Insights
The rules that bite: what a self-directed IRA can’t do
The prohibited-transaction rules are short, old, and unforgiving. They cause more self-directed disasters than bad investments do.
Most self-directed IRA failures are not the result of a deal going bad. They are the result of a rule going unread. The prohibited-transaction rules — Internal Revenue Code Section 4975, with a mirror in ERISA Section 406 — are the tripwires, and they are strict enough that a single misstep can unwind an entire account.
The principle in one sentence
A retirement account exists to benefit you in retirement, not to benefit you, or your family, today. Any transaction that blurs that line is prohibited.
Who is a “disqualified person”
The account cannot transact with a defined circle: you; your spouse; your ascendants and descendants (parents, grandparents, children, grandchildren) and their spouses; and entities that you or other disqualified persons control, generally at 50% or more. Fiduciaries and certain service providers to the account are included too. Notably, siblings, cousins, and friends generally are not disqualified persons — but the analysis is fact-specific, and the cost of guessing wrong is high.
The classic traps
Buying property from, or selling it to, a disqualified person. Personally staying in a vacation home your IRA owns. Lending to, or borrowing from, the account. Paying yourself to manage account-owned property — the “sweat equity” problem. Personally guaranteeing a loan the account takes. Each is a way of extracting a present benefit, and each is prohibited.
The penalty is severe
A prohibited transaction can be treated as a distribution of the entire IRA as of the first day of the year it occurred — meaning tax, and potentially penalties, on the whole balance, not just the offending piece. There is no partial credit.
The bottom line
The rules reward a simple discipline: keep the account and your personal finances strictly separate, route every dollar of income and expense through the account, and get professional review before any transaction that touches family or an entity you control. The custodian will not catch these problems for you. That job is yours.
This article is general information, not individualized investment, legal, or tax advice. Sources referenced include the Internal Revenue Service, Department of Labor, Securities and Exchange Commission, and FINRA. Consult a qualified professional about your circumstances.
Educational only. This page is general information, not individualized investment, legal, or tax advice. Rules depend on your account type, transaction, tax year, and circumstances — consult a qualified professional.