Does the IRS Audit a Self Directed IRA?

Does the IRS audit selfdirected IRA

Self-directed IRAs allow investors to invest in assets like real estate, precious metals, private placement securities, promissory notes and tax lien certificates without the restrictions that typically accompany traditional IRA assets. But self-directed IRA investments come with additional risks not present elsewhere.

Investments require you to abide by complex IRS rules and regulations, failing which could incur extra taxes or financial penalties.

IRS Audits of Self-Directed IRAs

Recent years have witnessed an explosion in self-directed IRA popularity. These retirement accounts allow investors to take control of their own finances, bypassing Wall Street and making alternative investments directly with themselves. It is important to keep in mind, however, that these accounts still must abide by IRS audit requirements just like traditional IRAs do.

IRA investments made with disqualified persons, or transactions which violate prohibited transaction rules, will be subject to taxes upon distribution (plus penalties and interest). Examples of prohibited transactions would include providing loans or grants directly to IRA owners or immediate family members; purchasing real estate from disqualified parties; or investing with disqualified partners as partners in a partnership agreement.

Peek v. Commissioner, 140 Tax Court 12, involved a couple who attempted to use their SDIRAs to purchase company shares through debt financing by FP Corporation. However, the IRS claimed any personal guarantees made by either owner for support debt financing would constitute illegal transactions that violated tax code regulations.

IRA Custodians

Most IRA custodians do not permit their clients to invest in alternative assets because their fees come mainly from stocks and ETFs. Furthermore, custodians tend to frown upon investments made via private agreements without public financial information available such as an investment such as stocks or mutual funds.

Finding a custodian familiar with the different investments that will comprise your self-directed IRA is crucial to its success. They should facilitate transactions according to your directions while handling paperwork and administration for those investments, and be knowledgeable of IRS regulations surrounding alternative assets investments (e.g. no personal benefit to disqualified parties).

Custodian fees should also be reasonable for their services. Review fee schedules to gain insight into how the custodian will make money so that you can make an informed decision when selecting an IRA firm.

IRA Investments

Self-directed IRA accounts give investors access to alternative assets which may prove more lucrative than traditional IRA investments. But due to increased risks and vetting investment opportunities and avoiding prohibited transactions, this type of account requires considerable commitment and expertise from its holders.

As custodians do not provide financial advice, it is up to individuals themselves to independently verify the information on their account statements – including prices and asset values – by independent means such as consulting a third-party professional valuation service or conducting background research on promoters.

Unauthorized transactions such as purchasing or selling assets with disqualified persons, renting property to them or using personal funds to maintain SDIRA properties can result in penalties and interest charges being levied against your account.

IRA Taxes

Individual Retirement Accounts, commonly known as IRAs, provide large tax breaks for both individuals and small businesses alike. An IRA can hold assets such as stocks, mutual funds and real estate – many different kinds of IRAs exist including traditional, Roth, SEP and SIMPLE accounts which are administered by custodians.

Some IRA custodians allow investors to utilize their retirement accounts for nontraditional investments such as real estate, precious metals and commodities, private placement securities, promissory notes and tax lien certificates. Such investments may carry with them unique risks such as limited information or liquidity and even fraud risk.

Investors should exercise due diligence when investing in alternative investments through a SDIRA and take steps to verify the accuracy of financial information provided by promoters, such as getting third-party valuations or researching tax assessment records, advises Chase Insogna of InsognaCPA (opens new tab). Doing this may help them avoid potentially expensive prohibited transactions as well as IRS penalties like early withdrawal penalties or account disqualification that may arise, Chase says.

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