Contrary to Popular Belief – The IRS IRA Rules Only Say What You Cannot Invest With an IRA
Stocks, bonds, mutual funds, loans — all of these are possible investments you can make with your self-directed IRA, ROTH, SIMPLE or SEP IRA.
Most standard investments, including tangible assets, are allowed, but which investments does the Internal Revenue Code say are restricted? It seems to fall to the types of investments the IRS finds easy to price, tax, and track, and whether or not the investments are also personally beneficial. It also falls to assets having actual value vs. speculative value, because the IRA fund should be investing in items that provide for retirement security.
“Because the account owner manages IRA assets, Congress and the enforcement agencies probably did not foresee the same need for supervision and guidelines as with pension assets, where the potential for abuse seemed greater.”
~ Journal of Accountancy
Key Video Highlights:
0:16 The IRS only limits what you can’t invest your IRA into according to IRC 408, Section M.
0:32 Terry covers specific items that you should avoid placing inside your IRA.
0:47 Terry talks about why only specific coins are allowed in an IRA.
1:25 – Quick list of specific items that you can’t invest inside your IRA.
2:05 – Big IRA Investment No-No — Life Settlements. Covered in IRC 408, sub-section A-3, Terry explains how life settlements are essentially purchasing insurance policies inside an IRA and they should be avoided.
3:37 – Terry covers essential IRS Letter Rulings, which clarify that you can’t invest in S-Corporation stock inside your IRA. Make sure you forward the rulings to your CPA or tax person.
Important IRS Code Sections that You Should Know
The IRA prohibited transaction rules for an IRA investor can be found in the Internal Revenue Code sections 219, 408 and 4975.
If you break them, your IRA could be disqualified. While some IRA custodians are more willing to look into alternative types of investments over the safer IRA investments like stocks, bonds, mutual funds, private tax liens and annuities, most custodians are not inclined to recommend the risk.
Self Directed IRA Rules Related To Collectibles
Section 408m of the IRS code says you cannot invest in “collectibles such as art, stamps, certain coins, alcoholic beverages, or antiques,” but as a self-directed IRA investor, “certain coins” requires investigation.
Unfortunately, the IRS is not fastidiously clear on the coins you cannot invest in, at least, not at first glance; however, it states that certain precious metals are allowed.
The exceptions are coins with a very pure mineral content rather than “collectors’ coins,” for example, American Gold Buffalo coins (non-proof) and American Silver Eagle (proof and non-proof). The bottom line is the coin mineral content is what gives them their value, not the interest displayed by collectors.
While the IRS is good at cataloging investments into groups, each asset you would like to invest in requires more research on your part before you can be sure that it is an IRA permitted investment.
“You can’t use your IRA as your own personal piggy bank. It’s tax-sheltered money, and it’s subject to all these rules that regular money is not subject to because you’re getting a tax deferral.”
~ Ed Slott, CPA
Notable collectibles forbidden from an IRA include furniture, antique silverware, baseball/football cards, comics, wine, Beanie Babies, etc.
The IRS wants to ensure that IRA investors are not putting their money into assets that might not hold their long-term value or be as easy to value as the more tangible investments, no matter what they currently sell for on auction sites.
If you have an investment in mind and are unsure if it falls into this category, you should speak with a CPA. Alternatively, you can ask the IRS for a specific ruling on the investment you’d like to make, but it can be costly and can take up to six months to obtain the necessary response letter.
IRA prohibited transaction – Life Insurance & Life Settlements
IRC 408(a)(3) prohibits using an IRA to purchase either a personal life insurance policy or a policy on anyone else’s life you have a vested interest in ensuring. It includes whole life, universal, term and variable policies of any amount for IRAs, SEP and SIMPLE plans.
This also includes life settlements – buying ownership of someone else’s life insurance policy and cashing in when they die – it’s still life insurance. A good reason for prohibiting the purchase of life insurance as an asset is because an IRA is focused on providing for a comfortable retirement, not the cost of death and its ensuing financial effects on surviving family members. If you would like more information on the life insurance restriction, you can research Internal Revenue Code (IRC) 408(a)(3).
IRA investment prohibited transactions – S-Corporation Stocks
Internal Revenue Code Sec. 1361(b) & Reg. 1.1361-1(b) says you cannot own S-corporation stock. A C-corporation pays taxes on the income that is generated by the company, and then they may or may not pay dividends to stockholders. An S-corporation passes the income from the business through to the stockholders – individuals and certain permitted trusts — and the income is taxed individually, thus causing a more complicated tax trail for the IRS to follow. If your IRA is an investor, then the S-corporation will lose its status, and its tax rate could change.
