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All the rules and restrictions are outlined in the IRS Publication 590.  Not following these rules set forth for Traditional IRAs could affect the tax status of your account and could result in disqualification of the account and severe tax consequences.

Everything in the IRA has to be an arm’s length transaction which means you as the IRA owner can’t benefit from the asset owned by the IRA.    You should always remember that the IRA is intended for your future retirement and not for you benefit now.  Therefore, you must always be asking yourself if there is any personal benefit for you now in doing such a transaction.

 In general, prohibited transactions are any improper use of your traditional IRA account by you, your beneficiary or any disqualified person.

Examples of prohibited transactions are:

  • Borrowing money from IRA
  • Selling property to the IRA
  • Receiving unreasonable compensation for managing the IRA
  • Uses IRA for security on a loan
  • Buying property for personal use with IRA funds – i.e Personally using IRA property for a residence, office, vacation home, etc.

It is also important to remember that the IRA has to be a closed loop in terms of expenses and income or profit.  The expenses related to the property must be paid from the IRA directly and all the income/profits be paid directly to the IRA as well.  For example,  if your IRA owns a rental property then all the rent must be returned directly to the IRA and all the expenses such as maintenance, insurance, taxes, etc must be paid directly from the IRA.

Who are disqualified persons? They are you, your IRA holder, your spouse, parents, children and their spouses, grand children, grand parents and great grand parents, grand children and great grand children and their spouses.  In other words your ascendents and descendants.  Also, anyone acting as a fiduciary and service providers of the IRA like your attorney, CPA or financial advisor.   The weird thing is that brothers and sisters are not included but I personally would not take a chance since I think this was an oversight in the rules.

Who is considered a fiduciary? The custodian of the IRA would be one.  Anyone who provides investment advice for your IRA for a fee would be another.  Anyone who has discretionary authority or control in managing your IRA or disposing of its assets would also be considered a fiduciary.

What happens when my IRA engages in a prohibited transaction?  

  1. The account stops being a IRA as of the first day of that year in which it occurred.
  2. The account is treated as if all assets were distributed to you at their fair market values on the first day of the year.
  3. If the total of those values is more than the basis in the IRA, you will have a taxable gain that is included in your income.

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