IRA Prohibited Transactions

Checkbook control gives you direct authority over your IRA's investments. It also puts the responsibility on you to avoid prohibited transactions. The rules are in Internal Revenue Code Section 4975, and breaking them can cost you the tax-advantaged status of your entire IRA.

Who is a disqualified person

• You, the IRA owner.
• Your spouse.
• Your parents, grandparents and other ancestors.
• Your children, grandchildren and other lineal descendants, and their spouses.
• Fiduciaries and people providing services to the IRA.
• Businesses, trusts or estates that are 50 percent or more owned by any of these people.

Siblings, aunts, uncles, cousins and friends are not disqualified persons under Section 4975, although transactions with them can still be prohibited if they benefit you indirectly.

The six types of prohibited transactions

1. Selling, exchanging or leasing property between your IRA and a disqualified person.
2. Lending money or extending credit between your IRA and a disqualified person, including a personal guarantee of an IRA loan.
3. Furnishing goods, services or facilities between your IRA and a disqualified person.
4. Transferring or using IRA income or assets for the benefit of a disqualified person.
5. A fiduciary dealing with IRA income or assets in their own interest.
6. A fiduciary receiving payment from a party dealing with the IRA.

Common mistakes in an IRA LLC

• Staying in, renting or personally using property the IRA owns, even for a weekend.
• Buying property from, or selling it to, your parents or children.
• Doing the repair or renovation work yourself instead of hiring an unrelated contractor.
• Paying yourself a salary or fee from the LLC.
• Paying IRA LLC expenses with personal money, or depositing IRA income into a personal account.
• Personally guaranteeing a loan made to the LLC.
• Lending IRA money to a business you or a family member controls.

What happens if a prohibited transaction occurs

Under IRC Section 408(e)(2), if the IRA owner engages in a prohibited transaction, the account stops being an IRA as of the first day of that year. The entire account is treated as distributed at its fair market value. The amount is taxable income (unless it is qualified Roth money), and if you are under age 59 and a half, the 10 percent early distribution penalty can also apply. Owing unrelated business income tax (UBIT) is different. It is a tax on certain income, not a prohibited transaction.

Investments IRAs cannot hold

Separately from prohibited transactions, an IRA cannot invest in life insurance, and collectibles such as artwork, rugs, antiques, gems, stamps, most coins and alcoholic beverages are treated as distributions. Certain gold, silver, platinum and palladium bullion meeting IRS fineness standards is permitted.

How to stay compliant

• Keep every IRA LLC transaction with unrelated third parties.
• Keep all IRA money in the LLC bank account.
• Pay every expense from the LLC account.
• Document each investment.
• Ask before you act when a family member, your own business, or your personal use is involved.