dscr-loan-self-directed-ira) Prohibited Transactions: The Rules That Can Destroy Your Retirement Account

A self-directed IRA (SDIRA) can be one of the most powerful vehicles for [real estate investing](/blog/brrrr-strategy-guide) — but it comes with a hidden minefield. Unlike conventional IRAs limited to stocks, bonds, and mutual funds, SDIRAs allow real estate, private lending, tax liens, and other alternative assets. But the IRS imposes strict rules about who can benefit from these investments and how transactions must be structured.

Violate a "prohibited transaction" rule and you don't just get a fine — the entire IRA can be disqualified, triggering immediate taxation of all assets in the account plus a 10% early withdrawal penalty if you're under 59½. For a $500,000 SDIRA, that's potentially $150,000+ in taxes due immediately.

This guide explains exactly what prohibited transactions are, who counts as a "disqualified person," and how to structure your SDIRA real estate investments to stay fully compliant.

What Is a Prohibited Transaction?

Under IRC Section 4975, a prohibited transaction is any direct or indirect:

Sale, exchange, or leasing of property between the IRA and a disqualified person
Lending of money 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 plan assets to, or use by or for the benefit of, a disqualified person
Any act by a disqualified person who is a fiduciary to deal with income or assets of the IRA for their own interest

The common thread: transactions that create personal benefit from IRA assets before retirement.

Who Counts as a "Disqualified Person"?

The IRS defines disqualified persons broadly to prevent self-dealing. Disqualified persons include:

Tier 1: You (The IRA Owner)

You are always a disqualified person with respect to your own IRA.

Tier 2: Your Lineal Ascendants and Descendants

Your spouse
Your children (biological, adopted, or step)
Your grandchildren
Your parents
Your grandparents

Note: Siblings are NOT disqualified persons. Your brother or sister can transact with your IRA, though you should still work with an SDIRA attorney before doing so.

Tier 3: Spouses of Lineal Ascendants/Descendants

Your son-in-law, daughter-in-law
Your parents' spouses (if remarried)

Tier 4: Entities You Control

Any corporation, partnership, trust, or estate in which you (or another disqualified person) owns 50% or more is disqualified.

This means if you own 60% of an LLC, that LLC is a disqualified person. Your IRA cannot buy property from, sell property to, or transact with that LLC.

Tier 5: Fiduciaries

Anyone who exercises discretionary control over the IRA (including your IRA custodian or trustee) is technically a disqualified person for certain purposes.

The Most Common Prohibited Transaction Mistakes

Mistake 1: Self-Dealing on Property Purchases

Prohibited: Your IRA buys a property that you personally own, or you sell your personal property to your IRA.

Why investors do this: They want to "park" personal real estate inside the IRA tax structure.

The correct approach: Your IRA must purchase properties from unrelated third parties in arm's-length transactions.

Mistake 2: Personal Use of IRA-Owned Property

Prohibited: You (or any disqualified person) use property owned by your SDIRA personally.

Why this matters: This is the most commonly tripped prohibition. Your SDIRA can own a vacation rental — but you cannot stay in it, even for one night, even if you pay market rent. Same rule applies to a disqualified person; your adult daughter cannot live in an SDIRA-owned rental.

Why investors do this: It seems like a no-brainer — the IRA "owns" it, so shouldn't the IRA owner get some benefit?

The IRS view: That personal benefit is exactly what's prohibited before retirement distribution.

Mistake 3: Paying Yourself for Services

Prohibited: If your SDIRA owns rental property, you cannot be paid for managing it, making repairs, or performing any services. You are a disqualified person — any compensation would be a prohibited transaction.

The correct approach: All [property management](/blog/property-management-complete-guide), maintenance, and services must be performed by unrelated third parties and paid from IRA funds. You can direct the investments and make decisions, but you cannot be compensated for labor.

What this means practically: You cannot be your own property manager for SDIRA-owned properties. You must hire a professional property management company (unrelated to you).

Mistake 4: Personally Guaranteeing IRA Debt

Prohibited: If your SDIRA takes out a mortgage (called a "non-recourse loan" in SDIRA context), you cannot personally guarantee the debt.

SDIRAs can borrow money — but only through non-recourse loans, where the lender's only recourse in default is the property itself. The lender cannot come after you personally or your personal assets.

Personal guarantees are prohibited because they create a direct financial benefit to the IRA that flows through you.

UBIT Note: When an SDIRA borrows money to purchase real estate, the leveraged income may be subject to Unrelated Business Income Tax (UBIT) — typically 37% for trusts. This is a significant planning consideration when using leverage in an SDIRA.

Mistake 5: Mixing Personal Funds with IRA Funds

Prohibited: Contributing personal funds to complete an IRA transaction, or paying IRA expenses with personal money.

