Examples of prohibited investments are Collectibles and Life Insurance Products.
Also, you can not have any “self dealings” which are prohibited IRA transactions.
In general, Internal Revenue Code Section 4975 defines a prohibited transaction as a transaction between a plan (your account) and a disqualified person.
Generally, “disqualified persons” are defined to be the account holder, other fiduciaries, certain family members (lineal descendents and spouses of lineal descendents), and businesses under the account holder’s (or disqualified person’s) control.
Prohibited IRA transactions are:
1. A sale or exchange, or leasing of property between a plan and a related party.
2. Lending of money between a plan and a related party.
3. Furnishing goods, services or facilities between a plan and a related party.
4. Transfer to, or use by, a related party of the income or assets of a plan.
5. Act by a related party whereby he deals with the income or assets of a plan in his own interest or for his own account.
6. Receipt of any benefit for his own personal account by any related party in connection with a transaction involving the income or assets of the plan.
A disqualified person is you, your children, grandchildren, spouse, or parents. It is also any business owned 50% or more by any of the above. According to the IRS, siblings, aunts, uncles, cousins and step relations are not included in the definition of disqualified persons.
If you engage in a prohibited transaction the IRS will consider your IRA fully distributed. However there are hundreds of exceptions granted each year to the prohibited transaction rules. The Department of Labor has been given the power to grant these exceptions.
One of the most important exceptions is 96-62 which says that you only have to demonstrate that your requested transaction is substantially similar to two or more individual exemptions granted within the previous five years. This is called a “class exemption”.
For further information please see U.S Department of Labor Class Exemptions
Essentially if your transaction is an arms length transaction that is a legitimate investment you can probably find similar exemptions that have been approved.
To protect yourself you need a properly constructed Operating Agreement for your Self Directed IRA LLC.
Also See FAQ