IRA Disqualified Person Rules and Prohibited Transactions

For an IRA, a disqualified person is anyone whose relationship to the account or its owner is close enough that dealing with the IRA would create a conflict of interest. Under Internal Revenue Code Section 4975, that list covers you as the account owner, any fiduciary of the account, certain family members, and business entities those people control together. Any transaction between the IRA and one of these people is prohibited, no matter how fair the price or how arm’s-length the paperwork looks.

Who Counts as a Disqualified Person

Section 4975(e)(2) sets out the categories. The definition reaches further than most account owners expect.¹

You. The IRA owner is always disqualified with respect to their own account.
Any fiduciary of the IRA. That means the custodian, the trustee, and any investment advisor who exercises discretion or control over the account’s assets.
Anyone providing services to the IRA, such as an accountant, attorney, or property manager the account has hired.
Certain family members (see the next section).
Corporations, partnerships, trusts, or estates in which disqualified persons together hold 50% or more of the ownership, measured by voting power, capital interest, or beneficial interest.

The statute also pulls in officers, directors, 10%-or-greater shareholders, and highly compensated employees of an entity that is itself a disqualified person. For an individual IRA, that layer usually only matters when the account invests in a closely held business where the owner already wears more than one hat.

Which Family Members Are In, and Which Are Not

The family definition is narrower than most people assume. Section 4975(e)(6) limits the restricted family to your spouse, your ancestors (parents, grandparents, and further back), your lineal descendants (children, grandchildren, great-grandchildren), and the spouses of those lineal descendants.¹ Your son-in-law and daughter-in-law are both on the list.

Siblings, aunts, uncles, nieces, nephews, and cousins are not. In theory, your IRA could buy a rental property from your brother without the family rule tripping the wire. Two cautions apply. If that same brother is also a fiduciary or paid service provider to the IRA, he becomes disqualified on that separate ground. And if he co-owns a business with you or your children, the entity math below can pull him back in through the back door.

How Businesses Get Pulled Onto the List

A corporation, partnership, trust, or estate is a disqualified person when people who are already disqualified hold 50% or more of it in combination. The IRS aggregates their stakes rather than looking at each person alone, and it applies the constructive ownership rules from Section 267(c) to attribute ownership between family members.¹

The trap looks like this. Say you own 20% of an LLC and your daughter owns 35%. Neither of you alone breaks 50%. Because you are both disqualified persons already, the IRS adds your stakes together. At 55%, the LLC is disqualified, and your IRA cannot transact with it at all. Passive investment structures and limited partnership interests do not escape the rule; the analysis follows ownership percentages, not management authority.

What Disqualified Persons Can’t Do With the IRA

Section 4975(c)(1) lists six categories of prohibited transactions between an IRA and any disqualified person:²

Buying, selling, exchanging, or leasing property. Your IRA cannot buy real estate from your father or lease office space to your spouse, in either direction.
Lending money or extending credit. Your IRA cannot lend to your child’s business, and your child’s business cannot lend to the IRA, no matter the interest rate or collateral.
Furnishing goods, services, or facilities. Your IRA cannot hire your son to manage a rental it owns, even at market rates and even with a professional license.
Using IRA assets for the benefit of a disqualified person, directly or indirectly.
Fiduciary self-dealing, where a fiduciary uses the position to direct IRA transactions for personal gain.
Fiduciary kickbacks from third parties in connection with IRA transactions.

The word “indirect” carries real weight. Courts have read it to reach transactions that technically pass through an intermediary but still benefit a disqualified person. Fairness and intent do not enter the analysis; if the transaction fits the definition, it is prohibited.

Traps Self-Directed IRA Owners Walk Into

Most violations happen through ignorance of these edges rather than deliberate abuse.

Doing the Work Yourself

If your IRA owns a rental house, you cannot mow the lawn, paint the walls, or fix the plumbing yourself. Personal labor is a service furnished to the IRA. The fact that you are working for free does not help; unpaid work is still a service, and the IRA has to hire unrelated third parties for maintenance and repairs.

