I have covered the topic of Prohibited Transactions in an earlier article – one of the main prohibitions is that you can’t self-deal with your IRA by borrowing from, selling to, or allowing a class of persons, called Disqualified Persons, to transact business with your IRA as well.
The problem that often comes up, especially with IRAs that invest in “self-directed” activities like Real Estate, is that folks look at the list of Disqualified Persons and determine that there are other persons that they can allow to make transactions with their IRA – and that since these others are not Disqualified, the transaction will no longer be a prohibited transaction.
Let’s back up and define Disqualified Persons – this means you, as the account owner, your spouse, your parents, grandparents or other ancestors, as well as your children, grandchildren, or other descendants, as well as the spouses of any of these persons. So, for example, your step-child wouldn’t be a Disqualified Person, as long as you haven’t legally adopted the child. In addition, your siblings aren’t Disqualified Persons either, nor would your girlfriend or boyfriend be disqualified. So technically, one of these people could transact business with your IRA – as long as there is no other reason to prohibit the transaction.
The problem is, if you (or another Disqualified Person) benefit directly or indirectly from a transaction with the IRA, the transaction is prohibited – no matter who the person is that you’ve transacted with. So, for example, if you’ve invested in a condo with your IRA money, and you rent the condo out to non-related persons, you’re in good shape. But if you try to play it cute and rent the condo out to your boyfriend, and you send your children to vacation with him for three weeks in the summer, the rental transaction is prohibited since disqualified persons have benefited from it.
In this case, it’s possible that the transaction could result in a penalty, or possibly invalidating your IRA, prompting an immediate disqualification and distribution including taxes and penalties, which could be a very bad thing.
Sterling Raskie, MSFS, CFP®, ChFC®
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