IRA Prohibited Transactions: The One Rule That Can End an IRA Overnight
Back in 2001, a guy named Darrell Fleck spotted a good deal: a fire-protection and alarm company that looked ripe for the picking. He wanted a partner, so he brought in Lawrence Peek, an attorney who’d represented him in the past. Each man opened a self-directed IRA and put $309,000 into a new company that bought out the fire-safety business. Fifty-fifty partners, fresh start.
And for a while, it worked. Beautifully, actually. By 2006, the business had grown enough that when they sold it, each IRA walked away with more than $1.6 million. Fleck and Peek even converted the stock to Roth IRAs along the way, which should have meant all that growth was headed toward them tax-free.
That is, it should have worked out great for both parties.
Until the tax court got involved, resulting in a landmark case, Peek v. Commissioner.
Here’s what happened.
Back at the very beginning, the deal needed a $200,000 seller-financed note to close. Fleck and Peek personally guaranteed that note. They even put their own homes up as collateral to back the guarantee.
That one decision to personally guarantee financing unraveled everything.
The Tax Court ruled that a personal guarantee is an extension of credit from the account owner to the IRA, and Section 4975 doesn’t allow that. Not a gray area, not a technicality, a straight-up prohibited transaction.
Because the violation happened at the moment the deal closed in 2001, the IRAs stopped being IRAs “right then.” Not in 2006 when the company sold. Not when the Roth conversion happened. 2001.
Which meant the Roth conversions didn’t protect anything, because there was nothing left to convert. The $1.6 million in gains from the 2006 sale got taxed personally to Fleck and Peek, on top of accuracy-related penalties for good measure.
I want to be clear about what this story does not mean. It doesn’t mean your IRA can’t own a piece of a closely held business. Self-directed IRAs do that successfully all the time. What it means is you can’t stand on both sides of the fence. You can’t let your IRA own the deal while you personally supply the muscle that makes the deal work, whether that’s a guarantee, collateral, or a loan out of your own pocket.
That fence looks narrow from a distance. But Section 4975 has some very sharp wire running along the top of it, and Fleck and Peek found out the hard way.
I’m Dan Anderson. I’ve spent more than two decades helping self-directed IRA investors structure deals that hold up, and just as often, helping people understand why a deal they were excited about needed to be restructured or walked away from entirely. Here’s the rub: most of the prohibited transaction mistakes I’ve seen weren’t made by reckless people. They were made by careful people who simply didn’t know the rule existed until it was too late.
Key Takeaways
- A prohibited transaction is any direct or indirect dealing between your IRA and a “disqualified person,” a defined list that includes you, your spouse, and your lineal family.
- Fair market value doesn’t protect you. A transaction can be priced perfectly and still be prohibited.
- The penalty depends on who’s involved. If the IRA owner or beneficiary is the disqualified person, the entire IRA is treated as distributed. If it’s someone else, like a fiduciary or a controlled entity, excise taxes of 15% and potentially 100% apply instead.
- A narrow 14-day correction window exists for certain transactions, but it doesn’t apply to most classic self-dealing situations.
- Two landmark Tax Court cases, Swanson and Peek, show how far this rule reaches, including into structures that seemed perfectly legal on paper.
What Section 4975 Actually Says
Congress created the prohibited transaction rules to close a specific loophole: without them, nothing would stop an IRA owner from shuffling assets between their personal holdings and their tax-advantaged account to dodge taxes, or from using IRA money to enrich themselves and their family today instead of preserving it for retirement.
Under IRC §4975(c)(1), a prohibited transaction generally includes any direct or indirect:
- Sale, exchange, or lease of property between the IRA and a disqualified person
- Loan or other extension of credit between the IRA and a disqualified person
- Furnishing of goods, services, or facilities between the IRA and a disqualified person
- Transfer of IRA income or assets to, or for the benefit of, a disqualified person
- Act by a fiduciary who deals with IRA assets for his or her own interest or account
Notice what isn’t in that list: any mention of price. The IRS doesn’t ask whether the deal was fair. It asks whether a disqualified person was involved at all. That single distinction trips up more investors than any other part of this rule, because it runs counter to how we normally think about ethical dealing. “I paid full market value” is a perfectly reasonable defense in most of life. Here, it’s not a defense at all.
