How to Avoid Prohibited Transactions For A Roth IRA
When you create a self-directed IRA, you are taking control of your retirement. This control comes with a great responsibility, something that shouldn’t be taken lightly. If you break some of the IRS’s formal guidelines, you could lose your IRA’s tax-free status or even face jail time if you do something malicious. So it is extremely important that you pay attention and NOT violate the cardinal sin of self-directed retirement, also known as “self-dealing.”
The IRS states…
“Generally, a prohibited transaction is any improper use of an IRA account or annuity by the IRA owner, his or her beneficiary or any disqualified person. Disqualified persons include the IRA owner’s fiduciary and members of his or her family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).”
Here are some examples of prohibited transactions for a Roth IRA that have been OUTLAWED by the IRS…
- Borrowing money from it
- Selling property to it
- Using it as a security for a loan
- Buying property for personal use (present of future) with IRA funds
One of the basic rules for avoiding prohibited transactions for a Roth IRA is to make sure all transactions are done at “arms length.” This essentially means that you or your decedents should not be involved in the performance of the investment. (For example, you cannot invest in a rental property that you manage.)
Another clause in the IRS’s language prohibits you from using investments where there is a “deal on the side” that makes the Roth IRA’s investment more lucrative than it would have normally been.
Basically, this means you can’t put $50,000 into your friend’s Roth IRA in exchange for him putting $50,000 into your Roth IRA.
To sum it up, do not invest your IRA funds in any investment in which you or your family plays a role. Always put the money into passive investments.
For me, the perfect investment for a Roth IRA is a mortgage note. When structured properly, mortgage notes are the most straightforward and passive way to invest. They have a strong return (tax-free in a Roth) and can be structured so that there are very few transactions going to the retirement account, and, therefore, create less headaches.
I have helped many investors set up mortgage notes that pay a solid 10% interest rate, and that only require the investor to make one payment annually.
These investors can’t distribute the monthly cash flow to themselves because it is in a Roth IRA, so we create a structure that limits the in-and-out transactions and also makes them a solid ROI.
Are you interested in setting up something similar?