Prohibited Transactions in Self-Directed IRAs: Rules and Compliance

Prohibited Transactions in Self-Directed IRAs are a critical consideration for retirement investors using a Self-Directed IRA (SDIRA), which has become one of the most powerful tools available for those who want to move beyond Wall Street. With a SDIRA, you can invest in real estate, private equity, startups, cryptocurrency, and other alternative assets that traditional brokerage IRAs simply do not allow.

But with that flexibility comes responsibility. The IRS enforces strict rules on how retirement funds can be used, and violating those rules can trigger one of the harshest penalties in the tax code: full disqualification of your IRA.

That’s why understanding what the IRS considers a prohibited transaction is essential before making any self-directed investment. The rules themselves are not complicated, but they are unforgiving when ignored. This guide explains what a SDIRA is, why investors use one, what you can invest in, and most importantly, which transactions are prohibited and how to stay compliant.

What Is a Self-Directed IRA (SDIRA)?

A Self-Directed IRA is not a separate type of IRA under the tax code. It is simply an IRA held by a custodian that allows you to invest in the full range of assets the IRS permits, not just stocks and mutual funds.

Most traditional brokerage firms limit IRAs to publicly traded securities because their business models are built around products that generate recurring fees. A true SDIRA custodian, by contrast, is designed to hold alternative assets and support transactions that do not occur on public markets.

From a tax perspective, SDIRAs are treated exactly the same as any other IRA:

• Traditional SDIRA: tax-deferred growth
• Roth SDIRA: tax-free qualified growth

The advantage of a SDIRA is flexibility, not different tax treatment.

Why Investors Use a SDIRA

SDIRAs continue to grow in popularity as investors seek more control and better diversification.

A SDIRA allows investors to:

• Reduce reliance on volatile public markets
• Hedge against inflation with tangible assets
• Access private investments unavailable to retail investors
• Invest in areas they understand and trust
• Diversify beyond mutual funds and ETFs

For many investors, owning real estate or private businesses inside a retirement account provides long-term stability and return potential that traditional portfolios alone cannot match.

What You Can Invest in with a Self-Directed IRA

A properly structured SDIRA can hold nearly any asset class the IRS allows, including:

• Residential and commercial real estate
• Private equity and venture capital
• Startups and founder shares
• Cryptocurrency
• Precious metals
• Private notes and lending
• Tax liens
• Syndications and private funds
• LLC and partnership interests

The IRS restricts only three categories of investments:

1. Life insurance contracts
2. Collectibles under IRC §408(m), such as artwork, antiques, wine, rugs, and gems
3. Prohibited transactions under IRC §4975

Of these, prohibited transactions are by far the most important compliance issue.

Understanding IRC §4975: Prohibited Transactions

Internal Revenue Code Section 4975 exists to prevent retirement account owners from using IRA assets for personal benefit before retirement. These rules also prohibit certain transactions between the IRA and “disqualified persons,” which include:

• You, the IRA owner
• Your spouse
• Parents and grandparents
• Children and grandchildren
• Entities you control, generally defined as 50 percent ownership or more

Below are the main prohibited transaction categories and how they commonly arise.

Sales or Exchanges of Property

IRC §4975(c)(1)(A)

You may not buy, sell, or exchange property between your IRA and yourself or another disqualified person.

Example:
You sell a rental property you personally own to your IRA.
Even if the sale is at fair market value, this is a prohibited transaction.

Lending or Extension of Credit

IRC §4975(c)(1)(B)

Loans between an IRA and a disqualified person are not allowed.

Examples:

• Your IRA lends money to your child’s business
• Your IRA borrows funds from your personal bank account

Both scenarios violate the rules.

Furnishing Goods, Services, or Facilities

IRC §4975(c)(1)(C)

Disqualified persons may not provide services to the IRA or to an IRA-owned entity.

Examples:

• You personally repair plumbing at an IRA-owned rental property
• You manage construction or renovations on an IRA investment

Even unpaid labor is considered a prohibited transaction.

Personal Use or Benefit of IRA Assets

IRC §4975(c)(1)(D)

You may not personally benefit from IRA-owned assets.

Examples:

• Staying in an IRA-owned vacation rental
• Using IRA funds to pay personal expenses
• Storing personal belongings in an IRA-owned property

Any personal use violates the rules.

Self-Dealing or Acting in Your Own Interest

IRC §4975(c)(1)(E)

You may not influence IRA transactions in a way that benefits yourself or other disqualified persons.

Example:
Your IRA invests in a company that you personally own or control.
Even if structured through an LLC, the IRS considers this self-dealing.

Receiving Compensation or Consideration

IRC §4975(c)(1)(F)

You may not receive any form of compensation from IRA investments.

Examples:

• Paying yourself a salary from an IRA-owned LLC
• Collecting management or consulting fees

Any personal financial benefit from IRA activity is prohibited.

What Happens If You Violate the Rules?

If a prohibited transaction occurs:

• The entire IRA is disqualified
• The account is treated as fully distributed
• Ordinary income taxes apply
• A 10 percent early withdrawal penalty may apply
• Interest and additional penalties may be assessed

Most importantly, the penalty applies to the entire IRA, not just the portion involved in the transaction.

Why the Right SDIRA Custodian Matters

The IRS places responsibility for compliance on the investor. Custodians do not approve transactions. They report them.

That said, a knowledgeable SDIRA custodian plays a critical role by:

• Reviewing investment structures
• Identifying prohibited arrangements before they occur
• Educating investors on compliance rules
• Supporting proper transaction setup
• Handling required IRS reporting
• Preparing UBIT and other tax filings
• Providing ongoing guidance and consultation

Many custodians simply process paperwork. Very few provide meaningful compliance and tax support.

Why Investors Choose IRA Financial

IRA Financial has helped more than 27,000 clients invest over $5 billion using Self-Directed IRAs and Solo 401(k) plans.

The firm was founded by Adam Bergman, a nationally recognized tax attorney and one of the country’s leading experts on self-directed retirement strategies. He has authored nine books on SDIRAs, compliance, and advanced retirement structures.

IRA Financial offers:

• Full custodial services
• Annual compliance and consulting reviews
• Tax filing and reporting, including Forms 5498, 1099-R, and 990-T
• IRA LLC structuring
• Ongoing investor education
• Transparent flat-fee pricing

Few providers match this level of tax, compliance, and structural support.

Conclusion

The Self-Directed IRA is one of the most flexible and powerful retirement tools available today. It allows investors to build wealth through real estate, private equity, startups, and other alternatives while preserving valuable tax advantages.

But flexibility comes with responsibility. Understanding prohibited transactions is essential to protecting your retirement account from unnecessary taxes and penalties.

With the right guidance and proper structure, a SDIRA can be a powerful engine for long-term wealth creation. With the wrong guidance, it can quickly turn into a costly tax mistake.

Success in self-directed investing is not just about what you invest in. It is about who you work with.