IRA Disqualified Person Rules and Prohibited Transactions

An IRA disqualified person is anyone whose relationship to your account is close enough that the tax code presumes a conflict of interest, so any deal between them and the IRA is off-limits regardless of price or fairness. Internal Revenue Code Section 4975 names the categories: you, any fiduciary or service provider to the account, a specific slice of your family, and any entity that those people together own half or more of.¹ Cross the line and the penalties run from excise taxes to complete loss of the account’s tax-advantaged status.

Who Section 4975 Puts on the List

The statutory categories are broader than most account holders expect:

You, the IRA owner. You are always disqualified with respect to your own account.
Any fiduciary of the IRA, meaning the custodian, trustee, or an investment advisor who exercises discretion or control over the assets.
Anyone providing services to the IRA, such as an accountant, attorney, or property manager the account hires.
Your spouse, your ancestors (parents, grandparents, and further back), your lineal descendants (children, grandchildren, great-grandchildren), and the spouses of those lineal descendants.
Any corporation, partnership, trust, or estate in which disqualified persons hold a combined 50% or greater stake, measured by voting power, capital interest, or beneficial interest.

The statute also reaches officers, directors, 10% shareholders, and highly compensated employees of entities that are themselves disqualified. Those categories tend to matter more for employer-sponsored plans than for individual IRAs, but they can surface when your IRA invests in a business where you wear more than one hat.¹

Which Family Members Are In, and Which Aren’t

The family list under Section 4975(e)(6) is narrower than most people assume. It runs straight up and straight down: spouse, ancestors, lineal descendants, and the spouses of those descendants.¹ Your daughter-in-law and son-in-law are in. So are your grandchildren’s spouses.

Siblings, aunts, uncles, cousins, nieces, and nephews are not on the list. Your IRA could, on the family test alone, buy a rental from your brother. Two cautions, though. If your brother is also a fiduciary or paid service provider to the IRA, he’s disqualified on that separate ground. And if he co-owns a business with you or with your children, the entity rule below can still catch you.

Entities That Get Pulled In by the Ownership Math

A corporation, partnership, trust, or estate becomes a disqualified person once people already on the disqualified list hold 50% or more of it. The IRS aggregates their stakes and applies the constructive ownership rules of Section 267(c) to attribute ownership between family members.¹

The math is what catches people. Say you own 20% of an LLC and your daughter owns 35%. Individually, neither of you crosses 50%. Combined, you’re at 55%, and because you’re both disqualified persons in your own right, the LLC itself becomes disqualified. Your IRA cannot transact with it at all. Passive minority stakes don’t get you around this rule; the analysis looks at ownership percentages, not management authority.

What Counts as Transacting

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

Buying, selling, or leasing property in either direction.
Lending money or extending credit in either direction, even at above-market rates with strong collateral.
Furnishing goods, services, or facilities.
Using IRA assets for a disqualified person’s benefit, even indirectly.
A fiduciary dealing with IRA assets for their own interest.
A fiduciary receiving compensation from a third party in connection with an IRA transaction.

The word “indirect” in the statute carries real weight. Courts have read it broadly to reach transactions that run through intermediaries but effectively benefit a disqualified person. Intent and fairness don’t matter. If a transaction fits the definition, it is prohibited even when the IRA got the better end of the deal.

The Mistakes That Actually Catch Self-Directed IRA Owners

Most violations happen through misunderstanding rather than deliberate abuse. A few patterns come up repeatedly.

Personal Labor on IRA-Owned Property

If your IRA owns a rental, you cannot mow the lawn, paint the walls, or fix the plumbing yourself. Unpaid work still counts as furnishing services to the IRA. Everything from routine maintenance to major renovation has to go to unrelated third parties.

Personal Use of IRA-Owned Assets

If your IRA owns a vacation cabin, you cannot stay in it. Not for a weekend, not for a single night, not even at fair market rent. Any personal use by you or another disqualified person is a transfer of IRA assets for a disqualified person’s benefit, and there is no safe harbor for paying full price. The same reasoning applies to IRA-owned vehicles, artwork, or any other tangible property.

