Self Directed Ira And 401k Prohibited Transaction Basics

By Author: Jeff Nabers
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The most notable difference between endeavors down the path of using a self directed IRA versus traditional investing is the unique rules that apply to the former. The extremely simple rule is that an IRA (specifically) cannot buy life insurance or collectibles (such as rugs, works of art, alcohol, bullion).

The more involved rule is known as no self dealing and is described in Internal Revenue Code section 4975. This rule basically says that for each retirement plan/account, there is a list of disqualified persons with whom that plan cannot do business. These DQPs include:

1. The accountholder/participant and any other fiduciary (person who makes investment decisions for the plan)
2. Companies who provide services
3. A member of the family of #1 or #2 above (family defined as spouse [husband/wife], ancestor [parents, grandparents, etc], lineal descendants [children, grandchildren, etc], and spouses of lineal descents)
4. A corporation (or other entity) that is 50% or more owned (directly or indirectly) by #1, #2, or #3 above
5. An officer, director, 10% or more owner, or highly compensated ...
... employee of #4 above.
6. A 10% or more (in capital of profits) partner or joint venturer of #4 above

Every self directed IRA/401(k) investor should make this DQP list before making any investments.

Too many people seem to think of the list as only the accountholder and his family. As you can see it is a bit more involved than that. This doesn't require calculus, but you should actually write out the list step by step to ensure that it is complete. This list can actually get quite extensive if you, your family member, or anyone who provides services to your plan has ownership in several companies.

So, what is a prohibited transaction?

In a nutshell, when a DQP transacts with a plan it is a prohibited transaction (abbr PT). The trick here is what is considered to be a transaction. This is generally defined in IRC 4975 as when one of the following happens between a plan and DQP directly or indirectly:

* sale, exchange or lease of property
* lending of money or extension of credit
* furnishing of goods, services, or facilities

So I consider that to be the general rule. There are a couple of special rules and they consider a PT to also include:

* When plan assets are transferred to, used by or creating benefit to a DQP
* When the accountholder/participant directs his plan in his own interests (to benefit him now instead of through a proper distribution)
* When the accountholder/participant receives compensation from anybody in connection with plan income or assets

The reason I call these last three items special rules is because they transcend the 50% rule in determining when corporations are DQPs. In other words, if XYZ Corp is owned 49% by the accountholder's mother then XYZ Corp isn't techinically a DQP. Buuuuuut, if the plan then transacts with XYZ Corp it is obvious that the transaction might violate one of these special rules simply because you can't ignore that the mother's position in XYZ Corp was probably considered in the decision to direct the plan into that transaction.

All in all, a little common sense goes a long way. The intent of IRC 4975 is to obviously keep the plan out of transactions connected to people that the #1 & #2 DQPs might be able to control or use as a strawperson. So, clever concoctions that aim to evade prohibited transactions rules by a technicality often times still violate the last 3 special rules. It all comes down to intent, and this is something that DOL (the Department of Labor - the government agency that solely bears the responsibility and authority to interpret prohibited transaction expemtions) concludes based on assembling a fact pattern.

So the directly or indirectly part of the rule allows them to let some common sense override the technical rules. It also means that if a plan invests into an entity (Corp, LLC, etc) and that entity invests with disqualified person, it may still be a PT. More on that (plan asset rule) in a later post.

In summary, every self directed IRA/401(k) investor should make a disqualified person list before doing any transactions that involve the plan. Overlooking this is on par with a teenager not making and reviewing a budget because he thinks he can learn from and apply the concepts without actually doing the budget. Once this list is made, prohibited transactions can easily be avoided as long as the plan is never involved in any deals connected to anyone on the DQP list.

About the Author:
Learn more about Jeff Nabers, his consulting firm and the benefits of a self directed ira at http://www.Nabers.com or call his firm at 877-903-2220.