Who Counts as a “Disqualified Person”
I have always chuckled at the idea of a person being “disqualified.” I have known some bipeds I thought should be declassified as human. But, unfortunately, the term as it is used here has nothing to do with the ability to vote someone off our island.
Instead, the term “disqualified person” does most of the heavy lifting in Section 4975, and it’s worth understanding precisely, because the definition is both broader and narrower than people expect.
Individuals Who Are Always Disqualified
- You, the IRA owner
- Your spouse
- Your parents, grandparents, and other lineal ascendants
- Your children, grandchildren, and other lineal descendants
- The spouses of your children and grandchildren
- Any fiduciary of the IRA, including your custodian and anyone with discretionary authority over the account
- Anyone providing investment advice to the IRA for a fee
Who Is Notably Excluded
This surprises almost everyone the first time they hear it. Siblings, aunts, uncles, cousins, and friends are not disqualified persons under Section 4975. Your IRA can transact with a brother or sister in ways it absolutely cannot with a spouse or child. That doesn’t mean every deal with a sibling is automatically a good idea, but it isn’t categorically prohibited the way a parallel deal with your daughter would be.
Entities Can Be Disqualified Too
The rule doesn’t stop at individuals. Under IRC §4975(e)(2), a company, partnership, or trust becomes a disqualified person if disqualified individuals, combined, own or control 50 percent or more of it. That combination rule matters. If you own 30 percent of a company and your spouse owns another 25 percent, the entity is disqualified even though neither of you crosses 50 percent alone.
An officer, director, or 10-percent-or-greater shareholder of a disqualified entity is also, in turn, a disqualified person. The definition cascades outward from there, which is exactly why complex ownership structures deserve a second look before your IRA gets involved with them.
Common Prohibited Transactions in Real-World Terms
The statute reads like, well, a statute. Here’s what it actually looks like in practice.
- Buying a property from yourself or selling one to your IRA, at any price, including full fair market value.
- Letting your IRA purchase a vacation home that you, your spouse, or your children use, even for a single weekend.
- Lending money from your IRA to yourself or a family member, or borrowing from your IRA personally.
- Performing repairs, management, or any other labor yourself on a property your IRA owns, even unpaid.
- Having your IRA invest in a business where you or a family member serves as an officer, director, or controlling owner.
- Receiving a commission or fee personally on a transaction your IRA enters into, such as a real estate agent earning a commission on their own IRA’s property purchase.
- Guaranteeing a loan made to your IRA or to an entity your IRA owns, even informally.
The Two-Track Penalty Structure Most Guides Get Wrong
Here’s where I want to slow down, because nearly every article on this topic treats the penalty as a single outcome: “your IRA gets disqualified.” That’s true in some cases and incomplete in others, and the distinction matters enormously depending on who’s involved in the transaction.
Track One: The IRA Owner or Beneficiary Is the Disqualified Person
Under IRC §408(e)(2), if you, the IRA owner, or your beneficiary engages in a prohibited transaction, the consequence isn’t an excise tax. It’s full disqualification. Your IRA stops being an IRA as of January 1 of that tax year. The IRS treats the entire account as distributed to you at fair market value on that date, which typically creates a substantial taxable event, plus a 10 percent early withdrawal penalty if you’re under 59½.
Track Two: A Different Disqualified Person Is Involved
When the prohibited transaction involves a disqualified person other than the IRA owner or beneficiary, such as a fiduciary acting in their own interest, or a controlled entity, a different mechanism applies under IRC §4975(a) and (b). Rather than disqualifying the account, the law imposes a 15 percent excise tax on the amount involved, for each year the transaction remains uncorrected. If the transaction isn’t unwound within what the code calls the “taxable period,” that tax jumps to 100 percent of the amount involved.
