Pardon me for paraphrasing a catch phrase from a ubiquitously marketed credit card.  But were you aware that you actually have a lot of flexibility in terms of the investments you can choose to put into an IRA?  Besides stocks, bonds, mutual funds, and ETFs, you can invest in real estate, gold bullion, and in fact pretty much anything else except for insurance and collectables such as art.  But you have to be careful how you manage those assets, especially the illiquid ones, or you could end up disqualifying the entire account and facing a huge premature tax bill.

The purpose of an IRA is to provide for your future retirement. As a result, IRC section 4975 prohibits investments and/or transactions that directly or indirectly benefit you today (or even someone close to you such as your spouse or financial advisor).  It’s called “self-dealing.”  If you understand and follow this precept, you can avoid what the IRS calls “prohibited transactions” in your IRA accounts.

Here are some examples of prohibited transactions:

• You buy a Tesla with funds in your IRA.
• You purchase a vacation home for rental purposes in your IRA and stay in the home yourself when it’s vacant (even if for only one night).
• Your spouse owns a website creation business and you purchase an office space using IRA funds for him/her to use.
• You earn a salary from a business held inside your IRA.
• You purchase a landscaping business in your IRA and hire the firm to landscape the front yard of your personal residence.
• You use the security in property held in your IRA to take out a personal loan (e.g. a HELOC).
• You own a painting company, purchase a rental property in your IRA, and then hire your company to paint it.
• You lend cash in your IRA to your financial advisor.

What happens if you have engaged in a prohibited transaction?  Even if the account was valued at $1 million and the prohibited transaction only involved a $10,000 asset, the entire IRA account will be deemed to have been distributed as of the first of the year in which the prohibited transaction occurred. That means all earnings and tax-deducted contributions in the account will be taxed.  To minimize this risk you would do well to segregate each illiquid asset in a separate IRA account.

Prohibited transactions are not the only issues you face when holding illiquid investments in an IRA. When you have to start taking withdrawals from your IRA starting at age 70 ½, or if you want to move an illiquid asset into a Roth as part of a Roth conversion, you will need to obtain and report the fair market value of that asset.  That can be difficult for an ongoing business or a piece of commercial real estate.

And that’s not all.  When a business is operated within an IRA, income in excess of $1,000 may be taxable as unrelated business income (UBIT).  Income produced by a rental property purchased using debt (i.e. a mortgage) within an IRA could be subject to an unrelated debt-financed income tax (UDFI).

The bottom line: If you are going to push the envelope by holding these types of assets in your IRA you would do well to utilize account custodians and tax accounts that have experience keeping you on the right side of IRS scrutiny.