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Steer clear of prohibited IRA transactions

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in Small Business Tax

To paraphrase John F. Kennedy, it’s not what you do in your IRA, it’s what you can’t do.

Strategy: Don’t engage in any “prohibited transactions.” The penalties can effectively wipe out the benefits you received from your IRA in the first place.

Other rules limit the type of investments you can make with IRA funds (see below).

According to the IRS, a “prohibited transaction” is an improper use of an IRA by its owner, the IRS beneficiaries or any disqualified person. For this purpose, a “disqualified person” includes IRA fiduciaries—for example, a professional responsible for managing the IRA funds—or some other family member.

The list of prohibited transactions is a long one. It includes:

  • Borrowing money from the IRA
  • Selling property to the IRA
  • Using the IRA as security for a loan
  • Buying property for personal use with IRA funds
  • Receiving unreasonable compensation for managing IRA funds.

But note that withdrawing funds from an IRA and then depositing the same amount back into the IRA, or a different IRA, within 60 days is treated like a rollover and won’t trigger any dire consequences.

What are the penalties? When a prohibited transaction occurs, the account stops being treated as an IRA as of the first day of the year of the violation. Net effect: You’re treated like you received a taxable distribution of all the IRA assets on Jan. 1 of that year. In that case, you owe ordinary in­­come tax on the difference between the value and your basis, as with any other withdrawal. If you’re in the peak earning years, you’ll have to pay tax at rates reaching up to 39.6%.

Tip: To add insult to injury, you’ll generally owe a 10% penalty tax if you’re under age 59½.

No-nos in your IRA

Generally, you can’t use IRA funds to invest in collectibles, including the following:

  • Artwork
  • Rugs
  • Antiques
  • Precious metals (with exceptions for certain bullion that meets purity standards)
  • Gems
  • Coins and stamps (with some exceptions)
  • Rare alcoholic beverages
  • Certain other types of tangible personal property.

Tip: A limited exception exists for certain U.S. Treasury gold and silver coins.

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