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.
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:
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 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.
To illustrate how prohibited transaction guidelines might apply to real life investments, here are some common prohibited transactions to avoid:
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.
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.
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.
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.
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.
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:
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.
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.
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!
Disclaimer:Â Broad Financial LLC does not provide legal, tax, or investment advice. Please consult with your tax or legal advisor before making investment decisions.Â
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