Personally Guaranteeing an IRA’s Loan

When a self-directed IRA borrows to buy real estate, the financing has to be non-recourse, with the property itself as the lender’s only security. The Tax Court has held that a personal guarantee from the IRA owner is an indirect extension of credit to the IRA, which is prohibited. In one case, taxpayers who guaranteed loans on IRA investments lost the tax-exempt status of both their traditional and Roth IRAs. This is among the most expensive mistakes in self-directed investing because it takes out the whole account.

Investing in Family-Controlled Entities

Your IRA cannot invest in an LLC or partnership where you and your lineal descendants together hold half or more of the equity, even as a purely passive limited partner. The threshold is ownership, not control.

What It Costs If You’re the One Involved

The penalty depends on who participates. When the IRA owner or a beneficiary is on one side of the prohibited transaction, Section 408(e)(2) treats the account as if it stopped being an IRA on the first day of the tax year the transaction occurred.³ All the assets are treated as distributed to you on January 1 of that year at fair market value.⁴

For a traditional IRA, the full value becomes ordinary income for that year. If you’re under 59½, the 10% early distribution penalty stacks on top.⁵ For a Roth, your contributions come back out tax-free because you already paid tax on them, but the earnings are taxable, and the 10% penalty hits those earnings if you haven’t met the age and five-year holding requirements. A single misstep in a six- or seven-figure account can produce a devastating tax bill.

One saving grace: each of your IRAs is treated separately for this purpose. A prohibited transaction in one account does not automatically kill your others.³ But if the same transaction touches more than one, each affected account loses its status on its own.

What It Costs If Another Disqualified Person Is Involved

When someone other than the owner participates, a different mechanism applies. Section 4975(a) imposes a 15% initial excise tax on the “amount involved” for each year the transaction goes uncorrected during the taxable period, payable by the disqualified person who took part.¹ The amount involved is the greater of what was given or what was received, valued as of the date of the transaction for purposes of the initial tax.²

If the transaction isn’t corrected within the taxable period, a second-tier tax of 100% of the amount involved applies. Correction means undoing the transaction and putting the IRA in the position it would have been in had the deal never happened. The excise taxes are reported on Form 5330.⁶

Pledging the IRA as Collateral Is Treated Differently

Using your IRA as security for a personal loan doesn’t work the same way as other prohibited transactions. 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 income and can trigger the 10% early withdrawal penalty, but the rest of the account survives, which is a meaningfully better outcome than full disqualification.

The Exemptions That Let Normal Fees Exist

Not every transaction between an IRA and a disqualified person is forbidden. Section 4975(d) carves out narrow exemptions. The one most relevant to ordinary IRA owners lets a disqualified person, including the custodian or trustee, receive reasonable compensation for services necessary to operating the account, so long as the arrangement can be terminated on reasonably short notice.⁷ That is why your custodian can charge you management fees without triggering a prohibited transaction. It does not shelter a fiduciary who steers transactions for personal benefit.

The Department of Labor also grants class exemptions for specific arrangements, and the details shift. Portions of PTE 2020-02, which covered compensation to investment advice fiduciaries in connection with rollover recommendations, were vacated by federal courts, with a notice of court vacatur published in March 2026.⁸ If your advisor tells you a particular exemption covers their compensation on a rollover, confirm the exemption is still in effect.

Keeping the Account Clean

The working rule is that your IRA should behave as if it belongs to a stranger. You don’t live in its properties, don’t work on them, don’t lend to it or borrow from it, and don’t do business with it through entities that you or your family control. Vendors, tenants, buyers, and service providers should have no family or business tie to anyone on the disqualified list.

Before your self-directed IRA signs anything, walk through the categories. Check the obvious relationships, and then check the entity ownership math with constructive attribution through family. If real estate financing is involved, confirm the loan is non-recourse and that nobody in your family is guaranteeing it. If a business you have any stake in is on the other side of the deal, get professional advice first. A consultation costs far less than reconstructing a wiped-out 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
7
eCFR. 26 CFR 54.4975-6 – Statutory Exemptions for Office Space or Services
8
U.S. Department of Labor. Class Exemptions