Disqualified Persons in a Self Directed IRA

May 8, 2018

If you want to improve the performance of your retirement account, consider investing offshore. Want to get in on the best ICOs or buy a rental property in a a high value international market, you’ll need convert your retirement account into a self directed IRA. When you go offshore, you need to watch out for disqualified persons in a self directed IRA. Here’s how to stay within the rules when you’re offshore.

When you invest a portion your retirement abroad, or move your entire account offshore, you must follow the same rules as if that account were in the United States. If you’re caught cheating, the penalties will be swift and severe… and your entire account might be affected (not just the portion you used for the improper investment).

Most investors have a US custodian to help them stay within the lines. When you invest using a self directed account, your custodian is always there for advice and support. They will also ask questions and investigate to ensure no rules will be violated by a particular investment.

This isn’t the case when you invest using an offshore IRA LLC. You’re in total control with an LLC and have no one backing you up. You must understand all of the rules and ensure that each and every transaction is compliant. And, considering that the entire account is at risk on every investment, the stakes are high.

The general idea behind the disqualified persons in self directed IRA rules is that all transactions must be at arm’s length. The best way to ensure that all the investments you make are fair to the account, and in the best interest of the account, is by prohibiting transactions with related parties.

That is to say, you may only transact with unrelated 3rd parties. Persons and companies that are not related to you and with whom you’ll (hopefully) strike a fair deal.

Note: When you create a self directed IRA or an offshore IRA LLC, you become both the account owner and the fiduciary. Thus, you need to understand all of the applicable rules.

The underlying principle of the disqualified person rules for self directed IRAs is that you, the account owner, should treat the account as a professional investment advisor would. You will only make investments that you believe will increase the value of the account or protect the value of the account. You won’t make investments that will benefit you or your relatives.

Ok, enough of the preamble. Who are disqualified persons in a self directed IRA?

Disqualified persons are individuals or entities between whom an IRA is prohibited (absent a special exception) from engaging in any direct or indirect sale or exchange or leasing of any property; lending of money or other extension of credit; furnishing goods, services or facilities; or transferring to or permitting the use of IRA income or assets.

The following members of your family are disqualified persons.

Spouse;
Parents;
Grandparents and Great-Grandparents;
Children (and their spouses);
Grandchildren and Great-Grandchildren (and their spouses).
Service providers of the IRA (e.g., IRA custodian, CPA, financial planner).
An entity (such as a corporation, partnership, limited liability company, trust or estate) of which 50% or more is owned directly or indirectly or held by a fiduciary or service provider.

These are the basic rules. There are additional rules around joint ventures and highly compensated employees that we’ll leave for another day.

You’ll see that brothers, sisters, aunts, uncles, cousins, step-brothers, step-sisters, and friends are NOT disqualified persons. Thus, arm’s length transactions involving these persons are permitted.

Remember that any deal you enter into must be in the best interest of the account and not for your benefit or the benefit of the other party. So long as the transaction is fair and the value paid is reasonable, you can do deals with your brothers and sisters.

The last on the list is the most common issue involving disqualified persons in self directed IRAs. “An entity (such as a corporation, partnership, limited liability company, trust or estate) of which 50% or more is owned directly or indirectly…”

When structuring a business transaction, you need to watch out for the 50% threshold. The intent here is that you should not invest IRA money in a business that you control. You could receive a benefit, such as a higher salary, or some other incentive for the investment.

Another issue when investing in partnerships is Unrelated Business Income Tax. When you receive an untaxed distribution, usually on a K-1 form, you must pay US tax at the highest rate before depositing that money into your IRA. You don’t get to receive business profits tax free.

UBIT is a complex topic. For more on UBIT in an a self directed account or offshore IRA LLC, see What is UBIT in an IRA?