IRA Prohibited Transactions: The Complete Guide
Investing through a self-directed IRA opens the door to real estate, private lending, precious metals, and dozens of other alternative assets. But that freedom comes with a firm set of guardrails. At the top of the list: Self-directed IRA prohibited transactions.
A single prohibited transaction can disqualify your entire IRA, triggering immediate taxes, penalties, and years of lost tax-advantaged growth.
What Is a Prohibited Transaction?
A prohibited transaction is any direct or indirect transaction between your IRA and a disqualified person that the IRS considers self-dealing or a conflict of interest. These rules exist under Internal Revenue Code (IRC) Section 4975.
Your IRA must operate at arm’s length. It is a separate legal entity. You cannot use it to enrich yourself today, cut personal deals with family members, or gain any current economic benefit from the assets it holds.
The Six Categories of Prohibited Transactions
Under IRC Section 4975(c)(1):
- Sale, exchange, or leasing of any property
- Lending of money or other extension of credit
- Furnishing of goods, services, or facilities
- Transfer to, or use by or for the benefit of, IRA income or assets by a disqualified person
- Act by a disqualified person who is a fiduciary dealing with IRA income or assets in their own interest
- Receipt of consideration by a disqualified person who is a fiduciary from any party dealing with the IRA
Who Is a Disqualified Person?
Disqualified persons include:
- The IRA owner (you)
- Your spouse
- Your lineal ascendants — parents, grandparents, great-grandparents
- Your lineal descendants — children, grandchildren, great-grandchildren
- Spouses of your lineal descendants — son-in-law, daughter-in-law, etc.
- Fiduciaries of the IRA — custodian, administrator, or anyone with discretionary authority
- A person providing services to the IRA — accountants, attorneys, investment advisors
- Any entity 50% or more owned or controlled by any of the above
- Officers, directors, or highly compensated employees (10% or more) of entities providing services to the IRA
Notice who is NOT on the list: siblings, aunts, uncles, cousins, and friends.
Prohibited vs. Permitted: Action-by-Action Comparison
| # | Action | Prohibited or Permitted? | Why |
|---|---|---|---|
| 1 | You buy a rental with your IRA and live in it on weekends | Prohibited | Personal use of an IRA asset |
| 2 | Your IRA buys a rental in another state with a third-party manager | Permitted | No disqualified person involvement |
| 3 | You loan your IRA $10,000 to complete a closing | Prohibited | Extension of credit |
| 4 | Your IRA lends money via a promissory note to an unrelated party | Permitted | Borrower is not a disqualified person |
| 5 | Your son manages the renovation and you pay him from IRA funds | Prohibited | Furnishing services by a disqualified person |
| 6 | You hire an unrelated contractor to renovate | Permitted | Contractor is not a disqualified person |
| 7 | You sell land you own to your IRA | Prohibited | Sale between you and your IRA |
| 8 | Your IRA purchases land from a non-disqualified third party | Permitted | Arm’s-length transaction |
| 9 | Your IRA buys into an LLC you also personally invest in (50%+ control) | Prohibited | Entity becomes disqualified |
| 10 | Your IRA invests in an LLC alongside your cousin (no 50%+ control) | Permitted | No disqualified person controls the entity |
| 11 | You use your credit card to pay for an emergency IRA property repair | Prohibited | Extension of credit from you to your IRA |
| 12 | Your IRA pays for the repair directly from IRA funds | Permitted | All expenses paid by the IRA |
Real-World Examples of Prohibited Transactions
Example 1: The Vacation Rental Trap
Maria’s IRA purchases a beachfront condo. She rents it most of the year but stays in it for two weeks during the holidays. Even brief personal use is a prohibited transaction.
Example 2: The Family Contractor
David’s IRA buys a fixer-upper. His father (a retired contractor) offers to oversee the renovation at a discount. Paying a lineal ascendant for services is prohibited.
Example 3: The Personal Guarantee
Lisa personally guarantees a bank loan to her IRA. A personal guarantee is an extension of credit from a disqualified person.
Example 4: Selling Personal Property to the IRA
James sells his commercial building to his IRA at appraised value. Price doesn’t matter — any sale between the IRA owner and the IRA is prohibited.
Example 5: The Sweat Equity Mistake
Karen spends weekends painting, mowing, and screening tenants at her IRA-owned apartment building. Even unpaid labor is a prohibited transaction.
Consequences and Penalties
| Consequence | Details |
|---|---|
| Full IRA disqualification | IRA treated as if distributed all assets on January 1 of the violation year |
| Ordinary income tax | Entire fair market value added to taxable income |
| 10% early distribution penalty | If under age 59½ |
| Excise tax on disqualified person | 15% of the amount involved |
| Additional excise tax if not corrected | 100% of the amount involved |
| Loss of tax-advantaged growth | All future compounding permanently lost |
Example of Financial Damage
Self-directed Roth IRA worth $300,000, prohibited transaction at age 45:
- Federal income tax at 24%: $72,000
- 10% early distribution penalty: $30,000
- State income tax: $10,000–$20,000
- Total loss: approximately $112,000–$122,000 — plus all future tax-free growth
The Correction Window
The IRS allows a correction period to reverse the prohibited transaction and restore the IRA. Successful correction can eliminate the 100% excise tax, but the initial 15% excise tax still applies. Consult a tax professional immediately if a prohibited transaction occurs.
Prohibited Transaction Exemptions
Key Statutory Exemptions:
- Reasonable compensation for custodian services
- Bank deposits
- Fair market value distributions (RMDs)
- Rollovers and transfers
What Is NOT Exempt:
- Selling personal property to your IRA at “fair market value”
- Loaning money to your IRA in an “emergency”
- Performing services for the IRA “for free”
- Indirect transactions through entities you control
How to Avoid Prohibited Transactions: A Practical Checklist
Before You Invest:
- Identify every person and entity involved
- Run each name through the disqualified person list
- Confirm no disqualified person will provide services, financing, or property
- Verify no disqualified person will receive benefit from the IRA asset
- Ensure all funds flow through your IRA custodian
- If purchasing real estate, confirm you will not use the property
During the Life of the Investment:
- Hire only non-disqualified third parties
- Never commingle personal funds with IRA funds
- Do not personally guarantee any loan
- Keep all transactions documented through your custodian
- Review new family relationships (marriages) that may create new disqualified persons
When in Doubt:
- Contact your custodian before proceeding
- Consult a tax professional or ERISA attorney
- If a deal benefits you personally right now, it probably crosses the line
Frequently Asked Questions
What is a prohibited transaction in an IRA?
Any transaction between your IRA and a disqualified person that falls within the categories defined under IRC Section 4975.
What happens if I accidentally make a prohibited transaction?
The IRS does not distinguish between intentional and accidental violations. The IRA may be treated as fully distributed on January 1 of the violation year.
Can I sell property to my IRA?
No. Regardless of price or fair market value.
Can I hire my child to manage my IRA rental property?
No. Your children are lineal descendants and disqualified persons.
What is a disqualified person?
Anyone identified under IRC Section 4975(e)(2) who is barred from transacting with your IRA. Includes you, spouse, parents, children, grandchildren, their spouses, and controlled entities.
Can I fix a prohibited transaction?
In some cases, yes, through the IRS correction period. The initial 15% excise tax typically still applies.
Does the prohibited transaction rule apply to Roth IRAs?
Yes. Equally to Traditional, Roth, SEP, and SIMPLE IRAs.
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