Prohibited Transactions and Disqualified Persons

What are the common prohibited transactions I should be aware of?

A prohibited transaction can result in audits, penalties, fines, or worst case, your IRA being distributed.

Investing in a prohibited Investment. 

The IRS rules for allowed investments are actually very wide, as long as you don't run into a prohibited Investment in a retirement account. The IRS sees these items below as a high risk of conflict of interest, such as a life insurance policy being attached to a person, not the assets of the retirement account. Or a person buying a classic Ferrari as an investment in their retirement account and then driving it around on the weekends, or a fine Turkish rug that is kept in someone's home. 

Doing business with disqualified persons

This includes people such as...

  • Your immediate family (spouse, children)
  • Parents and grandparents
  • Yourself
  • Blood-related or officially adopted children
  • Spouses of children
  • Companies where you own over 50%
  • Key highly compensated employees, officers, directors

Self-Dealing

Self-dealing is working with your own businesses, investments, or conflicts of interest to benefit yourself as well as your IRA retirement. Your IRA should benefit your IRA retirement, and your own interests should not be in conflict with your IRA. Some examples of self-prohibited transactions include...

  • Buying a property you already own yourself and putting it inside your IRA.
  • Living in the property that is in your IRA.
  • Paying yourself a salary to manage your own rental property.
  • Remodeling the bathroom of your self-directed investment property as a DIY project.
  • Buying land in your IRA, and then building a hunting campsite or lake house cabin you frequent with your friends and family on a small portion of it.
  • Investing in your business you own 50% or more of. 
  • Investing in a business you only own 5%, but you as the CEO make all decisions, including maybe decisions that could benefit your IRA.
  • Creating a significant benefit for a disqualified person, or unwritten quid pro quo in return for you making an investment with your IRA.
  • Investing in a racehorse, show dog, or prized livestock animal, and then sending it to your own competitions, your own parties to show off, and win your personal prizes and benefits instead of those benefits going to your retirement account.

Extension of credit

An extension of credit is getting a loan or margin inside your IRA. Any loans inside an IRA must be non-recourse. Non-recourse means that the loaning party can only go after the asset the loan was made for, such as the house or investment inside your IRA, and can't go after your personal assets like your car, personal home, and finances. This might change the terms from what you are used to at current market rates. An example of an extension of credit is...

  • Getting a traditional mortgage in you IRA
  • Using your personal credit or collateral outside your IRA to secure a loan inside your IRA
  • Using your Self-Directed IRA to secure a loan for yourself
  • Getting margin in your trading account. Margin loaning typically uses your outside income and assets to secure and confidently lend you the loan rather than being non-recourse of connected to the assets or contracts themselves. 

IRS publication 590A and IRC 4975 discuss prohibited transactions at length.