What are the most common and costly IRA mistakes? They fall under four different categories; prohibited transactions, self-dealing, indirect benefits and unrelated business income tax (UBIT).
Under the Employee Retirement Income Security Act (ERISA), there are a number of transactions that can not be made within a self directed IRA account, while maintaining the tax-free or tax-deferred status. Making a prohibited transaction can be a common and a very expensive IRA mistake, particularly if your trustee is not well versed in the ERISA laws.
Here are some examples of transactions that are not allowed, within your IRA. You can not borrow money from it or sell property to it. You can not use the account as security for a loan. You may not use account funds to buy property for personal use, whether for a present or a future home. And, your trustee may not receive unreasonable compensation for managing it.
Self-dealing are common and costly IRA mistakes. Funds may not be used to buy property or securities from a "disqualified person". Those who are disqualified under the self-dealing rule include you (as the account owner), your spouse, parents, grandparents, great-grandsparents, your children and their spouses, and service providers for the account. Service providers for the account would include your truste, CPA, financial planner, etc.
Transactions between your IRA account and companies or corporations that are owned by you or any of the people above are also prohibited. An exception applies if you own less than 50% of the company's stock.
Indirect benefits could be common and costly IRA mistakes, as well. Under this rule, you have to understand that Individual Retirement Account funds are meant to secure your future. You are prohibited from receiving a benefit from them today. There are a number of examples.
One of the most common and costly IRA mistakes is taking a vacation in a rental property owned by the account. Even if you pay the rent, you are not allowed to enjoy this property and neither are the close family members mentioned above. Your sister or brother could rent the house for a week, but not "you" personally.
Normally, the passive income generated by an IRA is not subject to this tax. But, in certain situations, profits or rental incomes from homes owned or sold within the account may be. Unrelated business income tax, or UBIT is another very common and costly IRA mistake, which can be the result of a real estate transaction, which required the use of a mortgage or other financing vehicle.
Most advisors recommend that the best real estate transactions are "cash only". In other words, the account can buy the property outright. Financing is allowed, but profits and rental incomes become subject to UBIT, which effectively reduces income margins.
There are other examples of income within the account that would be subject to UBIT. Check with your trustee or tax advisor, if you are unsure. It is better to be safe than make one of these common and expensive IRA mistakes