Example: Your SDIRA owns a rental property. The furnace breaks and the repair costs $3,500. Can you just pay it out of pocket and have the IRA reimburse you? No — this is a prohibited loan from you to the IRA.

The correct approach: All expenses related to the IRA property must be paid from IRA funds. This means maintaining adequate liquidity in your SDIRA cash account to cover repairs, vacancies, property taxes, and insurance.

Mistake 6: Receiving IRA Income in Your Personal Account

Prohibited: Rent payments from an IRA-owned property must flow back to the IRA, not to your personal bank account. If you collect rent from tenants and deposit it personally — even temporarily — it's a prohibited distribution.

Mistake 7: Transacting with Family Members

Prohibited: Your SDIRA buys a rental property from your parents, sells to your adult child, or loans money to your spouse's business.

This catches many investors off guard because they assume arm's-length pricing makes family transactions acceptable. It doesn't — the identity of the party matters, not just the price.

Consequences of a Prohibited Transaction

The penalties are severe and non-negotiable:

Immediate IRA disqualification: The entire IRA (not just the transaction) is treated as distributed to you as of January 1 of the year in which the prohibited transaction occurred.

Full income taxation: All assets in the IRA are added to your taxable income in that year. For a $600,000 IRA, you could owe $180,000–$240,000 in federal income tax in a single year.

Early withdrawal penalty: If you're under 59½, add a 10% penalty on the full distribution amount: another $60,000 in this example.

State income taxes: Depending on your state, add another 5–13%.

Total potential cost: On a $600,000 SDIRA, a single prohibited transaction could cost $300,000+ in taxes and penalties.

Structuring SDIRA Real Estate Correctly

The Checkbook IRA LLC

Many SDIRA investors use an LLC structure where the IRA owns an LLC (often called a "checkbook IRA" or "IRA LLC"). The benefits:

Faster transaction speed (you control the LLC checking account)
Lower custodian transaction fees
Easier property management

However, the prohibited transaction rules apply with equal force to the LLC. You still cannot personally use the property, be compensated for services, or transact with disqualified persons.

Partnering with Your IRA

Your SDIRA can co-invest alongside your personal funds or a non-disqualified person — but only if you never receive a personal benefit disproportionate to your IRA's ownership interest.

Example: Your IRA owns 50%, you personally own 50% of a property. All income, expenses, and decisions must be proportional to the ownership split. You cannot prioritize your personal 50% share at the IRA's expense.

Getting a Proper Custodian

Not all IRA custodians allow real estate. Self-directed IRA custodians who specialize in alternative assets include:

Equity Trust Company
Midland IRA
Entrust Group
Alto IRA
Advanta IRA

These custodians process transactions, hold title in the IRA's name, and help ensure proper documentation — but they do not provide legal or tax advice. Always work with an SDIRA attorney and CPA.

What You CAN Do with an SDIRA in Real Estate

Despite the restrictions, SDIRAs offer tremendous flexibility:

Buy rental properties (residential and commercial)
Make private loans secured by real estate (to non-disqualified parties)
Invest in real estate notes and mortgage pools
Participate in real estate syndications as a limited partner
Purchase tax liens and deeds
Invest in raw land for development
Fund fix-and-flip projects through private lending

The key: all transactions must be with unrelated third parties, all income goes to the IRA, all expenses are paid by the IRA, and you receive no current personal benefit.

For more on the foundational strategy, see our [[self-directed IRA real estate](/blog/real-estate-investing-retirement-accounts) guide](/blog/self-directed-ira-real-estate-guide).

Working with DSCR Lenders for SDIRA Properties

If your SDIRA is purchasing real estate with a non-recourse loan, your financing options are more limited than conventional investment property loans. DSCR lenders typically don't offer non-recourse loans; however, several specialized lenders cater to SDIRA real estate purchases. Your SDIRA attorney can help identify compliant financing options.

[Learn about [DSCR loans](/blog/best-dscr-lenders-2026) for self-directed IRAs →](/blog/dscr-loan-self-directed-ira)

Key Resources for SDIRA Compliance

IRS Publication 590-A — IRA contributions
IRS Publication 590-B — IRA distributions
IRC Section 4975 — Prohibited transaction rules
IRS Notice 2004-8 — Guidance on prohibited transactions

Self-Directed IRA Real Estate Guide
Self-Directed IRA Real Estate: Retirement Strategy
Solo 401(k) for Real Estate Investing
Real Estate Investing Through Retirement Accounts
[[[Passive Real Estate](/blog/real-estate-syndication-101) Investing](/blog/passive-real-estate-investing-guide) Guide](/blog/passive-real-estate-investing-guide)
[[DSCR Loan](/blog/dscr-loan-guide) for Self-Directed IRA](/blog/dscr-loan-self-directed-ira)

Self-Directed IRA Prohibited Transactions: The Rules That Can Destroy Your Retirement Account

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