get the question several times a week: If I buy a rental property with my retirement money, can I stay in it a few weeks a month or when it’s not rented out? The answer is a resounding NO!

Staying even one day in a rental property would be receiving an inappropriate benefit or indirect benefit from an IRA investment. You invested in a property and the benefit you receive is the free days in that property. And, before you ask, no you can’t pay FMV for the rent to your IRA.