Why You Won’t Get Hit With Both
This is the coordinating rule almost nothing online explains clearly. IRC §4975(c)(3) exists specifically so that an IRA owner doesn’t face full disqualification of the account and the excise tax on top of it for the same violation. If your account is disqualified under Track One, the excise tax under Track Two doesn’t also apply to you as the owner. The two tracks are mutually exclusive for the same person, which is a meaningful piece of relief buried in a part of the code most people never read.
That said, this coordination only protects the IRA owner from double punishment. If a separate disqualified person, say, a fiduciary, was also involved in the same transaction, that person can still face the excise tax track independently.
Can You Correct a Prohibited Transaction?
Sometimes, but the window is narrower than people hope, and it doesn’t apply to most of the self-dealing scenarios that affect individual IRA owners.
The Internal Revenue Code does include a 14-day correction period for certain transactions, but this exemption is built primarily for employer-sponsored plans, not for the kind of direct self-dealing an individual IRA owner typically faces. If your IRA personally loans you money, for example, unwinding the loan a week later doesn’t retroactively make it not a prohibited transaction.
Separately, for transactions that fall under the excise tax track rather than the disqualification track, correcting the transaction (essentially undoing it and making the account whole) within 90 days of an IRS notice of deficiency can eliminate the 100 percent additional tax, though the initial 15 percent excise tax generally still applies. This is a meaningfully different mechanism from the 14-day rule, and conflating the two is one of the more common mistakes I see in other explanations of this topic.
The practical lesson either way: don’t count on correction as a safety net. The far better strategy is structuring the deal correctly before it happens.
Two Cases Worth Knowing
Swanson v. Commissioner (1996)
Mr. Swanson used his IRA to purchase all the initial shares of a company he had just incorporated. The IRS argued this was a prohibited transaction. The Tax Court disagreed, holding that the initial capitalization of a new company by the IRA wasn’t, by itself, a prohibited transaction. The company became a disqualified person the moment it was formed, but forming it in the first place wasn’t a violation.
This case serves as an important foundation for understanding the “Checkbook IRA” and Self-Directed IRA LLC structures. It clearly shows that an IRA can fully own a business entity. However, the court also pointed out that once the entity is funded and owned by the IRA, it then becomes a disqualified person. This means that the IRA owner should follow all operational rules carefully and avoid using the company for personal gain, ensuring everything stays compliant.
However, it’s important to remember that the lesson investors should learn from this case is a bit too broad. Swanson is about protecting the creation of an entity, but it doesn’t say anything about what you can do with that entity later on. Any transactions you make afterward with a disqualified company will still be subject to the full implications of Section 4975.
Peek v. Commissioner (2013)
This is the case I opened with. Two IRA owners formed an acquisition entity to buy a business, with the purchase partly seller-financed. The IRA owners personally guaranteed that note. The Tax Court held that personally guaranteeing a loan made to an entity your IRA owns counts as an indirect extension of credit between you and your IRA, which is squarely prohibited.
Peek matters because the guarantee felt, to the people involved, like a reasonable business practice rather than a transaction with their own IRA. The court didn’t see it that way. If you’re ever asked to personally back a loan connected to an IRA-owned asset, treat that as a five-alarm warning sign, not a formality.
A Short List of Exceptions
Section 4975(d) does carve out a handful of exceptions relevant to individual IRA owners, though they’re narrower than people hope:
- Reasonable compensation paid to a disqualified person for necessary services, such as a contract with an unrelated custodian or administrator for legal, accounting, or recordkeeping services.
- Reasonable compensation and reimbursement of expenses for a disqualified person performing legitimate duties for the plan, again generally relevant to service providers rather than the IRA owner personally.
Notice what’s absent from this list: there’s no general exception for transactions priced at fair market value, and no exception that lets an IRA owner personally perform labor on an IRA-owned asset, even for free.
