Internal Revenue Code 4975 is the most important provision in the Internal Revenue Code when it comes to examining what a retirement plan, such as a Self Directed IRA or Solo 401K Plan can invest in.
The purpose of the prohibited transaction rules under IRC 4975 is to encourage the use of IRAs for accumulation of retirement savings and to prohibit those in control of IRAs from taking advantage of the tax benefits for their personal account. The IRS wanted people to in invest their retirement funds for their future and not rep any personal benefit, directly or indirectly without the payment of tax or penalty if pre-retirement age (prior to the age of 59/1/2). The IRS’s position is essentially that in most cases one received a tax deduction for making the IRA contribution (non Roth IRA) and thus recognized a tax benefit and as a result should not be able to reap any personal benefit without the payment of tax.
When it comes to understanding the Internal Revenue Code 4975 prohibited transaction rules, one must first understand the intent of the IRS when it first developed the Self Directed IRA prohibited transaction rules. The IRS and the Internal Revenue Code do not describe what a Self Directed IRA can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain type of transactions. The purpose of these rules is to encourage the use of IRAs for accumulation of retirement savings and to prohibit those in control of IRAs from taking advantage of the tax benefits for their personal account.
To begin with, a transaction involving IRA funds IRA transaction should not involve a “disqualified person”. The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest. The prohibited transaction rules outlined in Internal Revenue Code Section 4975 are centered around one using IRA funds in a transaction that directly involves or benefits, directly or indirectly a disqualified person. In other words, if the IRA transaction does not involve a disqualified person you will very likely not run afoul to any of the IRA prohibited transaction rules under IRC 4975.
Internal Revenue Code Section 4975 generally prohibits any transaction between a Self Directed IRA or Solo 401K and a disqualified person. Thus, in general, as long as the IRA transaction does not involve a disqualified person it will likely not violate any of the prohibited transaction rules outlined under IRC 4975. When it comes to investing Self Directed IRA funds, the most important thing to keep in mind is that one should never mix retirement funds with any personal funds or any disqualified person. Ad long as the Self Directed IRA investments involves solely retirement assets and does not involve or provide any direct or indirect benefit to a disqualified person there is little chance the IRC 4975 prohibited transaction rules will be violated.