Understanding Prohibited Transactions and Disqualified Persons in Self-Directed IRAs

When investing with a Self-Directed IRA (SDIRA), it’s essential to understand the concept of prohibited transactions and disqualified persons. These terms define specific rules set by the IRS to prevent IRA owners from benefiting improperly from their retirement assets. Violating these rules can lead to significant tax consequences, so let’s explore what they entail.

‍

What Are Prohibited Transactions?

A prohibited transaction occurs when an IRA owner uses their IRA in ways that violate IRS guidelines. These transactions typically involve the IRA owner or certain family members benefiting personally from IRA investments, which is strictly prohibited. The IRS intends that IRA investments be exclusively for retirement, meaning the assets must grow within the IRA without offering direct personal benefits to the account holder or related individuals.

‍

Examples of Prohibited Transactions

To help clarify, here are some typical transactions that are not allowed within an IRA:

• Investing in Your Own Business: IRA owners cannot use their IRA to invest in their own businesses, whether through private stock, promissory notes, or any other means of funding.
• Allowing Family Use of Real Estate: If your IRA owns real estate, it cannot be used by any family member, even if they are paying rent.
• Selling to Family Members: Selling any property held in your IRA to a family member is prohibited.
• Borrowing from Your IRA: The IRA owner cannot directly borrow funds from the IRA for personal use.
• Using IRA as Collateral: Using your IRA as a security for a loan is not allowed.
• Personal Use of Real Estate: Real estate in an IRA cannot be used personally by the account holder. This includes any occasional use or temporary stay.
• Selling Personally Owned Assets to Your IRA: You cannot sell assets you already own to your IRA to move them into the account.

‍
Who Are Prohibited People?

Disqualified persons are individuals who cannot directly or indirectly benefit from the investments within an IRA. These are specific family members and parties that have a close relationship with the IRA owner, creating potential conflicts of interest. These people cannot interact with the IRA assets in a way that could provide them with personal benefit.

‍

Commonly Prohibited People

The following individuals are generally considered disqualified persons:

• Spouse of IRA owner
• Parents and Grandparents of IRA owner
• Children and Grandchildren of IRA owner
• The IRA owner

‍
While this list covers most disqualified persons, it’s important to note that siblings are not automatically disqualified. However, depending on the nature of the investment, they could be considered disqualified. For example, selling a house held in an IRA to your brother or sister would be a prohibited transaction.

‍

Why These Rules Matter

These rules aim to maintain the integrity of retirement accounts and ensure their tax-deferred or tax-free growth for retirement purposes only. By avoiding prohibited transactions and interactions with disqualified people, you preserve your IRA’s tax-advantaged status and prevent penalties that can hinder your retirement savings.

‍

Final Thoughts

If you’re exploring self-directed retirement options, staying informed about prohibited transactions and disqualified persons is crucial. The potential for creative investment is vast with Self-Directed IRAs, but being aware of the rules ensures you can grow your retirement savings effectively and compliantly. When in doubt, consult a financial advisor or tax professional to avoid unintentional pitfalls and maximize the benefits of your self-directed retirement accounts.