If you have an individual retirement account (IRA), you probably already know that it is a great way to save for when you retire. Through your IRA, you can invest in stocks, bonds and mutual funds. Your IRA is governed by regulations established by the Internal Revenue Service (IRS). While the IRS does not dictate what you can do, the regulations it has enacted do provide limitations that prohibit certain types of transactions.
The Internal Revenue Code (IRC) Section 4975 defines a “disqualified person” as:
- IRC 4975(e)(2)(A) A fiduciary, which is the IRA owner, participant, or investing authority connected to the account;
- IRC 4975(e)(2)(B) An individual who provides a service to the plan, such as a trustee or custodian;
- IRC 4975(e)(2)(C) An employer with employees covered by the plan;
- IRC 4975(e)(2)(D) An employee organization with members who are covered by the plan;
- IRC 4975(e)(2)(E) Any individuals who own at least 50%, if not more, of C and D;
- IRC 4975(e)(2)(F) Any family members of all individuals listed above, which includes spouses, parents, grandparents, children, and grandchildren;
- IRC 4975(e)(2)(G) Any entities, including corporations, partnerships, trusts, LLCs, or estates, that are at least 50% owned or controlled by the individuals listed above;
- IRC 4975(e)(2)(H) Anyone who is highly compensated by or at least owns 10% of C, D, E, or G. This includes officers and directors; or
- IRC 4975(e)(2)(I) An individual who has 10% or more invested as a partner or joint venture of C, D, E or G.
In general, the IRS prohibits any transaction that occurs between individuals on the “disqualified person” list and the IRA. These types of transactions call into four categories.
- Direct Prohibited Transactions: These types of prohibited transactions typically involve the sale, exchange or leasing of a property between a disqualified person and the IRA. It also includes lending money or credits between the IRA and any disqualified persons. Goods, services, or facilities furnished between the IRA or a disqualified person is also a direct prohibited transaction.
- Indirect Prohibited Transaction: Indirect prohibited transactions include using income or assets from the IRA for personal reasons, which including providing them to a disqualified person. In lay terms, using your IRA funds to cover your mortgage is not allowed.
- Self-Dealing Prohibited Transactions: These transactions are typically those where the IRA owner, or other disqualified person, earns an income through an IRA asset’s transaction. For example, if you are a real estate agent and you earn a commission for selling your IRA asset through your company, this is prohibited.
- Conflict of Interest Prohibited Transaction: If you use your IRA to gain consideration between yourself and a disqualified person, you are in breach of the IRC. An example of this would be lending your IRA funds to your company in order to receive a promotion.