Understanding Checkbook IRA Prohibited Transactions

Key Points 

• Prohibited transactions involve dealings between retirement plan assets and disqualified persons.
• Checkbook IRA holders must carefully structure transactions to comply with IRS regulations.
• Due diligence and professional financial guidance can help investors avoid mistakes and preserve the tax-advantaged status of a Checkbook IRA.

A Checkbook IRA offers exceptional flexibility for investing in alternative assets such as real estate, cryptocurrency, and many other asset classes within a retirement account. However, with this expanded investment freedom comes the responsibility of adhering to IRS regulations. Rules surrounding prohibited transactions are in place to prevent improper dealings between an IRA and disqualified persons, helping to preserve the account’s tax-advantaged status.

While prohibited transactions carry serious tax consequences—including the potential loss of tax-deferred or tax-free growth—understanding the fundamentals can help you navigate Checkbook IRA investments confidently. With Broad Financial’s resources and guidance from your personal financial consultant(s), you can structure your investments with compliance in mind and fully leverage the benefits of a Checkbook IRA.

What Constitutes a Prohibited Transaction?

A prohibited transaction occurs when a Checkbook IRA—think of it as its own entity, which it technically is since you’ll have set up an IRA LLC or IRA Trust—engages in certain financial interactions with a disqualified person. These transactions typically involve:

• Using IRA funds for personal benefit
• Engaging in direct or indirect transactions with a disqualified person
• Providing services to an IRA-owned asset

Here’s a simple formula to remember:

Retirement Plan Asset + Disqualified Person = Prohibited Transaction

A retirement plan asset includes any investment, property, or entity owned by the IRA. A disqualified person is an individual or entity with a direct financial connection to the account holder, including:

• The IRA owner and their spouse
• The IRA owner’s parents, grandparents, children, and grandchildren (plus their spouses)
• Any fiduciary or service provider to the IRA (e.g., financial advisors, accountants, attorneys)
• Any entity owned 50% or more by disqualified persons

The intent of these rules is to ensure that retirement accounts function exclusively as long-term investment vehicles and are not used for immediate personal financial gain. The tax advantage, whether you choose to open your Checkbook IRA as a Self-Directed Roth IRA or Self-Directed Traditional IRA, is both incentive and reward for investing toward retirement.

Examples of Prohibited Transactions

To illustrate how prohibited transaction guidelines might apply to real life investments, here are some common prohibited transactions to avoid:

Buying or Selling a Property That You Own Personally

If you personally own a property, your Checkbook IRA cannot purchase it from you, nor can you sell an IRA-owned property to yourself or another disqualified person. This also applies to property transfers, exchanges, or indirect transactions where a third party is used to circumvent the rules.

Lending Money to Disqualified Persons

An IRA cannot extend loans to disqualified persons, including direct family members. For example, lending IRA funds to your child for a home down payment—even with a formal loan agreement—would result in a prohibited transaction.

Using IRA-Owned Property for Personal Benefit

If your IRA owns a rental property, neither you nor your immediate family can use the property, even if you pay market rent. Any personal use—whether for a weekend stay or a full-time residence—could trigger a prohibited transaction.

Providing Services to Your IRA-Owned Assets

IRA owners cannot perform maintenance, renovations, or management services on properties held within the account. Even if you don’t receive compensation, contributing personal labor is considered a prohibited transaction and can disqualify the account.

Paying Yourself from IRA Investments

If your IRA owns a business, you cannot take a salary, dividends, or other direct compensation from that business. Similarly, you cannot receive a commission from buying or selling IRA assets, even if you are a licensed real estate agent or broker.

Each of these examples highlights the importance of keeping IRA assets separate from personal financial dealings. Yes, you’re having to follow rules, but they are designed with your financial success and retirement in mind.

IRS Guidelines on Prohibited Transactions

There’s no reason to be scared by a little bit of tax lingo. To the contrary, gaining a better understanding of IRS guidelines can be empowering. In tune with the examples above, the IRS defines prohibited transactions under IRC §4975, including:

• Selling, Leasing, or Exchanging Property – Any direct or indirect real estate transaction between the IRA and a disqualified person is prohibited.
• Lending or Extending Credit – The IRA cannot issue loans to disqualified persons, nor can an account holder personally guarantee a loan used to acquire IRA assets.

• Furnishing Goods or Services – IRA owners cannot provide management, repairs, or services to their own IRA investments.

• Using Plan Assets for Personal Benefit – IRA funds must remain separate from personal expenses, business dealings, or investments that benefit the account holder outside of retirement.
• Receiving Compensation – Any personal financial gain derived from IRA investments is prohibited.

Remember, these guidelines serve to maintain clear separation between your retirement assets and personal financial interests, safeguarding the integrity and tax-advantaged status of your account.

Avoiding Prohibited Transactions

If an IRA engages in a prohibited transaction, the IRS treats the entire account as distributed as of January 1 of the year the transaction occurred. In turn, the full account balance becomes taxable as ordinary income. A 10% early withdrawal penalty applies if the account holder is under age 59½, and additional IRS penalties and interest may be assessed.

Avoiding prohibited transactions requires not only careful planning and understanding of IRS regulations, but also a practical approach to compliance.

Here are a few best practices to keep in mind:

Performing Thorough Due Diligence – It’s considered important to assess any investment opportunity to confirm it aligns with IRS regulations for Self-Directed IRAs. This includes reviewing the investment structure, identifying all involved parties, and ensuring that no disqualified persons are engaged in the transaction, either directly or indirectly.

Seeking Professional Insight – If you have questions about a potential transaction, consider consulting an accountant or attorney with expertise in tax law and retirement accounts. While Self-Directed IRA custodians facilitate transactions, they do not provide legal or financial advice.

Keeping Personal Finances Separate – Your IRA must remain entirely independent from personal assets and financial activities. Avoid using IRA-owned property for personal benefit, borrowing from your IRA, or engaging in transactions with disqualified persons. Even unintentional misuse of IRA funds can result in penalties.

Maintaining Proper Documentation – Keeping clear and detailed records of all IRA-related transactions, agreements, and income statements can help streamline compliance. Organized documentation helps confirm that all investment transactions were executed correctly.

Compliance Unlocks Potential

A Checkbook IRA opens the door to a world of investment opportunities, allowing account holders to explore alternative assets with greater autonomy. By understanding and adhering to IRS guidelines on prohibited transactions, you can confidently use a Checkbook IRA to build a robust and diversified retirement portfolio. Ready to get started? Contact us today!