Prohibited Transactions in a Self-Directed IRA
Self-directed IRAs allow investors to move beyond just investing into stocks, bonds and mutual funds to invest into real estate, private companies, LLCs, promissory notes, crypto, precious metals, and other alternative assets. But with that flexibility comes one of the most important, and misunderstood, areas of retirement law: prohibited transactions.
A prohibited transaction isn’t a minor compliance issue. It can disqualify the entire IRA, causing the entire account to be treated as distributed as of January 1 of the year the violation occurs, with taxes and potential penalties to follow. Understanding the rules is the foundation of safe and compliant self-directed investing.
This article breaks down:
- What prohibited transactions actually regulate
- The three investments IRAs cannot hold
- Disqualified persons
- The three categories of prohibited transactions
- Practical examples of compliant vs. non-compliant structures
What Prohibited Transactions Really Regulate
Most investors begin by asking “What can’t my IRA buy?” But the prohibited transaction rules are not about what your IRA can buy. They are rules governing who your IRA can transact with and how those transactions occur.
The prohibited transaction rules exist to prevent an IRA owner (or anyone closely connected to them) from using the IRA to benefit themselves today, rather than preserving it for retirement. For example, the prohibited transaction rules restrict you from moving appreciated assets you personally own, whether say real estate or stock, over to your IRA where you could then sell the asset and pay no tax. Congress realized that allowing IRA owners and certain family to transact or otherwise move assets they personally own to their IRA would allow for unfair tax avoidance past what was intended for IRAs and retirement accounts. So, Congress closed the door and created the prohibited transaction rules in IRC § 4975.
Also, if the IRA’s money, assets, or opportunities improperly benefit the account owner or certain disqualified persons, the IRS treats it as a prohibited transaction.
The Only Three Investments IRAs Cannot Own
While prohibited transactions revolve around people and relationships, IRAs do have three categorical investment restrictions:
- Life insurance contracts
IRAs cannot directly purchase life insurance policies. (IRC § 408(a)(3)) - Collectibles
Prohibited collectibles include artwork, rugs, antiques, gems, certain metals, alcoholic beverages, and tangible personal property considered for personal use—except for specifically permitted bullion meeting purity requirements. (IRC § 408(m)) - S-Corporation stock
IRAs are not eligible S-corporation shareholders, meaning an S-Corp cannot issue shares to an IRA. (IRC § 1361(b)(1)(B) and IRS Priv. Ltr. Rul. 199929029 (Apr. 27, 1999))
Beyond these three restrictions, IRAs can own any investment asset and IRAs at Directed IRA have owned assets as unique as livestock, start-ups that went public, single family rentals, land, shares of a professional soccer team, oil and gas interests, crypto, notes/loans secured on real estate being rehabbed and flipped, commercial real estate syndications, and private funds including hedge funds, venture capital funds, and private equity funds.
Disqualified Persons: The Core of Prohibited Transaction Rules
The most critical concept for prohibited transactions is the definition of a disqualified persons, because most prohibited transactions arise from interactions with these individuals or entities.
Disqualified persons include:
- The IRA owner
- The IRA owner’s spouse
- Lineal descendants of the IRA owner (children, grandchildren) and their spouses
- Lineal ascendants of the IRA owner (parents, grandparents)
- Any entity (LLC, corp, trust) where the IRA owner or other disqualified persons (e.g. spouse, child) combined hold 50% or more ownership or control.
(IRC § 4975(e)(2))
When Is a Company a Disqualified Person?
A company becomes a disqualified person if you or any other disqualified persons have capitalized, control or own 50% or more of a company. Under (its not IRS rules, its in the tax code)(as summarized in the Self-Directed IRA Handbook, Ch. 5):
- Ownership by you, your spouse, parents, grandparents, children, and grandchildren is combined.
- A company is disqualified if this combined group owns 50% or more of the entity’s equity, voting power, or beneficial interest.
- “Control” includes having authority over decisions—even if your ownership is below 50%.
- Multiple related owners with smaller stakes (e.g., 20% + 20% + 15%) can cause the entity to be disqualified once their combined ownership reaches 50%.
