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IRA Prohibited Transaction for a Self-Directed IRA LLC

What transactions are prohibited in a self directed IRA?

IRA Prohibited Transaction

The Prohibited Transaction Penalties under Internal Revenue Code Section 4975 generally start at 15% for most type of retirement plans. However, the penalty is harsher for Self-Directed IRAs.

IRA Holder or IRA Beneficiary Engages in a Prohibited Transaction

If you (or a beneficiary) have a Self-Directed IRA or Roth IRA and you’re involved in a prohibited transaction pursuant to Internal Revenue Code Section 4975, the IRA loses its tax-exempt status. Furthermore, you (or beneficiary) is treated for tax purposes to have received a distribution on the first day of the tax year in which the prohibited transaction occurred.

The distribution amount that you may have received is equal to the fair market value of the IRA as of the first day of such tax year. Additionally, it is must be included in the IRA holder’s income for the year.

Unless the IRA holder qualified for an exception to the early distribution penalty (i.e. over the age of 591/2, disabled, etc.), the 10% early distribution penalty will also apply.

Therefore, it’s important not to violate the prohibited transaction rules set forth under Internal Revenue Code Section 4975. Your IRA loses its tax exempt status. As a result, the entire fair market value of the IRA will be treated as taxable distribution, subject to ordinary income tax.

Additionally, you or the beneficiary will be subject to a 15% penalty as well as a 10% early distribution penalty if the IRA holder or beneficiary is under the age of 59 1/2.

Non-IRA Holder or Non-IRA Beneficiary Engages in a Prohibited Transaction Under IRC 4975

In the case where someone other than the IRA holder or IRA beneficiary (for example, another disqualified person) engages in a prohibited transaction, that person may be liable for certain penalties.

In general, a 15% penalty is imposed on the amount of the prohibited transaction and a 100% additional penalty may be imposed if the transaction is not corrected. Note – fiduciaries to an IRA or plan are not subject to the 15% or 100% additional penalty.

Penalties for Engaging in a Prohibited Transaction Under Internal Revenue Code Section 408

The Prohibited Transaction Penalties for engaging in an Internal Revenue Code Section 408 prohibited transaction differs from the Internal Revenue Code Section 4975 penalty.

If IRA assets are invested in collectibles or life insurance, only the assets used to purchase the investment are seen as distributed, not the entire IRA (individual retirement account).

In addition, pledging an IRA as a security for a loan is a prohibited transaction under Internal Revenue Code Section 408(e)(4).

Under this section, if you, the IRA holder, pledges a portion of your security for a loan, only the amount pledged is seen as distributed – not the entire IRA.

Understanding the IRA Prohibited Transaction Rules

The IRA prohibited transaction rules are extremely broad and the penalties extremely harsh. For example, immediate disqualification of entire IRA plus penalty.

Thus, if you’re self directing your investments, you must be especially cautious in engaging in transactions that may compromise your best judgment. Accordingly, it is crucial that any retirement investor looking to make an investment involving retirement funds work directly with a retirement tax professional or qualified tax advisor to make sure that the proposed transaction will not violate any of the IRS prohibited transaction rules.

Get in Touch

If you still have questions regarding any IRA prohibited transaction, contact IRA Financial Group directly at 800-472-0646. You can also fill out the form to speak with an on-site IRA professional who is available to answer all of your questions.


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