Self-Directed IRA Prohibited Transactions: What You Need to Know

A Self-Directed IRA (SDIRA) offers greater investment flexibility than traditional retirement accounts, allowing holders to invest in assets like real estate, private businesses, and precious metals. However, strict IRS rules prohibit certain transactions to prevent misuse of tax-advantaged funds. Violating these rules can lead to severe penalties, including the loss of the account’s tax-deferred status.

Understanding prohibited transactions is essential to avoiding costly mistakes. Even unintentional violations can result in significant financial consequences.

Categories of Prohibited Transactions

IRS regulations prevent Self-Directed IRA funds from being used for personal benefit or improper financial gain. These restrictions ensure retirement funds remain separate from personal finances.

Personal Use

IRA-owned assets cannot be used for personal benefit. If an IRA owns a rental property, the account holder cannot stay in it or allow family members to use it below fair market rent.

Purchasing a vacation home with IRA funds for future personal use violates IRS rules. Collectibles like art, antiques, and rare coins are explicitly restricted. Even if an asset generates income for the IRA, any personal involvement in its use or management can trigger a prohibited transaction.

Extension of Credit

Loans or credit extensions involving the IRA are prohibited. This includes borrowing from the account, using IRA assets as collateral, or guaranteeing a loan with IRA funds.

A common mistake occurs when an IRA owner secures a mortgage for an IRA-owned property and personally guarantees the loan. The only financing allowed is a non-recourse loan, where the lender’s only recourse is the IRA-held property. An IRA owner also cannot lend money from the account to themselves, their business, or any related party, even at market rates.

Self-Dealing

Self-dealing occurs when an IRA transaction directly or indirectly benefits the account holder. If an IRA purchases shares in a company the owner controls or if the owner receives a salary from an IRA-owned business, it is prohibited.

Another violation happens when an IRA owner personally performs maintenance or renovations on IRA-owned real estate. Even if this seems cost-effective, it is considered an indirect benefit, as it enhances the asset’s value without paying for labor. These rules ensure IRA funds are used strictly for retirement savings.

Disqualified Persons

The IRS restricts transactions between a Self-Directed IRA and certain individuals or entities to prevent conflicts of interest.

IRA Owner

The account holder cannot engage in transactions with their own IRA. This includes selling property to the IRA, purchasing assets from it, or providing services to a business owned by the account.

If an IRA holds rental properties, the owner cannot act as the property manager and collect a fee. Even structuring a deal through a third party to benefit the account holder can trigger penalties.

Family Members

Spouses, parents, children, grandchildren, and their spouses are disqualified persons. They cannot buy, sell, or lease assets to or from the IRA or provide services to businesses owned by the account.

For example, if an IRA owns a commercial property, the account holder’s child cannot lease office space in the building, even at fair market value. However, siblings, aunts, uncles, and cousins are not classified as disqualified persons, meaning transactions with them may be allowed.

Entities Owned by the IRA Owner

Businesses in which the IRA owner has at least a 50% ownership stake—directly or through family members—are disqualified from transacting with the IRA.

For example, if an IRA owner controls 60% of a real estate firm, that company cannot sell land to the IRA, even at market value. Even if ownership is below 50%, transactions may still be prohibited if they provide an indirect benefit to the account holder.

Penalties for Noncompliance

Violating IRS rules can have severe financial consequences. Once a prohibited transaction occurs, the IRS treats the entire IRA as distributed as of January 1 of that year. The full market value of the account becomes taxable, potentially pushing the account holder into a higher tax bracket.

For traditional IRAs, this distribution is taxed as ordinary income, with rates reaching up to 37% in 2024. If the account holder is under 59½, an additional 10% early withdrawal penalty may apply.

Beyond taxes, the IRS may impose additional penalties and interest. If a violation is discovered during an audit, accuracy-related penalties could add another 20% to the tax owed. In cases of willful noncompliance, fraud penalties may increase the penalty to 75% of the underpaid tax.

In severe cases, the IRS can disqualify the IRA entirely, permanently stripping it of its tax-advantaged status. If the violation involves an entity controlled by the IRA holder, excise taxes may apply. The Department of Labor can also assess penalties if employer-sponsored accounts are involved.

Reporting Requirements

Proper documentation and reporting are essential for maintaining compliance. Account holders must ensure transactions, asset valuations, and required disclosures are accurately reported to avoid audits or penalties.

IRS Form 5498 is used to report annual contributions, rollovers, and the fair market value of the account. While custodians file this form, account holders must provide accurate valuations for non-traditional assets like real estate or private businesses. Third-party appraisals or valuation reports may be required. If an asset is significantly undervalued, the IRS may assess additional taxes and penalties.

IRS Form 990-T is required for Self-Directed IRAs that generate unrelated business taxable income (UBTI) or unrelated debt-financed income (UDFI). If an IRA earns more than $1,000 in UBTI, it must file this form and pay applicable taxes, which can reach up to 37%. Misreporting or failing to file Form 990-T can result in audits and tax assessments.