How to Stay Compliant Without Overthinking Every Decision
After two decades in this business, the investors who stay out of trouble tend to follow a few consistent habits rather than memorizing the entire code section.
- Treat the IRA as a stranger’s account, not your own. Would you personally lend a stranger’s retirement savings to your son? That instinct check catches most problems before they start.
- Never let personal and IRA funds touch, even temporarily, even as a planned same-day reimbursement.
- Use unrelated third parties for every service the IRA needs: contractors, property managers, brokers, accountants.
- Map out entity ownership before investing. If you, your spouse, and your kids combined will own 50 percent or more of a company, that company is disqualified.
- Make it a habit to regularly meet with your tax and legal advisors to do compliance checks for your self directed investments. Paying for an hour of their time is money well spent!
- Ask before you act, not after. A five-minute conversation before closing is dramatically cheaper than unwinding a completed transaction.
Where IRA Express Fits In
As your account administrator, our job at IRA Express is to help you keep clean, compliant records and to flag transactions that raise questions before they become problems. We don’t sell investments, and we don’t have a referral network, so when something falls outside our scope, we’ll tell you plainly rather than point you somewhere with a hidden incentive.
If you’re structuring a deal that involves a family member, a controlled entity, or anything that makes you pause even slightly, contact Dan directly. I’d rather spend twenty minutes talking through a structure with you now than read about it in a notice of deficiency later.
You can also review how our accounts handle day-to-day compliance on our Self-Directed Plans page, or see how these rules apply specifically to real estate purchases on our guide to buying real estate with a self-directed IRA.
Frequently Asked Questions
Does paying fair market value protect a transaction from being prohibited?
No. Price has nothing to do with whether a transaction is prohibited. The question is only whether a disqualified person was involved.
Can my IRA do business with my sibling?
Yes, generally. Siblings are not disqualified persons under Section 4975, unlike spouses, parents, and children. That said, any transaction should still make business sense on its own merits.
What happens if I accidentally engage in a prohibited transaction?
If you, the IRA owner, are the disqualified person involved, the IRA is generally treated as fully distributed as of January 1 of that year, triggering immediate taxation. Talk to a tax professional immediately if you suspect this has happened; the available remedies are narrow and time-sensitive.
Is there a way to undo a prohibited transaction?
Sometimes, depending on who was involved and which penalty track applies, but the windows are narrow and don’t cover most classic self-dealing scenarios involving the IRA owner directly. Don’t rely on correction as a backup plan.
Can my IRA invest in a business I work for?
It depends entirely on your ownership and role. If you own less than 10 percent and don’t control the company, this is sometimes permissible, as a Private Letter Ruling on this exact scenario confirmed. If you’re an officer, director, or significant owner, the company is likely a disqualified person.
Does this rule apply the same way to a Roth IRA?
Yes. Section 4975 and the disqualification rules under Section 408(e)(2) apply to Traditional and Roth IRAs alike. The account type doesn’t change the prohibited transaction analysis.
Should I get a tax attorney involved before a complex transaction?
For anything involving family members, controlled entities, or financing structures like loan guarantees, yes. A qualified tax or legal professional familiar with self-directed IRAs can review the structure before you’re committed to it, which is far better than reviewing it afterward.
The Bottom Line
Section 4975 isn’t designed to punish creativity or alternative investing. It’s designed to keep one line firmly in place: your IRA exists for your retirement, not for today’s convenience. Every rule in this guide traces back to that single idea.
If you’re about to structure a deal and something about it makes you pause, that pause is worth listening to. Contact Dan directly, and let’s make sure the structure holds up before you’re financially committed to it.
Sources: Internal Revenue Code §4975 and §408(e)(2) (Cornell Legal Information Institute); Internal Revenue Service, Retirement Topics – Prohibited Transactions; Swanson v. Commissioner, 106 T.C. 76 (1996); Peek v. Commissioner, 140 T.C. No. 12 (2013).