Prohibited Transactions: What Every Self-Directed IRA Owner Should Know
If you are interested in investing in alternative assets, then it is important to know the restrictions placed upon them. These restrictions are called prohibited transactions. Prohibited transactions refer to transactions made through self-directed IRAs that break IRS rules.
Prohibited transactions occur when an IRA transaction is conducted with a disqualified person. There are several events in which you may even be considered the disqualified person. A disqualified person typically involves someone who exhibits fiduciary control over the IRA, including certain family members.
Breaking IRA distribution rules can be costly and have serious consequences. If a disqualified person is involved in a prohibited transaction, the IRS imposes a tax on the investor, and the investment loses its tax-free or tax-deferred status.
If you are unsure whether or not you are about to conduct a prohibited transaction, have an advisor assist you with your investment strategy. Here at IRA Services Trust Company, we pride ourselves in knowing the IRS rules imposed on self-directed IRAs. As your IRA custodian, we want you to be aware of prohibited transactions as well.
Who is Considered a Disqualified Person?
- IRA account owner
- Children and their spouses
- Grandchildren and their spouses
- IRA account owners parents and grandparents
- Companies, partnerships or trusts where the IRA owner, family members, or business partners own or control 50% or more shares of voting power, capital interests, or beneficial interests
- Officer, director, highly compensated employees, or <10% shareholders who own or control 50% or more of the company
Consequences of Engaging in Prohibited Transactions
If the IRA owner engages an IRA in a prohibited transaction, the IRA will be disqualified, and the IRA owner may incur taxes and penalties.
The IRA account will be distributed based on fair-market value of assets in the year the prohibited transaction occurred. Distributions of the IRA may be subject to applicable taxes, and tax exemptions are revoked, leaving the IRA owner with tax obligations on income and capital gains.
A 10% early withdrawal penalty is applied on all pre-tax withdrawals from a Roth IRA, if the IRA owner has not reached 59 1/2 years of age. In summary, you do not want to leave the filing of IRA investments to just anyone. At IRA Services Trust Company, we take our custodial duties seriously and do not involve ourselves in any prohibited transactions.
3 Types of Prohibited Transactions:
1. Per se prohibited transaction
A per se prohibited transaction occurs when an IRA engages in transactions with a disqualified person.
2. Extension of credit prohibited transactions
An extension of credit prohibited transaction occurs when a disqualified person extends credit to an IRA.
3. Self-dealing prohibited transactions
A self-dealing prohibited transaction occurs when a disqualified person benefits directly from an IRA’s investments.
What is considered a transaction?
According to the Internal Revenue Code, a transaction is defined as a sale, lease, lending of money or extension of credit, or furnishing of goods and services.