What Your IRA Can and Cannot Invest In

IRAs can provide financial security for your retirement if you make contributions and invest your money wisely. However, the tax law has some restrictions in IRA investments. If you do not keep within the rules, you trigger adverse tax results: immediate taxation of benefits and tax penalties. Here are some of those prohibited investments options to avoid as well as some popular investment options you can consider using:

Collectibles. The tax law specifically bars investments within a self-directed IRA that are collectibles. These include alcoholic beverages, antiques, art works, gems, guns, metals and coins (other than those explained below), rugs, and stamps. If you make such a prohibited investment, it’s treated as an immediate taxable distribution. If you’re under age 59-1/2, there’s also a 10% penalty. However, the tax law allows investments in state-issued coins and certain U.S. minted gold, silver, and platinum coins. You can also hold gold, silver, platinum, and palladium bullion that meets commodity market standards; the metal must be held by your IRA’s institutional trustee and not stored with the company that sold it.

Digital assets. The IRS has not yet ruled specifically on whether IRAs can hold bitcoin or other digital assets. It is assumed an investment in cryptocurrency or a non-fungible token (NFT) is permissible through a self-directed IRA. Qualified retirement plans are specifically permitted to do so, although the Department of Labor has issued a strong caution about the risk of such investment. Keep in mind that if you want your IRA to invest in a digital asset, you must first contribute cash; digital assets are treated by the IRS as property and not cash.

Real estate. In selecting assets for an IRA, the tax law lets you buy any type of real estate, including raw land, residential property, and commercial realty. The property can be purchased outright to generate rent or to hold for appreciation that is expected to result on a future sale. The law even allows IRA owners to pool their resources if they don’t have the full purchase price in their accounts. However, certain restrictions apply to prevent any “personal” benefit from such ownership:

• You and your relatives cannot live in or use the property
• You cannot work on the property (e.g., make repairs); all work must be done by a third party who is paid at the market rate
• You cannot be the seller of property to your IRA
• You cannot guarantee a loan for your IRA

What’s more, if you are a real estate agent, you cannot charge commission for a sale by a third party to your IRA.

If you need to finance the purchase of the property, you can only use a non-recourse loan (one that limits the lender’s recourse to the property and not to you or your IRA). And you need to find a custodian for your self-directed IRA; not all financial institutions offer this option.

Unrelated business income. If your IRA receives income that is viewed as unrelated business taxable income (UBTI), the account is currently taxed on it (taxes are taken by your IRA custodian/trustee from your IRA to pay the tax owed. Taxable income in your otherwise tax-deferred IRA can occur if you invest in master limited partnerships (MLPs), which are publicly traded investments. For example, you invest in an MLP that drills for oil. If the MLP owns drilling equipment that is leased to a third party, the rental income is treated as UBTI for your IRA. So, although a MLP is a permissible investment, it may not always meet your tax deferral goals.

Conclusion

It is advisable for an IRA owner to regularly review account investments, including a careful assessment of the investments’ returns, market fluctuations, the amount of fees, and whether your holdings still meet your investment objectives.

Sources:  DOL Employee Benefits Security Administration, Compliance Assistance Release No. 2022-01 at (https://www.dol.gov/newsroom/releases/ebsa/ebsa20220310)