What is a Prohibited Transaction?
17. May, 2010 
3 Comments
I love self-directed IRA’s. I recommend them all the time to investors and private lenders. A questions I get a lot is…
“Susan, I am looking into setting up a self-directed IRA but I have read some horror stories about people getting in trouble with the IRS because they did a “prohibited transaction.” What is a prohibited transaction and how do I know I’m not accidentally doing one?” — Jimmy Davis
Hey Jimmy, it’s good that you are aware of this. Here’s what you need to watch out for…
In a nutshell, you cannot invest in Collectibles or Life Insurance Contracts. In addition, there are certain transactions in which you cannot participate when using IRA funds. These are referred to as “prohibited transactions”.
Prohibited transactions are defined in IRS Publication 590. They were established to maintain that everything the IRA engages in is for the exclusive benefit of the retirement plan. Professionals often refer to these as “self-dealing” transactions. Self-dealing occurs when an IRA owner uses their individual retirement funds for their personal benefit rather than to benefit the IRA. As an IRA owner, if you violate these rules, your entire IRA could lose its tax-deferred or tax-free status.
Here are some examples of what the IRS considers a prohibited transaction:
• Your IRA cannot buy property you currently own from you.
• You cannot personally guarantee a loan for a real estate purchase by your IRA.
• You cannot use personal furniture to furnish your IRAs rental property.
• Your IRA cannot buy a vacation property you or your family intend to use.
• You cannot pay yourself income from profits generated from your IRAs rental property.
Self directed IRA’s are a phenomenal tool for real estate investors. Just make sure you’re making the right decisions. Or working with a company who can educate you appropriately. I recommend Guidant Financial.
Susan,
The self-directed IRA(SDIRA)seems to give the account holder great control, liquidity, and flexibility.
I’ve been hearing more people recommending the SDIRA lately, but I’m not comfortable that I understand whether there is a “downside”, and what that might be.
So, can you please advise as to what risks and disadvantages may be associated with SDIRAs?
Thanks very much!
The big risk in a true SDIRA is that you’ll screw up and engage in a prohibited transaction. If there’s a custodian involved there’s a little more oversight but when you’re in charge you’re in charge. So make sure you do your research.