IRS Rules

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The Tax Benefit of IRAs

An IRA helps you save for retirement by sheltering the income produced by plan investments from taxation. Since gains are not taxed when earned, you can grow your savings dramatically over time.


In exchange for this tax-sheltered status, IRA plans are subject to IRS rules. The general principal is that IRA funds are set aside for your future benefit in retirement, not for your current use.


This means that you cannot benefit at the current time from your IRA investments. You also may not inject value into the IRA through the provision of goods or services beyond basic administration of plan investments.

Rules Overview

All investments of the IRA must be for the exclusive benefit of the IRA.

Investments in life insurance and collectibles are prohibited.  Any investment asset not specifically prohibited is allowable.

There can be no direct or indirect benefit – in either direction – between a plan and a disqualified person.  Disqualified persons are you, lineal family, and fiduciaries to your plan.

When actions are taken that are not exclusively for the benefit of the plan or create a benefit between the plan and a disqualified person, a prohibited transaction occurs.  The tax consequences of a prohibited transaction are severe.

Some investments are allowable but will create income that is taxable to the IRA.  These taxes occur when an IRA invests in a way that produces trade or business income rather than passive investment gains, or when leverage is used.

IRS Rules relating to IRA plans are covered in section 408 of the US tax code.

Prohibited Investments

The IRS rules do not specifically list allowable investments.  A few types of assets are prohibited by the code, and anything else is therefore allowable.

If a plan purchases a prohibited investment, the amount of the purchase is considered to be a distribution to the IRA account holder.

Life Insurance Contracts

An IRA may not invest in life insurance contracts per IRC Section 408(a)(3).

Collectibles

When creating IRA plans in 1974, Congress determined that collectible are not suitable means to save for retirement.  

IRC section 408(m)(2) defines collectibles as

  • Works of art
  • Rugs or antiques
  • Metals or gems
  • Stamps or coins
  • Alcoholic beverages
  • Any other tangible personal property specified by the secretary of the treasury.

The tax code was amended in 1997 to make an exception from the collectible exclusion for specific precious metals, as outlined in IRC Section 408(m)(3). Allowable precious metals include:

  • US Eagle coins in gold, silver, platinum & palladium
  • Gold, silver, platinum & palladium bullion with 99% purity
  • Certain foreign-minted coins that meet the bullion fineness criteria

S-Corporation Shares

While there is no prohibition for an IRA to invest in a subchapter S Corporation, such transactions are not possible.  The reason is that S-Corporation rules in IRC Section 1361 only allow for individuals as shareholders.  If the corporation were to accept a non-person such as an IRA as a shareholder, it would cease to be a S-Corporation and would need to become a subchapter C Corporation.

The Exclusive Benefit Rule

Section 408(a) of the tax code defines IRA plans.  The very first sentence describes an Individual Retirement Account designed “for the exclusive benefit of an individual or his beneficiaries…”

This exclusive benefit rule needs to be considered two ways:

  • The investments of the IRA must be in the best interest of growing the IRA savings and meeting the retirement benefit needs of the IRA account holder.
  • Investments may not provide a benefit to plan beneficiaries or disqualified persons other than growing the savings value of the plan.

The IRS recommends the following criteria to determine if a plan’s policies are for the exclusive benefit of the plan beneficiaries:

  • The cost of an investment must not exceed its fair market value (FMV) at the time of its purchase.
  • A fair return commensurate with the prevailing rate must be provided.
  • The investment must be sufficiently liquid to permit distributions per the plan terms.
  • The safeguards and diversity that a prudent investor would adhere to must be present.

Disqualified Persons

A violation of IRS prohibited transaction rules defined in IRC Section 4975 occurs when there is an exchange of benefit between an IRA and a disqualified person.

Disqualified Persons include:

  • The IRA account holder
  • Their spouse
  • Ancestors such as parents, grandparents, etc.
  • Lineal descendants such as children, grandchildren, etc.
  • The spouse of a lineal descendant
  • Fiduciaries to the plan or those providing services to the plan such as investment advisors or tax counsel.
  • An entity such as a business or trust where controlling interest is held by one or more of the above individuals. Control is considered either equity or beneficial interest in an entity greater than 49%, or director level decision-making power over the entity.
  • A key employee such as a board officer or a holder of more than 10% ownership interest of a company that is controlled by a disqualified party.

Prohibited Transactions

A prohibited transaction occurs when a transaction or provision of benefit occurs between an IRA and a disqualified person.  A violation of the rules also occurs when the plan is used in a way that is not for the exclusive benefit of the IRA.

