By Dr. James M. Dahle, WCI Founder

With an explosion in interest in alternative investments (for better or worse), it seemed worthwhile to lay out the actual rules with regard to what you can and cannot do with an IRA. As you dive into this world, you will discover that many retirement plan providers, whether those plans are 401(k)s or IRAs, have significant additional limitations above and beyond what the IRS actually allows. This is often to reduce their hassle, reduce their costs, and earn them more money.

For example, if you go to a bank and open an IRA, you may only be allowed to invest in its crummy, overpriced actively managed funds in that IRA. Many 401(k)s won't allow you to make Roth contributions or Mega Backdoor Roth IRA contributions or accept IRA rollovers even though the IRS allows it.

So if you want to invest in something or do something unique with an IRA, your first step should be to see whether your desired action/investment is actually prohibited by the IRS, and if not, look around until you find an IRA provider willing to let you do it. Naturally, many of these sorts of things probably shouldn't be done in the first place, especially if the additional costs of doing so are particularly high. And often, it is simply just easier to do them using a taxable investing account.

But if all or most of your money is in retirement accounts, it may be worth it to try to invest in these alternative investments using retirement money.

We're going to go through two lists today—a list of prohibited investments and a list of prohibited transactions.


Investments Prohibited in an IRA

These are investments that cannot be purchased by an IRA.


#1 Life Insurance

You cannot put life insurance in an IRA. You can, however, put it in a 401(k) if the amount is “an incidental amount.” Basically, the premium can't be more than 50% of the annual employer contribution for a whole life policy or 25% if it is a universal or variable life policy.


#2 Collectibles

Collectibles are also specifically disallowed. This includes art, antiques, furniture, porcelain, alcohol (wine), stamps, baseball cards, comic books, Beanie Babies, and similar investments.


#3 Coins

As a general rule, you cannot own physical gold coins in an IRA. There are exceptions to this, though. Basically, the idea is if the coin is very pure in quality and not considered a collector's coin, you can invest in it. So American Eagle coins are allowed but Krugerrands are not. Basically, the coins need to be currency and not collectibles.


#4 Options

You can use some options/derivatives strategies in an IRA, but there are others that you cannot. Many other derivatives also cannot be used in an IRA. The riskier the strategy, the less likely you can use it in an IRA. Here are some examples:

Okay in an IRA:

  • Buy calls
  • Sell calls
  • Buying puts
  • Selling puts
  • Covered calls
  • Collars

Not okay in an IRA:

  • Trading on margin
  • Selling naked
  • Short selling


#5 Personal Real Estate

You can own real estate in an IRA, but you can't use it. You can't put your home or your vacation home in it. All expenses for the real estate have to come out of the IRA, and all income must go into the IRA. Your IRA can't buy real estate from you or your family, and it can't sell it to you or your family either.


Aside from those restrictions, anything else goes inside an IRA if you can find a custodian willing to deal with the hassles and if you are willing to pay the costs associated with doing it. That includes investment real estate, cryptocurrencies like Bitcoin, gold ETFs, private companies, hedge funds, oil and gas investments, limited partnerships, and tax lien certificates, in addition to more traditional investments like stocks, bonds, mutual funds, ETFs, and CDs.

Keep in mind that I don't actually recommend you invest in most of these alternative investments at all. I'm just saying you could invest in them if you desired. If you are interested in a self-directed IRA (or 401(k)) that allows you to invest in these sorts of assets, take a look at our recommended retirement plan providers.


Unrelated Business Income Tax

Charities and other tax-exempt entities (like IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs) are subject to Unrelated Business Income Tax (UBIT). If your IRA invests in a business such as a Master Limited Partnership (MLP) or a Limited Partnership (LP), the income from that business will be subject to tax at corporate tax rates (21% as of December 2021), even if the partner is an IRA. Dividends and interest are typically excluded, but the income that shows up on a K-1 usually is not. These investments are generally better held in a taxable account.

IRA investors typically get tripped up by this when they invest in real estate. If you're investing in a private real estate debt fund or similar, that income is OK since it is interest. But if you're investing in an equity syndication or fund, it gets a little more interesting. If the property is financed with debt, only that portion of the income attributable to the debt is subject to UBIT. If the property is paid off, no big deal. If it is 100% financed, all of the income over $1,000 is subject to a 21% tax. That tax is paid by the IRA—not by the owner of the IRA—and the IRA actually has to make quarterly estimated tax payments on it if the income is more than $1,500.

So while leveraged equity real estate, small businesses, and energy MLPs are not technically prohibited IRA investments, it's really not a good idea to have them in your IRA. Do yourself a favor if you really want these investments: put them in a taxable account. You'd avoid this hassle, and you could also take advantage of the depreciation-associated tax breaks that these investments qualify for.


Transactions Prohibited in an IRA

In addition to prohibited investments, there are also prohibited transactions.


#1 Borrowing from the IRA

Unlike a 401(k), you can't borrow from an IRA at all. A 401(k) will allow you to borrow the lesser of $50,000 or 50% of the account value. At times, that amount may be temporarily lifted. In 2020, for example, you could borrow $100,000 or 100% of the account value. You can borrow the money for the shorter of five years or until tax day next year. But that's not an option with an IRA. You can make a withdrawal, but you can't get a loan.

prohibited transactions investments in ira


#2 Borrowing Against an IRA

Unlike cash-value life insurance, your home, or your car, you can't pledge an IRA as collateral for a loan.


#3 Buying and Selling Personal Property

As mentioned earlier, your IRA cannot buy your property or that of your family members (and family member is pretty widely defined to include spouses of your children and even your great-grandparents). You also can't sell property to you or your family members.


#4 Renting Property to You

You and your family members cannot use the property owned by the IRA, even if you pay the IRA rent for it. So if you bought an apartment building with IRA money, you could not turn around and hire your child as a live-in manager in the property.


The penalty for any of these prohibited transactions in an IRA is pretty severe. Basically, the next January 1 after you do it, the account stops being an IRA at all. It's considered 100% distributed to you, and you will owe a 10% penalty on all of it. And if it is a traditional IRA, the entire IRA will be taxable in that year. The penalty for prohibited investments isn't quite as bad, but it's close. The amount put into the prohibited investment is considered to be distributed from the account.

The theme here is clear. There are a lot of investments that you can invest in that maybe you shouldn't, and there are a lot of investments you can put into an IRA that maybe you shouldn't. But if you know and follow the rules, you shouldn't get yourself into too much trouble using retirement account money for alternative investments.

What do you think? Do you use retirement account money for alternative investments? Why or why not? If so, how? Comment below!