Similar to Prohibited Investments, there are Prohibited Transactions that one needs to stay from when executing IRA investments. It does not matter if your IRA is self-directed or not, an IRA LLC or IRA Trust or neither. When investing into non-traditional assets (e.g., real estate), there would certainly be a higher chance that one could enter into a PT. But, don’t be scared about it, just make sure you dot the I’s and cross the T’s on the investments you are considering. I have long taken the position that, on its very nature, keeping “clean” from having a PT is not difficult. Rather, when people are “trying to push the envelope” with an investment or treating their IRA funds as a piggy bank is when they can get sloppy, not diligent and subject themselves to honest or dishonest mistakes or errors in judgement.
Investments which are “prohibited transactions” can have severe income tax consequences to the IRA holder or other “disqualified persons” (you,
parents, kids, spouses of any of the above) who participate in the transaction. IRC § 4975(c)(1) provides that a “prohibited transaction” includes any “direct or indirect”:
a) sale or exchange, or leasing, of any property between a plan and a
b) lending of money or other extension of credit between a plan and a
c) furnishing of goods, services, or facilities between a plan and a disqualified
d) transfer to, or use by or for the benefit of, a disqualified person of the
income or assets of a plan;
e) act by a disqualified person who is a fiduciary whereby he deals with the
income or assets of a plan in his own interest or for his own account; or
f) receipt of any consideration for his own personal account by any
disqualified person who is a fiduciary from any party dealing with the plan
in connection with a transaction involving the income or assets of the plan.
A basic requirement of an IRA is that it be created or organized for the exclusive benefit of the IRA holder or his or her beneficiaries. IRC §408(a). Certain types of investments may violate this requirement to cause the IRA to lose its tax-favored status. An example of this may not involve a transaction with a “disqualified individual”, but a transaction that violates the Exclusive Benefit Requirement in that it does not benefit the IRA holder and/or his/her beneficiaries (think of your IRA loaning money to a friend at 0% interest. This could be viewed as a violation of the EBR.