Prohibited Transactions

A Thorough Guide to Prohibited Transactions and Self-Directed IRA Rules

The Self-Directed IRA has enough freedom in it that it’s often defined by what you cannot do, not what you can do. Specifically, the IRS makes it known which items you should not use within a Self-Directed IRA. That means that you will have a wide berth when it comes to choosing items to invest in, including real estate, precious metals, and even non-traditional investments like tax liens and private loans.

But what if you are still unsure? Let’s take a thorough look at the specific prohibited transactions and rules governing Self-Directed IRAs to ensure you keep your accounts up to par:

Defining the “Disqualified Person” within a Self-Directed IRA

Read up on Self-Directed IRAs often enough and you’ll encounter this phrase: “disqualified person.” What does it mean exactly, and who might the disqualified persons in your life be? Here are the people it includes:

  • You (the account holder)
  • Your spouse
  • The IRA beneficiary
  • Your direct ascendants/descendants
  • Advisors, custodians, administrators
  • A corporate entity you own
  • A shareholder or partner

In essence, many of the people you might like to see benefit from your retirement account are disqualified. This rule is in place to avoid using a retirement account, for example, to hold real estate which you rent out to a relative. These prohibited transactions prevent wealthy people from avoiding taxes with these favorable relationships and ensure that the Self-Directed IRA acts more like a traditional investment rather than a way to give perks to family and friends.

While this might seem limiting, keep in mind that the list of Disqualified Persons, on the whole, is small. The people with whom you can do business via a Self-Directed IRA essentially includes everyone else.

Understanding the Self-Directed IRA Prohibited Transactions

Once you have a handle of the disqualified persons, you will understand where many of the prohibited transactions within an IRA might occur. You cannot lease out an apartment you own through a Self-Directed IRA to your son or daughter, for example. The same extends to other investment types; lending to a disqualified person with money from an IRA would also be considered a prohibited transaction.

But it’s also important to remember that you are a disqualified person. This can lead to a number of prohibited transactions that you never would have thought were “wrong” in any way, including the following examples:

  • Purchasing real estate through a Self-Directed IRA and going to said property to personally make repairs. This might seem like something any wise real estate investor might do, but because you are the disqualified person in this case, this is considered a “direct or indirect furnishing of goods, services, or facilities between an IRA and a disqualified person.”
  • Using a home, you own through a Self-Directed IRA for personal use would also qualify. The IRS prohibits a direct/indirect transfer of the income/assets of an IRA for personal use. This means you can’t buy your own home to live in within a Self-Directed IRA; you would be expected to use a property management company that collects income from a tenant who is not a disqualified person.

Understanding “Disqualified persons” is the key to understanding how to treat investments within a Self-Directed IRA. Essentially, the investments you keep within an IRA have to be separate from you. They are not for your personal benefit, as the IRS wants to distinguish retirement investments from personal investments. The purpose of the tax protection of retirement accounts being deferring the growth until later, the IRS does not want to see taxpayers avoid paying taxes now because of the misuse of current assets as “retirement” assets.

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