Sometimes understanding who your IRA can and can’t do business with is confusing. Who is considered a disqualified person? Who can your IRA partner with? What are the differences? This article answers all of those questions and provides a better understanding of the self-directed IRA rules. Self-directed accounts have many benefits, but if not operated within compliance of IRS regulations, your account can lose its tax-free or tax-deferred status.
Disqualified Persons & Transactions
A disqualified person is one whom your IRA cannot do business with. These people include yourself and all lineal ascendants and descendants such as your spouse, your children, your grandchildren, your parents, and your grandparents. When dealing with real estate in an IRA this means that you cannot buy to, sell to, or rent to any of these disqualified people. For example, you cannot purchase a piece of real estate that you already personally own. This is considered self-dealing and benefits you currently—instead of at the time of your retirement. You may purchase a property from your aunt, uncle, brother, sister, or cousin, as long as there are no “sweetheart deals” (family discounts) involved.
The same applies to people your IRA can make payments to. Your IRA cannot write a check to a disqualified party or to you. For example, if you personally pay expenses related to your IRA by check or credit card, your IRA is prohibited from reimbursing you. If your IRA were to write you a check or make a payment toward your own credit card, it could look like a distribution to the IRS.
Qualified Persons & Transactions
Although you cannot do business with disqualified parties as explained above, you can partner with those people. For example, if you wanted to partner with your father to purchase a piece of real estate your IRA could own a percentage and your father could own a percentage. This wouldn’t be considered a disqualified transaction since you’re not renting the property to your father and you didn’t buy the property from him. You’re simply partnering with him to make the investment. If your IRA owned 50 percent of that property and your father owned the other 50 percent, your IRA and your father would split all income and expenses 50/50. Income and expenses relevant to the percentage owned flow directly into and out of your retirement account. Your IRA never writes your father or you a check—making the partnership a legal transaction.
The same applies to you personally partnering with your IRA. Although self-dealing is a disqualified transaction, partnering your self-directed account with yourself to make a new investment does qualify. To learn more about who your IRA can partner with, you can read our previous blog “Are You Short of Funds to Purchase Investment Property?”
In short, think of it this way: Your IRA can partner with any family member you’d like to make a new investment. However, if your IRA performs an action that involves (or should involve) writing or receiving a check from a lineal ascendant or descendant—then that transaction is prohibited.
To avoid confusion, always consult with a tax advisor and do your due diligence before making any investment.
For questions regarding disqualified persons or oher rules & regulations regarding self-directed IRAs, please contact Midland Trust.