What is a Prohibited Transaction?

According to IRS Publication 590 - Generally, a prohibited transaction is any improper use of your traditional IRA account or annuity by you, your beneficiary, or any disqualified person. Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).

 

Who is a Disqualified Person?

Many prohibited transactions stem from the involvement of a disqualified person.  The following people are considered disqualified persons for the purposes of your self-directed IRA:

  • You, the account owner
  • A beneficiary of the IRA
  • Your spouse
  • Your lineal ascendants/descendants and their spouses
  • Plan service providers and fiduciaries (including advisors, custodians, and administrators)
  • An entity (corporation, estate, partnership, etc.) in which you own at least 50% of the voting stock, directly or indirectly.
  • An officer, director or a 10% or more share holder or partner. 

Disqualified_Persons2015

(See IRS Section 4975 for a complete list of prohibited parties credentials)

 

What investments are NOT permitted by the IRS?

A self-directed IRA offers a wide range of investment options but the IRS does not allow investments in collectables such as:

  • Artworks
  • Rugs
  • Antiques
  • Metals (excpet for gold, silver, palladium, and platinum bullion)
  • Gems
  • Stamps
  • Coins (except for gold and silver coins minted by the US Treasury Department)
  • Alcoholic Beverages

(For more information see IRS Publication 590.)

 

Types of Prohibited Transactions

  • Sale, exchange or leasing of a property between an IRA and a disqualified person.
  • Extension of credit or cash loan between an IRA and a disqualified person.
  • Furnishing goods, services, or facilities between an IRA and a disqualified person.
  • Transfer of IRA income or assets to, or use by or for the benefit of, a disqualified person. (Example: Renting a property owned by your IRA to your child)

(For more information see IRS Publication 590.)

 

What are the Potential Consequences?

A Self-Directed IRA allows you more investment options and flexibility than many other retirement accounts but it is of the upmost importance to avoid prohibted transactions in order to adhere to IRS rules. Failure to comply may lead to costly and serious consequences.

  • If there is a prohibited transaction in connection with an IRA account at any time during the year, the account stops being an IRA as of the first day of that year.
  • The IRA is treated as distributing all its assets to the IRA owner at their fair market values on the first day of the year. If the total of those values is more than the basis in the IRA, the IRA owner will have a taxable gain that is includible in his or her income.

 

Prohibited Transaction Exemptions

According to IRS Publication 590 - The following two types of transactions are not prohibited transactions if they meet the requirements that follow.

  • Payments of cash, property, or other consideration by the sponsor of your traditional IRA to you (or members of your family).
  • Your receipt of services at reduced or no cost from the bank where your traditional IRA is established or maintained.
Payments of cash, property, or other consideration

Even if a sponsor makes payments to you or your family, there is no prohibited transaction if all three of the following requirements are met.

  1. The payments are for establishing a traditional IRA or for making additional contributions to it.
  2. The IRA is established solely to benefit you, your spouse, and your or your spouse's beneficiaries.
  3. During the year, the total fair market value of the payments you receive is not more than:
    1. $10 for IRA deposits of less than $5,000, or
    2. $20 for IRA deposits of $5,000 or more.

If the consideration is group term life insurance, requirements (1) and (3) do not apply if no more than $5,000 of the face value of the insurance is based on a dollar-for-dollar basis on the assets in your IRA.

Services received at reduced or no cost.

Even if a sponsor provides services at reduced or no cost, there is no prohibited transaction if all of the following requirements are met.

  • The traditional IRA qualifying you to receive the services is established and maintained for the benefit of you, your spouse, and your or your spouse's beneficiaries.
  • The bank itself can legally offer the services.
  • The services are provided in the ordinary course of business by the bank (or a bank affiliate) to customers who qualify but do not maintain an IRA (or a Keogh plan).
  • The determination, for a traditional IRA, of who qualifies for these services is based on an IRA (or a Keogh plan) deposit balance equal to the lowest qualifying balance for any other type of account.
  • The rate of return on a traditional IRA investment that qualifies is not less than the return on an identical investment that could have been made at the same time at the same branch of the bank by a customer who is not eligible for (or does not receive) these services.