IRC Section 4975 defines prohibited transactions as occurring when there is any direct or indirect:

  • Sale or exchange, or leasing, of any property between a plan and a disqualified person.
  • Lending of money or other extension of credit between a plan and a disqualified person.
  • Furnishing of goods, services, or facilities between a plan and a disqualified person.
  • Transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan.
  • Act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account.
  • Receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

When an IRA account holder or other plan beneficiary engages in a prohibited transaction, the tax consequences are severe.  The entire IRA, not just the amount involved, is considered to have been distributed on the first day of the year in which the transaction occurred.  

Operating Within the Rules

In simple terms, you really, really need to keep IRA activities very separate from personal and family finances.

As you consider how to best protect and grow your IRA, keep in mind that is the sole the purpose of your Gratis IRA.  A self-directed IRA is not a means for you to access your IRA capital for your own purposes.

Think of yourself as a fund manager tasked with growing savings for your future self.  Only when you reach retirement age and start taking distributions out of the IRA will you start to see a personal benefit.

Following are a few key guidelines to proper and safe usage of your Gratis IRA.

Keep Things Separate

Once IRA capital has been invested into the Gratis IRA Trust, it remains within the trust.  If you operate the Gratis IRA Trust as a standalone closed system and you will be on the right path.

Investment assets must be acquired in the name of the trust and paid for with trust funds from the trust checking account.  Likewise, any expenses associated with future maintenance of a trust investment must be paid by the trust.  Closing the loop, all income produced by investments is returned to the trust.

Never inject yourself or personal capital into the activities of the trust.  You cannot transfer property or cash from yourself or a disqualified person into the trust.  You should never pay for expenses associated with the trust and be reimbursed or otherwise comingle IRA and personal funds in a transaction.

Never personally use IRA held property.  Your IRA cannot purchase a property for you to live in or vacation in, nor can the IRA purchase property to rent to a disqualified person such as a child or parent.

Never borrow from or lend to the trust.  You should also never pledge trust assets as collateral for a loan in your own name, or pledge personal assets to guarantee debt taken by the IRA.

Stick to Administration

As a disqualified person to your IRA, you may not benefit from or provide benefit to the IRA.  This prohibition does not prevent you from administering the IRA and the investments you choose to make with your Gratis IRA, so long as you are acting in the IRA’s interest and not your own.

You can research opportunities, negotiate, and execute contracts on behalf of the Gratis IRA Trust.

You can pay for the expenses of acquiring and maintaining trust investments, using funds from the Gratis IRA Trust.

You can receive the income produced by investments and deposit that income into the trust checking account.

You can choose and pay vendors to provide services to the trust such as tax or legal counsel, investment advisors, agents, contractors, property managers, etc.

You should not inject value into the IRA via the provision of goods, services, or facilities to the Gratis IRA Trust.  Examples might include acting as a real estate agent for a plan real estate transaction, performing work on an IRA owned property, or running an active marketing program to generate opportunities for your IRA.

Rely on Expert Counsel

The best way to ensure the operation of your self-directed IRA remains within the IRS guidelines is to hire an expert.  There are many licensed professionals such as tax attorneys and CPAs who can help you understand and operate within the IRS rules.

Be Deliberate

Ready, fire, aim is not the best approach when it comes to self-directing your IRA plan.  

Before you make an investment, take the time to ensure the strategy is well suited to an IRA, is in alignment with IRS rules, and fits within your comfort level and long-term investment goals.

Investments that are Allowable but Taxable

Some transactions are allowable for an IRA but will generate income that is taxable to the IRA.

When debt-financing is used in an investment Unrelated Debt-Financed Income (UDFI) is produced.  Common examples include margin trading, purchasing investment property with a mortgage, or investing in a real estate syndication or fund that uses debt in addition to investor capital. 

The portion of income the IRA receives due to leverage is considered taxable.  

When an IRA invests in a trade or business activity on a regular or repeated basis Unrelated Business Taxable Income (UBTI) is generated.  UBTI generating investments include property flipping, operating business taxed as pass-through entities, and certain kinds of venture capital or business equity investments. 

Just because an investment produces taxable income does not necessarily mean you should avoid the opportunity.  Depending on the details, the tax impact may not be severe, and the net after-tax income produced by the investment might still be favorable.

Before making any investment that might trigger tax on UDFI or UBTI, you should seek counsel from a licensed professional.