IRC 4975 and the Self Directed IRA – What You Need to Know

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August 25th, 2011

When contemplating make an investment using a Self Directed IRA it is vital to familiarize oneself with the IRS rules – also known as the IRS prohibited transaction rules. Before exploring the IRA prohibited transaction rules, it is important to understand the IRS’s intent for intent for drafting these rules. Based on legislative history, the purpose of the prohibited transaction rules is to encourage the use of IRAs for accumulation of retirement savings and to prohibit those in control of IRAs from taking advantage of the tax benefits for their personal account.

The IRS and the Internal Revenue Code do not describe what a Self Directed IRA or retirement funds can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain type of transactions that the IRS believes will directly or indirectly benefit the IRA holder or a close family member.

When evaluating a self directed IRA investment, the first question is whether the IRA investment involves a “disqualified person”. Pursuant to Internal Revenue Code 4975, an IRA transaction should not involve a “disqualified person”. The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest.  The prohibited transaction rules outlined in Internal Revenue Code Section 4975 are centered around one using IRA funds in a transaction that directly involves or benefits, directly or indirectly a disqualified person.  In other words, if the IRA transaction does not involve a disqualified person you will very likely not run afoul to any of the IRA prohibited transaction rules under IRC 4975.  Or said another way, an IRA transaction should not directly or indirectly involve a disqualified person.

In addition to the prohibited transaction rules under Internal Revenue Code Section 4975, Internal Revenue Code Section 408 outlines a number of transactions that an IRA may not engage in.  Firstly, an IRA may not purchase life insurance contracts.  Secondly, an IRA may not purchase any collectibles, such as artwork, a metal or gem, baseball cards, stamps, etc.  Although, the IRS does permit a Self-Directed IRA to own certain gold coins (American Gold Eagle coins or coins at least .995 fine (99.5% pure)), one ounce silver coins minted by the Treasury Department, any coin issued under the laws of any state, a platinum coin described in 31 USCS 5112(k) ; and gold, silver, platinum or palladium bullion of a certain fineness that is in the physical possession of a financial institution.

In addition, as a result of certain restrictive shareholder restrictions imposed on “S” Corporations, an IRA cannot own stock in an S Corporation. Note – an IRA can own stock in a “C” Corporation.

To learn more about the Self Directed IRA prohibited transaction rules and Internal Revenue Code Section 4975, please contact an IRA expert at 800-472-0646 or visit www.selfdirectediraexperts.com

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