David Moore of Equity Advantage warns investors that one prohibited transaction can wipe out an IRA’s protections, leaving the entire account taxable and possibly penalized. The IRS doesn’t allow mistakes here, and even small missteps can have big financial consequences. Let’s look at what prohibited transactions are, why they matter, and how you can stay compliant.
What’s a Prohibited Transaction?
A prohibited transaction happens when you or a “disqualified person” (such as a spouse, child, parent, or related business) benefit directly from your IRA. If that happens, the IRS treats the entire account as if you cashed it out on January 1 of that year.
That means:
- You lose the tax-deferred or tax-free status.
- The whole balance becomes taxable income.
- If you’re under 59½, you’ll also face a 10% penalty.
Common mistakes include:
- Repairing or managing IRA-owned property yourself.
- Buying, selling, or leasing between your IRA and family members.
- Lending money to or from your IRA.
Even something as small as fixing a faucet in an IRA-owned rental could trigger this rule.
Self-Directed & Checkbook IRAs
Self-directed IRAs let you invest beyond Wall Street, including real estate, private notes, or small businesses. A checkbook IRA adds another layer of control by using an LLC owned by the IRA and managed by you.
But with more control comes more risk. You can manage investments administratively, like signing checks or hiring contractors, but you can’t perform the work yourself. Doing so is considered “self-dealing,” which counts as a prohibited transaction.
Want to Be Hands-On? Consider ROBS
For investors who want to actively work in their business, David Moore recommends a Rollover Business Startup (ROBS). This strategy uses:
- Retirement funds rolled into a new 401(k).
- The 401(k) purchasing stock in a new C corporation.
- The C corporation using that money to operate the business, where you can be employed.
Unlike IRAs, ROBS allows active participation. But it comes with strict retirement plan and corporate compliance requirements. Not all accounts qualify either, inherited IRAs and Roth IRAs generally cannot be rolled into a ROBS.
Which Path Is Right for You?
- IRA + LLC (Self-Directed or Checkbook IRA): Best for passive investing where you don’t perform labor or services.
- 401(k) + C Corporation (ROBS): Best if you want to actively run a business and take a salary.
Best Practices for Investors
- Define your goals: passive vs. active involvement.
- Get professional tax and retirement plan guidance.
- Always use third-party contractors for IRA-owned assets.
- Double-check rollover eligibility before moving funds.
- Keep thorough documentation of all transactions.
Prohibited transactions can undo years of savings in a single mistake. If your goal is to stay passive, a self-directed IRA may work well. If you want to be hands-on, ROBS is the safer route.
Before making any moves, consult IRA Advantage or another qualified advisor to ensure your retirement funds are protected and aligned with your long-term goals.
The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 503-635-1031.