Let’s consider an example. Let’s say you, your spouse, and your friend each personally own 33.3% of an LLC that bought a property, rehabbed it, and now the LLC is flipping it and selling it. Now let’s say you want to buy this property with your IRA to own as a rental. Could your IRA buy the property from the LLC? In this example, no, because you and your spouse are disqualified persons and your total ownership of the LLC is 66.6% and is over 50%. As a result, the LLC is a disqualified person to your IRA.
Once you understand who a disqualified person is you can easily determine whether your IRA will engage in a prohibited transactions. For most self-directed investors this rule doesn’t pose a problem or limit your transactions, but for some who do creative deal structuring or who want to move assets or get their family involved these rules become critical.
What this means in practice:
Your IRA cannot transact with you, your spouse, your kids, your parents, or any business you or they substantially own.
The Three Categories of Prohibited Transactions
The rules fall into three categories, each targeting a different type of misuse.
1. Per Se Prohibited Transactions (Automatic Violations)
These are transactions that are inherently prohibited whenever they involve a disqualified person. Intent does not matter.
Common examples:
- The IRA buys property or assets from the IRA owner or a disqualified family member
- The IRA sells property to a disqualified person
- The IRA lends money to a disqualified person
- A disqualified person provides goods, services, or receives use or benefits from the IRAs assets.
If the IRA and a disqualified person are on opposite sides of the same transaction, it is almost always a per se prohibited transaction.
“Per se prohibited transactions are automatic violations whenever your IRA is on either side of a transaction with a disqualified person. The flowchart below walks through the exact test used in determining whether a per se violation exists:
— Is there a transaction?
— Is a disqualified person involved?
If both answers are “yes,” the transaction is prohibited, regardless of intent, market value, fairness, or documentation.”
2. Self-Dealing Prohibited Transactions (Benefit-Based Violations)
Self-dealing prohibited transactions occur when the IRA owner or another disqualified person receives a direct or indirect personal benefit from the IRA’s investment.
Examples include:
- Using IRA-owned real estate personally
- Taking compensation for managing an IRA-owned property or business
- Arranging for the IRA’s investment to relieve a personal obligation
- Structuring an investment where a benefit “flows back” to a disqualified person
Self-dealing can occur even when the disqualified person is not a party to the transaction, as long as they benefit. For example, let’s say your IRA buys real estate and you happen to be a real estate agent so you receive the 3% buyer’s agent commission paid by the seller. This isn’t a per se prohibited transaction because your IRA didn’t pay the commission to you personally, but it is a self-dealing prohibited transaction because you benefited from your IRAs investment by receiving the commission. As a result, you would need to waive the commission in the transaction if you were the agent for your own IRA or have another agent who is not disqualified represent your IRA who could then receive the commission.
“Self-dealing occurs whenever the IRA owner—or any disqualified person—receives any benefit, direct or indirect, from the IRA’s investment. The flowchart below demonstrates the two-part test:
- Is anyone receiving compensation or benefit from the IRA’s investment?
- Is that person a disqualified person?
If the answer is “yes” to both, the investment structure is prohibited, even if the transaction appears fair or arms-length.”
3. Extension of Credit Prohibited Transactions
Extension of credit prohibited transactions occur when a disqualified person extends credit or guarantees debt for their IRAs investments. .
This includes:
- Personally guaranteeing a loan used by the IRA or an IRA/LLC
- Pledging personal assets or collateral to help secure IRA financing
- Co-signing on loans tied to IRA-owned property or businesses
- Allowing the IRA to rely on personal creditworthiness
- Structuring any arrangement where a disqualified person’s financial strength or resources support the IRA’s investment
Even if the loan terms are fair or commercially reasonable, the mere presence of a personal guarantee or credit support from a disqualified person is enough to create a violation.
In a case known as Peek & Fleck v. Commissioner, Mr. Peek and Mr. Fleck’s Roth IRAs bought an existing small business from a third-party seller. 140 T.C. 12 (2013). In acquiring the company, the Roth IRAs paid some money down to buy the business and the seller of the business agreed to take payments over time via a loan from the seller to the Roth IRAs for the balance of the purchase price of the business. As part of the seller-financing loan to the Roth IRAs, Mr. Peek and Mr. Fleck both signed personal guarantees and pledged their personal homes as collateral for the loans to the Roth IRAs. The IRS audited the transaction and alleged that the personal guarantees and pledging of personal assets resulted in an extension of credit prohibited transaction. The Tax Court agreed and sadly Mr. Peek and Mr. Fleck had a prohibited transaction.
