A prohibited transaction is an improper use of your IRA that can result in serious tax penalties. This article explains what counts as a prohibited transaction, who is considered a disqualified person, and what to do if one occurs. Expand the sections below to learn more.
A prohibited transaction is any improper use of an IRA account by a disqualified person, which can include you as the account owner or others who have access to the account. Prohibited transactions can lead to severe consequences, including penalties and taxes on the full balance of the IRA.
According to the IRS, a disqualified person includes:
The IRA owner.
Beneficiary or beneficiaries of the IRA.
Family members of the IRA owner (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).
A fiduciary of the IRA — someone who has discretionary authority or control in managing the IRA or its assets, or provides IRA investment advice for a fee.
Prohibited transactions can include:
Borrowing money from the IRA.
Selling your own property to the IRA.
Using the IRA as security for a loan.
Using the IRA to buy property for personal use.
Using the IRA to invest in collectibles.
Using any IRA assets for personal use.
If a prohibited transaction occurs, your IRA may be subject to serious tax and financial consequences.
Taxes are applied to the income and gains from the IRA from the time the account engaged in the prohibited transaction.
You may be required to withdraw all assets in the account as of Jan. 1 of the tax year in which the prohibited transaction took place.
You are responsible for paying all applicable taxes on the balance. A 10% early withdrawal penalty may also apply if you are not yet age 59½.
If any of these prohibited transactions occur, your IRA could be treated as if you withdrew the entire balance as of Jan. 1 of the year the event occurred. However, if you pledged only a portion of your IRA as security for a loan, only the pledged amount would be treated as a distribution.
If you need help determining whether a transaction could be prohibited, or if you think your IRA may have been involved in a prohibited transaction, we recommend contacting your tax advisor.
If a prohibited transaction results in a distribution of your funds, it is reported on IRS Form 1099-R. For prohibited transactions, Code 5 is entered in Box 7 of the Form 1099-R issued to report the distribution from your IRA.