Creating and Sustaining Self Direction: IRA's and Prohibited Transactions

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Lance W. Newton

For more than 15 years I’ve worked in insurance, banking and real estate. I enjoy sharing information with and learning from those who read my blogs. I welcome your feedback and comments.

Feel free to email me at lance@selfdirectioncentral.com .
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Disclaimer
The opinions expressed in this blog are in no way intended as Tax, Legal or Investment advice. Anyone considering Self Direction of retirement assets should consult their trusted Tax, Legal and other investment professionals before implementing these types of plans. Remember Self Direction of your Retirement Assets is not an "All or Nothing" proposition. You can have multiple IRA's from different providers.
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Creating and Sustaining Self Direction: IRA's and Prohibited Transactions

IRA's and Prohibited Transactions

What is a "Prohibited Transaction"?

A "Prohibited Transaction" occurs when an IRA investor makes an investment that involves a "Disqualified Person". Under IRS Section 4975 (c).

Disqualified Persons are generally defined as:

Your parents or grandparents (ancestors)
Your children
Your spouse or the spouse of anyone above
Any business entity where you hold a controlling (51%) or more interest

The IRS has been known to look closely at transactions with a business entity where the IRA investor held less than a 51% interest too.

The IRS Penalizes Prohibited Transactions

In an IRA, a prohibited transaction (if detected and reported) results in the distribution and taxation of all of the IRA Assets held from the beginning of the year the prohibited transaction is discovered. Custodians and TPA’s have no liability for any Prohibited Transactions on your part, but may detect them when reviewing documents related to your transactions and typically notify you of potential issues if they see them. They are obligated by law to report any prohibited transactions they detect to the IRS.

Any "party in interest" to an IRA can request an individual exemption through an "Advisory Opinion" (AO) before making a transaction from the Department of Labor (DOL) under §2570.30-§2570.52 by submitting a complete application (as described in §2570.34) of the transaction being contemplated. If your documentation is thorough and complete, in about 2 months the DOL will issue a letter that is an opinion based on the specific facts of your situation. If you are serious about obtaining an exemption, the request should be prepared by the appropriate tax and legal professionals and this will add to the cost of your investment. The request should be delivered to: Exemption Application, PWBA, Office of Exemption Determinations, Division of Exemptions, U.S. Department of Labor, 200 Constitution Avenue NW., Washington, DC 20210.

Of course like most things with the IRS, you cannot rely on an opinion issued for a set of facts identical or very similar to the facts in your situation to be the same opinion that would be given if your transaction gets reviewed.

There is a simple test of whether a transaction might be prohibited that costs you nothing but time to consider:

1. If you try to deal with your spouse, your parents or your children or anyone that provides accounting or other services to your pension plan, there is a good chance this is a prohibited transaction and you should seek a written legal opinion before doing the transaction. The IRS has been known to look closely at transactions with brothers and sisters too.

2. If a transaction you have in mind might include any of the above parties in the future, do not do it or get professional help and opinions before you do.

3. If there is any current benefit (even a non-financial benefit) to you or any of the above parties, it is likely that you are contemplating a prohibited transaction and probably should not do it and certainly not without the review/help of a tax or accounting professional.

The best way to avoid a prohibited transaction is not to deal with immediate family members or businesses you are involved in. It is fine to work with your cousins, nephews or nieces as long as you follow the rules. If you cannot resist the temptation to self deal or seek to use a Self Directed Retirement Plan specifically to self deal, you are only fooling yourself.