Points Covered This Episode
- Prohibited Transactions frequently lead to the loss of half – or even all – of the host Self-Directed IRA
- Bryan’s definition of Prohibited Transaction: A prohibited transaction happens when the money or assets in the account are used to benefit you or your loved ones in the here-and-now rather than being a benefit to you exclusively during retirement.
- Prohibited Transactions are practically impossible to correct in Self-Directed IRAs… in Solo 401(k)’s, correction tends to be much simpler
- Common Examples: Borrowing from your IRA, paying yourself a salary for maanging your account, taking commissions for the sale of a property purchased or sold by your IRA, etc.
- Sometimes Prohibited Transactions can be very subtle, such as if you allow a family member to use your IRA’s property for seemingly innocent reasons
What’s the AMAZING thing about self-directed retirement accounts? EXTRAORDINARY flexibility, of course. What’s the WORST thing about self-directed retirement accounts? EXTRAORDINARY flexibility, of course… whenever that flexibility leads to a dreaded prohibited transaction. I’m Bryan Ellis. Today you learn what a prohibited transaction is and how to avoid them… because your retirement account depends on it. This is Episode #5.
Hello, Self-Directed Investor Nation! Welcome to broadcast of record for savvy self-directed investors like you!
Today’s show page can be found at SelfDirected.org/5 because, of course, this is Episode #5. And frankly, you should definitely check out today’s show page, because in addition to the normal links, resources and discussion about today’s topic – Prohibited Transactions – you’ll also find a link to a great eBook about that topic, which I wrote and which you can download at no cost. This is a topic worth a bit of your focused attention, because getting this wrong – particularly if you’re using a self-directed IRA – quite likely means you’ll lose at least half of your entire IRA… and maybe much, much more. But PT’s can be easy to avoid with a bit of knowledge, which you can get from the eBook available to you for free download at SelfDirected.org/5, and by listening in to today’s episode for a great introduction to this critical topic.
Quickly… yet again… THANK YOU folks for the extraordinary reception you’ve give to the FRESHLY UPDATED edition of Self Directed Investor Talk. I’m honored and humbled and grateful.
So… prohibited transactions.
Frankly, prohibited transactions are the absolute bane of the existence of every self-directed retirement account user… particularly self-directed IRA users.
Now look… this is a rather complicated topic, but I, your humble host, am uniquely well suited to making it completely understandable.
So let’s start with the basics. A definition is in order here.
Our friends at the IRS define it this way: “Generally, a prohibited transaction in an IRA is any improper use of an IRA account or annuity by the IRA owner, his or her beneficiary or any disqualified person.”
There you have it, my friends… another bit of practically worthless explanatory text from the feds.
Here’s my definition: A prohibited transaction happens when the money or assets in the account are used to benefit you or your loved ones in the here-and-now rather than being a benefit to you exclusively during retirement.
Before we go any farther, I want you to understand the seriousness of this issue. If you commit a prohibited transaction in your IRA, chances are extremely high you’ll lose at least half of the value of the IRA… particularly Traditional IRA’s. And frankly, it’s not at all uncommon for IRA’s to be ENTIRELY wiped out, even if the dollar value of the prohibited transaction is but a tiny percentage of the entire account value.
Prohibited transactions are serious for solo 401k’s too… very serious. But unlike IRA’s, the law provides some ways to essentially just pay a fine to unwind a prohibited transaction. That means that unlike IRA’s, prohibited transactions don’t automatically slaughter solo 401k’s. And that’s another… and maybe the biggest… reason why I believe solo 401k’s to be inherently superior to IRA’s of all types.
Now The easiest way to understand PT’s is to ask yourself this question:
- Who is directly or indirectly benefiting as a result of this transaction?
If the answer to that question is that ANYBODY benefited from the transaction other than your IRA, and your IRA’s contractual counterparty, then you need to look closer. Because if there’s any direct or indirect benefit for you, for your loved ones, or even for any businesses you own or organizations you control, then are quite likely in prohibited transaction territory.
Some easy examples:
- If you borrow money from your IRA, that’s prohibited, because you’re benefiting from access to your IRA’s money.
- If you set up a checkbook IRA LLC and pay yourself a salary for running the LLC, you’re benefiting from your IRA’s assets, and that’s prohibited.
- If your IRA buys a wonderful beachfront condo, and you or your family members use it occasionally, that’s a clear benefit for you and is prohibited.
You get the idea… don’t use your retirement account in any way that directly or indirectly benefits you or your loved ones. If you follow that rule, you’ll eliminate about 90% of all prohibited transaction risks.
Now that’s the basic idea.
Here’s one truth about using self-directed retirement accounts that you simply must NEVER, EVER ignore:
Before every transaction involving any so-called “alternative” assets like real estate or mortgage notes or anything else, you should DEFINITELY get an opinion from an expert attorney who has substantive experience with prohibited transactions.
Of course, members of the Self Directed Investor Society can worry far less about this issue, because that type of legal review is a wonderful benefit that many of them receive. But I digress.
Speaking of lawyers with experience in this matter, they’re actually quite rare. The very best of the best of them is our legal counsel for the Self Directed Investor Society, none other than the Great One, Mr. Tim Berry. His contact info is on today’s show page at SelfDirected.org/5
There are, in fact, so few lawyers with real expertise about this that part of my job as the Voice of the Self-Directed Investor Nation is to teach the topics of Self-Directed IRA’s and Prohibited Transactions to lawyers across the country. My next class, which is not open to the public, will be this coming week in California, where I’ll be teaching continuing education to California attorneys through a program at UCLA, and I’m looking forward to helping to educate the legal community about this topic, which is going to do nothing but get bigger and bigger.
And do you know the fundamental gist of what I tell attorneys when I help them to further their educations about prohibited transactions? It’s this:
Remember why IRA’s were created by Congress in the first place… and if your client is trying to use their IRA in a manner that is not wholly in keeping with the singular, clear reason IRA’s were created back in 1974, then the transaction is likely prohibited.
So why were IRA’s created by Congress?
Much to my surprise, that’s a GREAT STORY… could be a good movie… and for that reason, I’m going to tell you that story so you can be as well educated as these lawyers who take my classes.
BUT… you’ll have to wait to get that until the next episode of this very show, as we’re out of time for in this episode! But hold back your tears! Don’t allow the end of this show to plunge you into depression as you fight your addiction to and dependence upon your daily dose of Self Directed Investor Talk, because the next episode… Episode #5… of Self Directed Investor Talk is available RIGHT NOW.
The link for that show appears on today’s show page, which is SelfDirected.org/5… SelfDirected.org/5. As we part ways, my friends, ponder this little question: Have you ever done anything with your IRA or 401k that you now fear may have been a prohibited transaction? What was it? Join the discussion and share your answers at SelfDirected.org/5 … let’s all get a little bit smarter together!
My friends… invest wisely today, and live well forever!
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Bryan Ellis is host of Self Directed Investor Talk, America's #1 podcast and for affluent self-directed investors. He's also an expert in self-directed IRA's, solo 401k's and 1031 exchanges. You can find Bryan's writing in very highly respected publications including Forbes, Entrepreneur and TheStreet. Bryan lives in metro Atlanta, Georgia with Carole Ellis - his wife, business partner and best friend - and his 4 children ranging in age from 2 to 19.