The IRS alleged an extension of credit prohibited transaction
Why the Congress prohibits it:
The rules governing retirement accounts views credit support from the IRA owner as giving the IRA an advantage it would not otherwise have. This creates an improper present-day benefit, because the IRA owner’s personal financial standing is being used, and risked, to solve a problem or create an opportunity for the IRA. The IRA must remain fully independent—funded only by IRA assets, existing plan income, and permissible non-recourse financing.
Extension of credit violations occur when a disqualified person financially supports an IRA investment. This includes personal guarantees, credit support, pledging assets, or otherwise strengthening the IRA’s position using personal resources.
Real-World Prohibited Transaction Examples
Compliant Example
Your IRA acquires a rental property from Sally Seller who is not a disqualified person. Your IRA rents the property to a tenant, again not someone who is disqualified. And your IRA engages and pays third-party persons or companies to provide repairs or improvements to the property.
Why it works:
No disqualified persons are involved, no personal services are provided, and the IRA remains the sole economic beneficiary.
Prohibited Example: Buying From a Family Member
Your son owns a real estate. Your IRA purchases it.
Why it’s prohibited:
Your son is a disqualified person. A per se prohibited transaction occurred when the IRA bought paid any amounts to buy the asset.
Prohibited Example: Using an IRA Property
Your IRA owns a vacation rental. You stay there for the weekend.
Why it’s prohibited:
You (a disqualified person) received a personal benefit, even if rent was charged.
Prohibited Example: Personally Guaranteeing a Loan
You use an IRA/LLC to buy real estate and you personally guarantee the mortgage.
Why it’s prohibited:
The guarantee for the IRA (or IRA/LLCs) loan is an extension of credit by a disqualified person.
How to Stay Compliant
✔️ Work only with non-disqualified sellers, borrowers, partners, and service providers
✔️ Avoid any personal benefit, compensation, or use of IRA assets
✔️ Use non-recourse loans for IRA real estate transactions when using debt
✔️ Keep all IRA income/expenses flowing through the IRA custodian
The simplest test:
Does the IRA benefit exclusively — or do you benefit too? If you benefit personally, then it’s probably a prohibited transaction.
FAQ: Clearing Up the Common Gray Areas
Can my IRA invest in a business my sibling owns?
Yes. Siblings are not disqualified persons, but ensure you personally do not receive compensation or other benefits from the investment.
Can my IRA buy a property and lease it to a company of which I own 30% and the remaining 70% is owned by unrelated parties?
Yes, this is not a per se prohibited transaction because the lease is a transaction but it is not with a disqualified person. However, be careful in this instance because this could constitute a self-dealing prohibited transaction if the lease terms include some unfair benefit to you or your company. The lease terms and transaction should be at market rate terms to avoid self-dealing issues.
Can my IRA loan money to my spouse’s business?
No. Your spouse is a disqualified person.
Can I get a loan for a property in my personal name and use my IRA to fund the down payment?
No, this would be a prohibited transaction as you cannot personally extend credit for your IRAs investments, nor could you use your IRA to make a down payment (other than by taking a distribution) for a property you buy personally.
Conclusion
Self-directed IRAs offer extraordinary flexibility, but the prohibited transaction rules must guide every deal you structure. When investors understand disqualified persons, the three prohibited transaction categories, and the three restricted asset types, they can confidently pursue real estate, private equity, notes, crypto, and other alternatives, while keeping their IRA compliant and protected.
References (From the Self-Directed IRA Handbook, 2nd Edition)
Chapters & Pages Referenced
- Definition of Disqualified Persons — pp. 51–57
- Prohibited Transaction Rules & Categories — pp. 41–45
- Per Se Prohibited Transactions — pp. 43–45
- Self-Dealing Rules — pp. 45–51
- Extension of Credit — pp. 47–48
- Asset Restrictions (Life Insurance, Collectibles, S-Corp Stock) — pp. 39–41
- Examples & Scenarios — throughout Chapter 5
