Adam Bergman

Founder, Tax Lawyer, Author

A Self-Directed IRA lets you invest your retirement savings in real estate, private companies, crypto, private loans, and other assets most brokerage IRAs won’t hold. The tradeoff is that you’re responsible for following the IRS prohibited transaction rules. They aren’t complicated, but breaking one can disqualify your entire IRA. Here’s what the rules cover, who they apply to, and how to stay on the right side of them.

What Is a Self-Directed IRA?

A Self-Directed IRA isn’t a separate kind of IRA under the tax code. It’s an IRA held with a custodian that allows alternative assets as well as stocks and funds. Tax treatment is the same as any IRA: tax-deferred growth in a Traditional IRA and tax-free qualified distributions in a Roth IRA.

A Self-Directed IRA can hold:

• Residential and commercial real estate
• Private equity, startups, and LLC or partnership interests
• Private loans and notes
• Precious metals that meet IRS standards
• Cryptocurrency
• Tax liens
• Syndications and private funds

The tax code bars only two types of investments in an IRA: life insurance and most collectibles, such as art, antiques, gems, and most coins. Everything else is fair game as long as you avoid prohibited transactions.

Who Is a Disqualified Person?

The prohibited transaction rules under IRC §4975 center on transactions between your IRA and “disqualified persons.” These include:

• You, the IRA owner
• Your spouse
• Your parents, grandparents, and other ancestors
• Your children, grandchildren, and their spouses
• Fiduciaries of the IRA and anyone providing services to it
• Any entity that disqualified persons own 50% or more of, counting everyone’s ownership together
• Officers, directors, 10% owners, and highly compensated employees of those entities

Siblings, aunts, uncles, and cousins aren’t on the list. A deal with them can still be a problem if it indirectly benefits you.

The Six Types of Prohibited Transactions

1. Selling, exchanging, or leasing property
Your IRA can’t buy property from, sell property to, or lease property to or from a disqualified person. For example, you can’t sell a rental you own personally to your IRA, even at fair market value.

2. Lending money or extending credit
Your IRA can’t lend money to a disqualified person or borrow from one. You also can’t personally guarantee a loan made to your IRA. In Peek v. Commissioner (2013), the taxpayers’ personal guarantees on a loan to an IRA-owned company cost them their IRAs’ tax-advantaged status.

3. Providing goods, services, or facilities
You and other disqualified persons can’t provide services to the IRA or to a company it owns, even for free. You can’t fix the plumbing in an IRA-owned rental or manage a renovation yourself.

4. Personal use of IRA assets
You can’t use IRA assets or income for your own benefit. That rules out staying in an IRA-owned vacation home, storing your things in an IRA-owned building, or paying personal bills with IRA money.

5. Self-dealing
As the person making decisions for your IRA, you can’t use it to benefit yourself. For example, you can’t have your IRA invest in a company you already control to prop up your own stake.

6. Receiving compensation
You can’t receive payments in connection with your IRA’s investments. In Ellis v. Commissioner (2013), an IRA owner had his IRA-owned business pay him a salary. The Tax Court ruled it a prohibited transaction, and his entire IRA was treated as distributed.

For real estate examples in more detail, see The Prohibited Transaction Minefield: Rules to Keep Your Real Estate IRA Compliant.

What Happens If You Break the Rules?

If you, as the IRA owner, engage in a prohibited transaction:

• Your IRA stops being an IRA as of January 1 of the year the transaction happened.
• The entire account is treated as distributed, not just the part involved in the transaction.
• That amount is taxed as ordinary income.
• If you’re under 59½, a 10% early withdrawal penalty may also apply.

If a disqualified person other than you is involved, that person can owe a 15% excise tax on the amount involved. The tax rises to 100% if the transaction isn’t corrected.

What About a Solo 401(k)?

A Solo 401(k) follows the same prohibited transaction rules, with one useful difference. It can allow you to take a participant loan of up to $50,000 or 50% of your vested balance, whichever is less. Borrowing from an IRA isn’t allowed.

Why Your Custodian Matters

Your custodian doesn’t review or approve your investments. Compliance is your responsibility. A custodian that specializes in self-directed accounts can still help you get it right by explaining the rules before you invest, setting up the account correctly, and handling IRS reporting.

At IRA Financial, we’ve helped more than 27,000 clients invest using Self-Directed IRAs and Solo 401(k) plans. We offer:

• Custodial services for alternative assets
• IRA LLC (Checkbook IRA) setup
• Tax reporting, including Forms 5498, 1099-R, and 990-T
• Access to our specialists for compliance questions
• Flat-fee pricing, so your costs don’t rise as your account grows

Final Thoughts

Most of the prohibited transaction problems I’ve seen come down to one mistake: treating the IRA’s assets as your own. Your IRA can own almost anything, but until you take a distribution, you and your family can’t buy from it, sell to it, work for it, or use what it owns. If a deal involves you or a family member in any way, stop and get advice before you sign.

This content is for educational purposes only and does not constitute legal, tax, or investment advice. Consult a qualified professional before making any investment decisions.

Frequently Asked Questions

What is a prohibited transaction in a Self-Directed IRA?
It’s any improper use of your IRA by you or a disqualified person, such as selling property to your IRA, borrowing from it, working on its investments, or personally using its assets.

Is my brother or sister a disqualified person?
No. Siblings aren’t disqualified persons. A transaction with them can still be prohibited if it indirectly benefits you or another disqualified person.

What happens if I make a prohibited transaction?
Your IRA is treated as fully distributed as of January 1 of that year. You’ll owe income tax on the whole balance, plus a 10% penalty if you’re under 59½.

Can I manage my IRA’s investments myself?
You can make investment decisions, and with a Checkbook IRA you can manage the IRA-owned LLC. You can’t do hands-on work, such as repairs, or pay yourself for managing the investment.