Prohibited transactions are dealings your self-directed IRA must avoid to comply with IRS regulations that govern them. If you self-direct an IRA or solo 401(k), it is your responsibility to understand what these transactions entail and to avoid them at all costs. Failure to avoid prohibited transactions in an IRA can dramatically impact and even disqualify the tax-sheltered status of your account.
So, take our advice and don’t mess with the IRS.
Our previous blog in this IRS rules for IRAs series covered dealings with disqualified persons. Your IRA is not allowed to do business with disqualified persons or allowing these people or entities to enjoy current benefits from your IRA–doing so is a prohibited transaction.
This article explains prohibited transactions in greater detail, because all prohibited transactions in an IRA are not simply dealings with disqualified people. Protect yourself and your hard-earned retirement funds by taking the time to learn the IRS rules on prohibited transactions inside and out.
Top 4 Ways to Avoid Prohibited Transactions in Your IRA
1. Remember: You and your self-directed IRA are separate entities.
As the plan owner, you have great control in choosing your own investments, but any asset purchased with plan funds is owned by the plan and not by you personally.
2. Understand IRA-owned assets are meant to benefit you when you retire—and not a minute beforehand.
Investments cannot benefit you in the here and now. They can only benefit you at the time you retire and can begin taking distributions. Remembering this fact will lessen issues that could arise should you act otherwise.
Common prohibited transactions with disqualified persons (including yourself) are:
- Borrowing money from your IRA; loaning funds to another disqualified person (such as your mom or dad)
- Using your IRA as security for loans
- Using your IRA to buy property from yourself or other disqualified persons
- Buying real estate in your IRA for personal use (such as a vacation rental)
- Allowing a disqualified person to vacation in home your IRA owns
- Purchasing property from or selling IRA-owned property to a disqualified person
- Receiving personal income from rental property owned by your IRA
- Renting IRA-owned property to a disqualified person (like a son or a daughter in a house your IRA purchased in their college town)
- Hiring a disqualified person to perform work or services for assets in your IRA
The above are just a few examples to give you a feel for transactions not allowed in your IRA. For a comprehensive list of the rules and consequences regarding prohibited transactions and disqualified persons, see IRC 4975.
3. Do not invest in collectibles or life insurance in your IRA.
These items are well defined in IRC 4975 and include
- Works of art, rugs, antiques, porcelain, gems, alcoholic beverages, stamps, cards, comic books and like investments
- Life insurance
- Note that qualified plans such as 401(k)s have an exemption (with exceptions) to this rule. Consult your CPA for guidance.
4. Seek proper counsel from appropriate tax or legal advisors familiar with rules for IRAs.
These professionals can help you avoid dealings that put your IRA in danger of operating outside the boundaries.
Do You Have Any Questions?
Identifying prohibited transactions in an IRA or solo 401(k) can be confusing, especially since there are so many alternative assets you can use to build retirement wealth. However, with a little knowledge and additional resources, you can learn what to avoid.
You can also contact Advanta IRA for more information about prohibited transactions in an IRA. We offer free consultations, and our resources library is full of recorded webinars, short videos, blogs, podcasts, and more to help you become more knowledgeable in the world of self-direction and alternative investments.
More on IRS rules for IRAs and 401(k)s:
This article was first published on September 20, 2017 and has been updated with current information.