Prohibited Transactions

Prohibited Transactions in a Self Directed IRA

Working with a self-directed IRA means more freedom and control over your retirement funds, but it also means more involvement. You might be using your retirement funds to run a business, manage a piece of real estate, or fund a private equity deal. In all of these cases there will be significantly more involvement than there is when you just throw money at a few stocks. In your role as an active manager, you have to keep in mind one important regulation that does not usually apply to stock investing. This is the part of the US Tax Code known as Prohibited Transactions.

Prohibited Transactions are those actions which your self-directed IRA, or its assets, are prohibited from engaging in. These regulations were put into place to help prevent misuse of retirement account benefits. Although at first glance, the rules seem a bit complicated, they’re actually fairly easy to understand. Prohibited Transactions can be broken down into two main components: the person and the action. Only certain people are included in the regulations of Prohibited Transactions, and of those people only certain actions are prohibited. Let’s take a look and see how it breaks down.

The people that are regulated are known as Disqualified Persons and include the account holder, his/her spouse, the account holder’s close family (children, grandchildren, parents, etc.), and anybody who has financial ties to the retirement account (e.g. financial advisor). In other words, anybody who typically could have a vested interest or payout from the retirement funds. Again, since the purpose of Prohibited Transactions is to prevent the early misuse of retirement assets, only those most people most likely to benefit are included in the regulation. Obviously one could make a case for friends or other relatives as well, but the IRS had to draw the line somewhere, and that is where it currently stands. (For a complete and in-depth list of Disqualified Persons, read more here.)

Now let’s move on to regulated actions. In short, any benefit taken from a retirement asset or given to it by a Disqualified Person, is considered a Prohibited Transaction. This is true even if there is a fair exchange of value. An example of taking benefit from an asset would be allowing your grandson to live in an apartment owned by your retirement account, even if he pays standard rent. An example of giving benefit to an asset is to hire that same grandson to paint the apartment. Giving benefit is one area where those who invest in real estate have to be exceptionally careful. Any work that needs to be physically done to the property may not be performed by the account holder or any of the other Disqualified Persons. A third party must be employed in order to perform these functions.

As you can see, the concept and scope of Prohibited Transactions is not too difficult to comprehend. A few minutes spent reviewing the list of Disqualified Persons will give you the head start you need to have a proper perspective on any given transaction. If any questions do arise, please contact Madison Trust so that you can get the information you need.