Using the Property Yourself

If your IRA owns a vacation cabin, you cannot stay in it. Not for a weekend, not for a night, not even if you pay full market rent. Personal use by you or any disqualified person is a transfer of IRA assets for that person’s benefit, and there is no safe harbor for fair-value payments. The same rule applies to any IRA-owned vehicle, artwork, or other tangible asset.

Personally Guaranteeing an IRA Loan

When a self-directed IRA borrows to buy real estate, the loan has to be non-recourse, secured only by the property itself. The Tax Court has held that a personal guarantee from the IRA owner is an indirect extension of credit between the owner and the IRA, and therefore a prohibited transaction. In one reported case, taxpayers who guaranteed loans for IRA-owned investments lost the tax-exempt status of both their traditional and Roth accounts. It is one of the most expensive mistakes in self-directed investing because the whole account goes.

Investing in a Family-Controlled Entity

Your IRA cannot invest in a partnership or LLC in which you and your lineal family together hold 50% or more of the equity, even as a passive limited partner with no say in operations.

Consequences When You Are the Person Involved

The penalties turn sharply on who participated. If the IRA owner or a beneficiary is on the other side of the prohibited transaction, Section 408(e)(2) treats the account as ceasing to be an IRA on the first day of the tax year in which the transaction happened.³

The IRS then treats the account as if it had distributed everything to you on January 1 of that year, valued at fair market value.⁴ For a traditional IRA, the full balance becomes ordinary income for that year. If you are under 59½, the 10% early distribution penalty stacks on top of the income tax.⁵

For a Roth IRA, contributions come out tax-free because you already paid tax on them, but earnings become taxable and the 10% penalty applies to those earnings unless you have met the age and five-year holding requirements. Either way, a single prohibited transaction can generate a devastating bill on a mid-sized or large account.

Each of your IRAs is treated as a separate account for this purpose, so a violation in one does not automatically kill the others.³ If the same transaction touches more than one, each affected account loses its status on its own.

Consequences When Another Disqualified Person Is Involved

When someone other than the IRA owner is on the other side, a different mechanism applies. Section 4975(a) imposes an initial 15% excise tax on the “amount involved” for each year the transaction remains uncorrected during the taxable period. The disqualified person who participated pays the tax.¹

The “amount involved” is the greater of the money or fair market value given or the money or fair market value received; for the initial 15% tax, that value is measured on the date of the transaction.² If the transaction is not corrected within the taxable period, a second-tier tax of 100% of the amount involved follows. Correction means unwinding the deal and putting the IRA back in the position it would have been in had the transaction never happened, reported on IRS Form 5330.⁶

One Narrower Rule: Pledging the IRA as Collateral

Pledging an IRA for a personal loan is treated differently from the transactions above. Under Section 408(e)(4), only the pledged portion is treated as distributed to you; the rest of the account keeps its IRA status.³ The deemed distribution is still taxable and potentially subject to the 10% early withdrawal penalty, but the account is not wiped out.

A Working Rule to Stay Clear

The simplest way to stay on the right side of these rules is to run your IRA as if it belonged to a stranger. You do not live in its properties, you do not repair its buildings, you do not lend to it or borrow from it, and you do not do business with it through entities you or your family control. Every tenant, buyer, seller, and service provider should have no family or business tie to you or anyone else on the disqualified list.

Before your self-directed IRA signs anything, walk the categories one more time. Check the obvious personal relationships, then do the entity ownership math, including constructive ownership through family members. If the IRA is borrowing, confirm the loan is non-recourse and that no one in the family is guaranteeing it. If the deal involves a business you have any stake in, get professional advice first. A consultation costs very little next to the tax bill that follows a disqualified account.

1
Office of the Law Revision Counsel. 26 USC 4975 Tax on Prohibited Transactions
2
Office of the Law Revision Counsel. 26 US Code 4975 – Tax on Prohibited Transactions
3
Office of the Law Revision Counsel. 26 USC 408 – Individual Retirement Accounts
4
Internal Revenue Service. Retirement Topics – Prohibited Transactions
5
Internal Revenue Service. Topic No. 557, Additional Tax on Early Distributions from Traditional and Roth IRAs
6
Internal Revenue Service. Instructions for Form 5330