“A prohibited transaction with respect to an IRA occurs if the owner or beneficiary of the IRA engages in certain transactions. However, in this case, with an individual retirement account, instead of imposing an excise tax on the parties to the transaction, the Code provides that the account is no longer an individual retirement account, and it is treated as if the assets were distributed on the first day of the taxable year in which the prohibited transaction occurred.
~ (IRC Section 408(e)(2))” — IRS.gov
Be aware, also, of investing in anything that proves to be a conflict of interest – anything that benefits you, a close family member of lineal origin (meaning your ascendants, descendants, and spouse) or your financial advisor. We will cover that as another topic shortly, but it is wise to stay abreast of every type of prohibited transaction with retirement plans, especially in regards to your self-dealing in IRAs.
- Prohibited transactions self directed IRA rules mainly forbid IRA investment in collectibles, life insurance, or S-corporation stock.
- You won’t have any difficulty finding IRA allowable assets with your self-directed IRA.
- The IRS code explicitly outlines where you cannot invest your IRA.
Summary of Recommended Resources:
Journal of Accountancy The Dos and Don’ts of IRA Investing
Dallas News Self-Directed IRAs Need Extra Scrutiny
Read our Full Video Transcript
Hi, my name is Terry White, CEO of Sunwest Trust, and I’m writing this on Tuesday at 2:00. We’ve been talking about things that you can invest your IRA in, so today, we wanted to look specifically at the Internal Revenue Code. As I think I’ve said before, the IRS does not tell you what you can invest in with your IRA, they simply tell you what you cannot invest in. The first thing, and if you’re interested in it, you can look these up. This is out of Internal Revenue Code Section 408m that says, “collectibles such as art, stamps, certain coins, alcoholic beverages, or antiques.” Those are things you cannot invest in.
Certain Coins Are Not Allowed in an IRA
It’s interesting to note that it says “certain coins” because we’ll find out later on in future videos that there are some precious metal coins that you can invest in. We’ll talk about those in more detail during a future video. Be sure and watch those as we go along. I think the main reason that you can’t invest in those things is sometimes they are a little harder to value, and they probably can walk away easily. If you had something like that in your IRA, it could get stolen, the value is hard to determine, those kinds of issues. For some reason, it’s hard to determine why the IRS makes the choices that they do, but you can’t have collectibles—art, stamps, certain coins, alcoholic beverages, or antiques, and I usually tell people to avoid baseball cards, beanie babies, those kinds of things.
Can Life Settlements Be Held in an IRA?
The second thing you can’t have, and this is found in Section 408a3, is life insurance. That means that you can’t own life insurance on yourself. In other words, I couldn’t buy a life insurance policy on my life or on anyone’s life that I had an insurable interest in. I couldn’t buy a policy and have the IRA as the owner. Our consultants have informed us that the same applies to life settlements. I don’t know if you’ve heard about those, but typically what happens is a person will buy a life insurance policy, and then for whatever reason—they may not need it anymore. Instead of allowing the policy to lapse, what they do is they sell the beneficial interest and the ownership of that policy to someone else, and it basically becomes an investment where unfortunately you’re investing in this person’s future death so that you may have a million dollar policy that pays out when they die. You may sell it for $100.000 or so. I don’t know what kind of numbers they go for, but when that person eventually passes away, then the beneficiary who invested gets the proceeds from the life insurance policy, and that’s a pretty big business nowadays, and we have seen people invest in those in their IRA, but our consultants have told us that’s life insurance, and although you’re not buying a typical life insurance policy, it is classed a life insurance policy, and at Sunwest Trust, we won’t allow you to hold life settlements in your IRA.
Key IRS Letter Ruling Regarding S-Corp Stock
The last thing comes from an IRS letter ruling. You probably don’t even need these numbers, but it’s 199929029, April 27th of 1999, Internal Revenue Code Section 1361-b1b, which basically says you cannot own S-corporation stock. If you’re not familiar with that, there are basically two types of corporations and then LLC. You have what’s called a C-corp, which is most of the corporations you know of—IBM, General Electric. Those are all C-corps, and the differentiation between a C-corp and an S-corp is that a C-corp pays taxes on the income that is generated by the company. Similarly, they may or may not pay dividends to stockholders. However, with an S-corp, the income from the business passes through to the stockholders, and so an IRA cannot own stock in an S-corp. So those three things—collectibles, life insurance, or S-corp stock cannot be owned in an IRA.
We’ll talk more about prohibited transactions that involve disqualified parties, but that just gives you a general idea of the things that you cannot invest in your IRA, and so that opens a huge, huge array of other things that you can invest in. I hope this video has been helpful to you so it gives you some ideas on what you may want to do with your self-directed IRA. If you have any questions about setting up the self-directed IRA, give us a call at 1-800-624-7167. We encourage you to go our website, SunwestTrust.com and look at the videos on offer. There are over 130 videos there that explain a lot of different things about self-directed IRAs.