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Individual Retirement Accounts (IRAs) are retirement savings plans in the US that give owners certain tax advantages. By law, in order to enhance the accounts’ stability and security, IRAs are prohibited from engaging in certain transactions, adding a measure of protection to ensure that the funds will be available for the owner’s retirement. These IRA prohibited transactions target not only the types of investments that can be made, but also the people or organizations that are parties to transactions with an IRA. Compliance with IRA regulations is monitored by the Internal Revenue Service (IRS).
First established by the Employee Retirement Income Security Act of 1974 (ERISA), IRAs permit workers to open accounts and fund them with a limited amount of their earnings. Amounts contributed to one’s IRA, as well as any earnings, are exempted from federal income taxation, and usually state income taxation as well, until actually withdrawn from the IRA. Changes have been made to the IRA program since inception, including the introduction of the Roth IRA, but the IRA prohibited transactions apply to all IRAs.
Limits to the kind of assets the account may own are reflected in one of the most significant IRA prohibited transactions. Deposits to an IRA must be cash, and an IRA may not invest in collectibles such as works of art, stamp and coin collections, and antiques. Some precious metals may be purchased by an IRA as long as they meet certain qualifications. IRAs are strictly prohibited from purchasing life insurance.
One of the more misunderstood IRA prohibited transactions regards the use of an IRA’s assets to purchase real estate. This is prohibited only if that ownership provides an immediate benefit to the taxpayer. For example, an IRA owner may not use the IRA’s assets to purchase his own residence, even if he then makes rental or mortgage payments to the IRA. Real estate may be owned by an IRA if the owner doesn’t benefit from it, such as an apartment complex whose residents pay their rent directly into the IRA. The IRA’s owner may not act as a paid property manager, however.
Another misunderstanding arises over the power of the IRA custodian to prohibit transactions. The Internal Revenue Code is very clear, though, specifically granting custodians the authority to establish more restrictive transaction policies. For example, many IRA custodians will only permit the purchase of securitized real estate, such as real estate investment trusts (REITs), despite the fact that the Code generally permits direct ownership of real estate. The use of an IRA’s assets to make Code-compliant, non-traditional investments must be made through a custodian that permits the particular investment contemplated.
There is also a group of IRA prohibited transactions categorized by the IRS as transactions with disqualified persons. Among others, anyone with a fiduciary responsibility to the IRA, or anyone who benefits from it, is considered a disqualified person. This includes the custodian of the IRA and its employees, as well as the IRA’s owner and other listed beneficiaries. The relatives by blood or marriage of disqualified persons are also disqualified. Thus, an IRA may not lend money to its owner or any member of her family, nor may it be used as collateral for any such loan.
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