Prohibited Transaction Basics

What you'll find on this page:

Overview

There are some investment types and transactions that the IRS prohibits in a tax-deferred account or plan. In general, a prohibited transaction is any improper use of your tax-deferred account by you, your beneficiary, or any disqualified person. Any transaction that benefits you or a transaction that benefits someone you know who is deemed a disqualified person by the IRS, is prohibited.

Self-dealing

Those types of prohibited transactions are often referred to as "self-dealing."

Essentially, your IRA retirement can't conduct transactions which benefit you, your direct family, or your business. If you do, your IRA will lose its tax-deferred status and you'll be taxed and have to pay penalties.

Here are some very basic descriptions for what are prohibited transactions:

Real estate

You can't hold property in your IRA or other tax-advantaged retirement account that you or other disqualified persons live in, plan to live in, or use in any way while that property is held in your retirement account. The property must be for investment purposes only.

Private placements

You can't hold private equity shares of your own business (or that of any other disqualified person) in your IRA or other tax-advantaged retirement account.

Promissory notes / loans

You can't loan money to yourself or other disqualified persons from your IRA or other tax-advantaged retirement account.

Stepped transactions

A stepped transaction is one in which an owner of an IRA or retirement account conducts one or more transactions toward making a prohibited transaction.

In other words, you can't loan money from your IRA to your brother (who's not a disqualified person), who then loans that money to his wife, who then loans it to you.

In most instances, stepped transactions are conducted in an attempt to circumvent the tax laws, and in others, it's done accidentally. The IRS considers both as prohibited.

Prohibited asset types

While you can invest in a wide variety of alternative assets in your tax-deferred account, there are at least three asset types you cannot invest in:

  • Collectibles, such as, art, antiques, stamps, gems, rugs, or anything the U.S. Treasury Department deems to be a collectible
  • Life insurance
  • The stock of a Sub-Chapter S Corporation

This isn't a complete list, so proceed with caution if you're interested in investing in something which might fall under one of those three asset categories. Check with the IRS or consult with a qualified tax professional before investing.

Disqualified persons

Disqualified persons include members of your family who are your ancestors (e.g., your mother, grandfather), direct lineal descendents (e.g., your children, grandchildren) and their spouses, and your fiduciary.

The IRS defines a fiduciary as anyone who:

  • Exercises any discretionary authority or discretionary control in managing your IRA or exercises any authority or control in managing or disposing of its assets
  • Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so
  • Has any discretionary authority or discretionary responsibility in administering your IRA

Penalties and additional taxes

Conducting a prohibited transaction, even unintentionally, will result in your account losing its qualified tax protected IRA status.

With an alternative asset self-directed IRA, determining what is and isn't a prohibited transaction or self-dealing can be complex depending on how your investment is structured.

Use these IRS resources to learn more:

IRS resources

Because there are many choices and scenarios when investing in alternative assets, it's important that you understand your unique situation and how the tax laws and codes might impact you.

We recommend you consult with a qualified tax professional or investment advisor regarding your particular situation.

Additional resources

PENSCO does not provide tax, legal, or investing advice, but you can learn more by referring to our online resources:

This information is for general informational purposes only and is not intended as an individualized recommendation or to be a substitute for specific individual tax, legal or investment planning advice. Where specific advice is necessary or appropriate, PENSCO recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager. PENSCO Trust Company performs the duties of a custodian and, as such, does not provide investment advice or sell investments, nor offers any tax or legal advice.

You should always consider your unique situation and what is appropriate for you.