Although self-directed retirement plans allow for many diverse types of investments, there are several prohibited transactions as proscribed by the IRS that investors must adhere to . . . or risk paying penalties or having their accounts lose their tax-advantaged status.
A common error account holders make is to liquidate an investment that is in their self-directed IRA directly to them or to another IRA. This is not allowed because all income and expenses related to the investment must flow through the self-directed retirement account that made the initial investment. Therefore, any returns from the investment must go back to the IRA that invested in them.
Three common types of prohibited transactions are when:
- The account holder liquidates the IRA investment directly into another IRA – The proceeds must go back into the self-directed IRA first, and then can be rolled over or transferred into another IRA. Bottom line—the money has to go back into original account that made the investment. For example, say you had invested in a rental property through your self-directed IRA. If you sell that real estate, you are prohibited from directly taking the proceeds of the sale or liquidating them into another retirement account. The real estate IRA must receive the funds, which may then be distributed by the account custodian to the individual or transferred into another IRA, upon written instruction by the account holder.
- The investor takes the funds out from the investment directly and moves them to another account – Account holders are prohibited from doing this because the individual is not the investor, the self-directed IRA is. This causes the receiving custodian to treat and code the funds incorrectly. The other custodian will operate under the belief the money is income, a rollover or a contribution; however, this is not income from an asset it holds. Any transactions must be executed by the account custodian (upon instruction of the account owner), who will confirm that the transaction is allowed. There must be a trail that can be followed by the IRS in order to ensure the transaction and assets are treated properly.
It’s important to note here as well that any rollover from the liquidated assets into another IRA can be a taxable event, so investors are strongly advised to discuss their plans with their financial advisors or tax planners. The IRS will want to know where those funds came from. A distribution becomes a taxable event when the funds or asset is not rolled over to another tax-advantaged account within 60 days.
- The individual takes funds directly as a “distribution” – The account administrator cannot record this withdrawal as a distribution if the administrator did not first accept the funds. This is against the law and can have a negative cascading effect for the account holder.
If you ever have any doubt about a transaction, or you and your financial planner need clarification about how to handle liquidated assets, contact Next Generation Trust Services at Info@NextGenerationTrust.com or (888) 857-8058. Our experienced professionals can answer your questions about any aspect of self-directed retirement plans and the alternative assets allowed in them.