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3 Potential Pitfalls to Investing With a Self Directed IRA and How To Avoid Them

Investing With a Self Directed IRA: Don’t Fall Off The IRS Cliff

Self directed IRAs are a great investing tool when they are correctly used and are properly understood. However, these types of accounts are not for everyone.

With a Self-Directed IRA, there is a lot more responsibility placed on the IRA account holder.

As a “Self Directed Investor,” you have to be proactive and willing to pay attention to what’s going on with your investments. If you don’t have the desire or the time to spend on managing your account, then a self directed IRA might not be for you.

There are some pitfalls to watch out for when making your investments.

When you decide to self directed your investments, here are three that you should keep at the forefront of your mind.

1. Prohibited IRA Transactions

Through a self directed IRA, you can invest in just about anything, other than non-allowable assets, such as life insurance and collectibles.

Also, according to the IRA rules and guidelines, the only catch is that you may NOT make any investments with disqualified parties.

Who are disqualified parties?

By definition, a disqualified party includes you, your spouse and any lineal descendants, more specifically family members (Mom, Dad, Grandma, Grandpa, your kids, & their spouses, etc.).

This is by no means a complete definition. If you ever have a question about whether or not someone would be considered a disqualified party, make sure to consult with a CPA or tax attorney.

To see the IRS definition, visit

Since you are aware of who disqualified parties are, let’s delve deeper into other types of prohibitive transactions.

We now know an investment with a disqualified party or purchasing life insurance or collectibles is considered to be a prohibitive IRA transaction, but what else?

A prohibited transaction may occur anytime you try to use your IRA to benefit you personally or vice versa. For instance, if you use your IRA to purchase an investment beach house in Miami, you cannot stay in it for a week (or any amount of time for that matter). Even if you are paying your IRA a fair rental rate for the time that you are there, it would still be considered a prohibited transaction.

Another question I get a lot goes like this, “I’ve got this great little piece of land that I own personally, can I sell or assign it to my IRA?” The answer is “NO!!!”

Selling land you already own to your IRA would be considered a prohibited IRA transaction. We already know that YOU are considered a disqualified party to your own IRA, so that eliminates selling it to your IRA because you cannot purchase anything from an excluded party. Second, all contributions to an IRA must be made in cash. A piece of land is not cash, so this eliminates the possibility of assigning anything to your IRA.

2. Do Your Vetting And Due Diligence Before Making an Investment

This one is significant, and I can’t stress it enough. As we all know, there are numerous dishonest people in the world.

It seems that more and more when we pick up the newspaper. We see people like Bernie Madoff, who have swindled people out of millions through their Ponzi schemes.

The last thing besides an IRA prohibited transaction, you would ever want to have happened to your retirement account is to fall prey to a 3rd party investment scam artist.

Our advice to you is to:

  • Do your research.
  • Look into the company.
  • Ask tons of questions.
  • Don’t make any rash decisions.

If a company is pressuring you to make a quick decision or offering you incentives and bonuses to get your money to them more quickly, these should be “red flags” that something is suspicious.

Remember, there’s no such thing as a free lunch.

If something sounds too good to be true, it probably is.

While self-directed IRAs can be a safe way to invest retirement funds, investors should be mindful of potential fraudulent schemes when considering a self-directed IRA. Investors should understand that the custodians and trustees of self-directed IRAs may have limited duties to investors, and that the custodians and trustees for these accounts will generally not evaluate the quality or legitimacy of an investment and its promoters.

3. Understand How Unrelated Business Income Tax “UBIT” Works – This is a BIGGIE!

What is UBIT?

UBIT refers to Unrelated Business Income Tax. UBIT applies to certain types of investments through your IRA.

Essentially, it is put in place to keep IRA investments from having unfair advantages over regular, tax-paying businesses.

Your IRA may be subject to Unrelated Business Income Tax if it is involved in any of the following:

  • Operates a trade or business,
  • Receives certain types of rental income,
  • Receives certain types of passive income from a business entity it controls,
  • Invests in a pass-through entity, such as a partnership that conducts business, or
  • Uses debt to finance investments.

If you have any questions about UBIT or whether or not an IRA investment that you are involved with will be subject to UBIT, we strongly urge you to consult a CPA or tax attorney.

Terry White

About Terry White

I started my business career after getting my degree in Accounting from the University of New Mexico in 1983. My first job was as a controller for a local title company, and in 1987 I started First Financial Escrow, Inc. Over the years I played a part in several startup companies including First Financial Equities, Inc., First Financial Trust, Inc., First Financial Marketing, Inc. and Asset Ventures, Inc. In 1997 First Financial Escrow, Inc. was able to purchase the escrow accounts from Sunwest Bank and changed its name to Sunwest Escrow. As the market changes, Sunwest has grown and changed along with it. Besides my wife, Sheila, we have three boys, two daughters-in-law, one grandson, another grandson on the way and a future daughter-in-law. Sunwest is my passion, and I enjoy coming to work every day to see what will happen next. I enjoy fly fishing, spending time in Colorado, biking and watching my boys play soccer.