Welcome and Why Prohibited Transaction Rules Matter
Mat Sorensen:
Welcome everyone to the Directed IRA podcast. This is Mat Sorensen, joined by the amazing and dapper Mark J. Kohler. Today, we’re covering something critical for your self-directed IRA—something you do not want to mess up: prohibited transaction rules. This is the number one rule you need to understand.
Mark J. Kohler:
Absolutely critical. And thanks for the “dapper” comment—I did my hair today. Mat’s just in a quarter zip, I’ve got the jacket on.
Mat Sorensen:
Yeah, he’s definitely flexing on me a little here.
Mark J. Kohler:
I think Mat’s just encouraging me to keep it up.
Mat Sorensen:
I like having a co-host I need to keep up with. It pushes me to be better.
The Kite String Rule Analogy
Mark J. Kohler:
We want to keep this topic light because rules can feel overwhelming. Let me give you a simple analogy.
There’s a story about a kid flying a kite with his dad. The kid says, “I hate the string—it’s holding the kite down. Why don’t we just cut it and let it fly?” The dad explains that the string is actually what keeps the kite in the air.
The kid doesn’t believe him, so the dad cuts the string—and the kite falls.
That’s exactly how prohibited transaction rules work. They’re not there to hold you back. They’re there to help your retirement account succeed. Without them, everything falls apart.
Mat Sorensen:
I love that. And if you mess this up, the IRS is what sends the kite crashing down.
If you violate these rules, your entire IRA can be treated as distributed—meaning it becomes taxable, possibly with penalties. That means everything in your IRA loses its tax-advantaged status.
The good news? These rules are not complicated. Think of it like learning a board game. Once you understand them, it’s the same patterns over and over.
Per Se Violations and Disqualified Persons
Mat Sorensen:
The first category is called a per se prohibited transaction. This happens when your IRA transacts with a disqualified person.
The IRS gives IRAs tax advantages, but they don’t want you manipulating deals to benefit yourself or your family.
Mark J. Kohler:
Let me give an example.
I have a cattle business inside my HSA. When I go to buy cows, I can’t buy from my parents, my kids, or my spouse. Why? Because they’re disqualified persons.
The IRS assumes family would give you a favorable deal, which would be abusing the tax system. So I have to buy from a third party at market value.
Mat Sorensen:
Exactly. Disqualified persons include:
- You
- Your spouse
- Your parents
- Your children
Also, any company owned 50% or more by those people is disqualified.
So no selling your own assets to your IRA, no transferring assets in at a favorable price. The IRS already thought of that.
Mark J. Kohler:
Fun side note—fiancés are not disqualified persons. So technically, unmarried partners could transact.
Self-Dealing and Personal Benefit Traps
Mat Sorensen:
The second category is self-dealing.
This happens when a disqualified person benefits from an IRA investment.
Example:
You’re a real estate agent. Your IRA buys a property, and you collect a commission. That’s self-dealing—even though the IRA didn’t directly pay you.
Mark J. Kohler:
Another example—if your IRA owns a property, you can’t live in it or use it.
Even temporary use, like staying in your IRA-owned Airbnb, is a violation.
Mat Sorensen:
Exactly. No personal use. No sweat equity either.
If your IRA owns a property, you can’t go fix it up yourself. You must hire third parties.
Mark J. Kohler:
This is where people get hung up. They think, “I can’t work on it, so I shouldn’t invest through my IRA.”
That’s the wrong comparison.
Compare:
- IRA investing in an ETF earning ~10–11%
vs
- IRA investing in real estate earning 20%+ with contractors
It’s still a strong return—you’re just paying for labor instead of contributing it.
Mat Sorensen:
And for many people, their time is better spent elsewhere anyway.
Extension of Credit and Non-Recourse Loans
Mat Sorensen:
The third category is extension of credit.
This happens when you personally guarantee a loan for your IRA.
Example:
- Your IRA buys a $300K property
- You put $100K down
- You finance $200K
That’s allowed—but the loan must be non-recourse.
That means:
- The lender can take the property if you default
- But they cannot go after you personally
If you personally guarantee the loan, you’ve created a prohibited transaction.
Mark J. Kohler:
Bottom line: don’t lend to your IRA, don’t borrow from your IRA, and don’t guarantee debt for your IRA.
A Real IRS Case That Lost
Mat Sorensen:
There’s a real case—Peak v. Commissioner.
Two investors used their Roth IRAs to buy a business. Part of the purchase was seller financing, and they personally guaranteed the loan.
The business was successful. They made over $1MM each.
But they lost on audit because of the personal guarantee.
The IRS disqualified the IRA.
Mark J. Kohler:
And the reasoning is simple:
By guaranteeing the loan, they effectively added value to their IRA beyond contribution limits. That’s not allowed.
Quick Recap of Prohibited Transactions
Mat Sorensen:
Here are the three main types of prohibited transactions:
- Per se transactions
Your IRA transacts with a disqualified person
- Self-dealing
A disqualified person benefits from the IRA’s investment
- Extension of credit
A disqualified person guarantees or lends to the IRA
Avoid these, and you’re on the right track.
Final Thoughts and Disclaimer
Mark J. Kohler:
Follow the rules, and your “kite” will stay in the air. Ignore them, and it won’t.
If you found this helpful, share it with someone else and leave a review.
Mat Sorensen:
And remember—this is educational only. Always consult your own legal, tax, or financial professionals before making decisions.
