A prohibited transaction is a transaction between a plan and a disqualified person that is prohibited by law. Prohibited transactions are certain transactions between a retirement plan and a disqualified person. If you are a disqualified person participating in a prohibited transaction, you must pay a tax. A self-managed retirement account allows you to invest in a wide variety of assets.
Prohibited transactions can occur for many reasons. Some of those reasons include buying a prohibited asset, making a transaction involving a disqualified person, or participating in a transaction that could qualify as self-trading. Therefore, it is important to know what types of investments are prohibited, who is considered a disqualified person, and how to make investments in your plan without being guilty of self-management. If the owner of an IRA made a prohibited transaction, the IRA is considered distributed as of January 1 of the year the transaction took place.
Regardless of the amount involved in the prohibited transaction, the entire account is considered distributed and the owner of the IRA is subject to applicable taxes on the amount distributed. The amount of the distribution is based on the fair market value of the account as of January 1 of the year in which the prohibited transaction was made. In addition, an early withdrawal penalty of 10% will apply if the owner of the IRA is under 59 years of age at the time of the transaction. Finally, taxes apply to all income and profits earned by the IRA after the prohibited transaction has been made.
If a person other than the owner of the IRA made a prohibited transaction (for example, a broker, financial planner, or advisor hired by the IRA), an excise tax of 15% will apply to the amount in question. If the owner of the IRA doesn't correct the prohibited transaction, a 100% penalty may apply. In general, a prohibited IRA transaction is any misuse of an IRA account or annuity by the owner of the IRA, its beneficiary, or any disqualified person. Generally, if the owner of an IRA or his beneficiaries make a prohibited transaction in connection with an IRA at any time of the year, the account ceases to be an IRA as of the first day of that year.
In essence, prohibited transactions don't limit WHAT an IRA can invest in, but rather WHO you can transact with an IRA. The difference between a self-directed account and a more traditional brokerage account is that the self-directed account allows for the broadest possible spectrum of investments that are not expressly prohibited. Using IRA assets to purchase property for personal use is considered a misuse of IRA assets and could result in disqualification from the IRA. Conducting prohibited IRA transactions can result in penalties, special taxes, and the loss of IRA status for your assets.