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An Advisor’s Guide to IRA Prohibited Transactions

With individual retirement account assets exceeding $7 trillion, advisors need to be familiar with prohibited transaction rules. 

The individual retirement account market, which now accounts for over $7 trillion in assets, is undergoing some significant changes. There are now a number of IRA custodians that permit investments in private placements, real estate and other non-publicly traded assets, and the Department of Labor recently finalized rules regulating IRA advisors. So it would behoove advisors to familiarize themselves with the nuances of these accounts, especially IRA-prohibited transaction rules. Recognizing possible missteps is key to avoiding significant tax consequences.

A prohibited transaction is any of several actions listed in Internal Revenue Code Section 4975(c)(1) that involves an IRA and a “disqualified person.”

Disqualified Persons

Under the prohibited transaction rules, disqualified persons include:

• A fiduciary, which is anyone who exercises any discretionary authority or discretionary control over the IRA or its assets or provides IRA investment advice for direct or indirect compensation.

Because the IRA owner typically has investment discretion over the IRA, she’ll be a fiduciary. A discretionary investment manager or compensated investment advisor also will be a fiduciary. In April 2016, the DOL issued its final regulation redefining what counts as compensated investment advice for determining fiduciary status, although the regulation doesn’t become applicable until April 2017.

• Person providing services to the IRA, such as an advisor, broker, custodian or accountant.

• Spouse, ancestor, lineal descendant or spouse of a lineal descendant of a fiduciary or service provider.

• Corporation, partnership or trust or estate of which 50 percent or more of the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock (if a corporation), the capital interest or profits interest (if a partnership) or the beneficial interest (if a trust or estate), is held directly or indirectly by fiduciaries or service providers.

Officer, director, a 10 percent or more shareholder or a highly compensated employee of any such corporation, partnership, trust or estate.

• Ten percent or more (in capital or profits) partner or joint venturer of any such corporation, partnership, trust or estate.

Prohibited Transaction Types

A prohibited transaction is any direct or indirect:

Sale, exchange or leasing of any property between an IRA and a disqualified person.

Lending of money or other extension of credit between an IRA and a disqualified person.

Furnishing of goods, services or facilities between an IRA and a disqualified person. (As discussed below, an exemption permits a disqualified person to perform some services.)

Transfer to, or use by or for the benefit of, a disqualified person of IRA income or assets. An impermissible use can arise in several ways. Use of perks generated by an IRA investment is one example. Securities purchases or sales by an IRA to manipulate their value to the advantage of the disqualified person also fall within this prohibition. But, mere co-investment by an IRA and a disqualified person is permissible, as long as the IRA investment isn’t made to enable or protect a personal interest, and the interests of the IRA and disqualified person don’t conflict.

Dealing by a disqualified person who’s a fiduciary with IRA income or assets for personal interest or account. Similar to the previous point, this prohibition will not be violated merely because the disqualified person derives an incidental benefit from a transaction involving IRA assets. However, it’s important to note that whether a benefit is incidental may not always be clear.

Receipt of consideration by a disqualified person who’s a fiduciary from a party to a transaction involving IRA income or assets. Although this prohibition is aimed at kickbacks, it can apply to a fiduciary’s receipt of gifts, entertainment or paid-for attendance at conferences.

Intent to commit the prohibited transaction doesn’t matter. The fairness or benefit to the IRA, or approval of the transaction by an independent party, won’t affect a transaction’s prohibited character. For example, a disqualified person’s payment to rent IRA property will be prohibited, even if he pays independently determined fair rental value.


A transaction that otherwise would be prohibited may be permissible under an exemption listed in Section 4975(d), a class exemption issued by the DOL or an individual exemption granted by the DOL.

• Section 4975(d) exemptions. Although many of the listed exemptions apply only to plans, some may be helpful in the IRA context.

Providing services. Any “contract, or reasonable arrangement, made with a disqualified person for office space, or legal, accounting, or other services necessary for the establishment or operation” of the IRA if no more than “reasonable compensation” is paid. This exemption permits payment to an IRA custodian, broker, investment advisor or manager or other service provider with IRA funds. It applies only to compensation for services rendered in the performance of IRA duties.

Note, this exemption doesn’t permit the IRA to pay the fiduciary, or a person in whom the fiduciary has an interest that may affect the fiduciary’s judgment, for a service. For example, an IRA owner may not pay herself for managing the IRA’s investments, nor may the IRA owner cause the IRA to pay her child a commission for selling an investment product to the IRA. In such situations, the services may be performed, but without compensation other than reimbursement for expenses directly related and specific to the services.

Sales, leases and loans with service providers. As long as the service provider isn’t a fiduciary who controls or gives advice with respect to the transaction, and the IRA pays no more, nor receives less, than adequate consideration, this exemption would permit, for example, the IRA’s purchase of a security from its broker or an affiliate of its custodian, if all exemption conditions were met.

Correction. An otherwise impermissible acquisition, holding or disposition of a security or commodity (other than one involving fiduciary use of IRA assets or income for a personal benefit) may be corrected (by rescinding the transaction to the extent possible) within 14 days of when the disqualified person discovered or reasonably should have discovered that the transaction was prohibited. This exemption, effectively, is the only avenue to cure a prohibited transaction that already has occurred.

Class exemptions. The DOL has issued class exemptions that allow for transactions that would otherwise be prohibited to take place if specified conditions are met. No application or governmental approval is needed to rely on a class exemption.

Exemption for loans to IRAs. Any disqualified person may make an interest-free unsecured loan to an IRA to enable payment of its ordinary operating expenses, including the payment of benefits, or for a purpose incidental to the IRA’s ordinary operation. This exemption is useful when the IRA lacks liquid assets sufficient to make a required minimum distribution to an IRA owner who’s attained age 70½. In that situation, the IRA owner (or another disqualified person) may loan funds to the IRA necessary to satisfy the distribution requirement. Incidental purposes include bank overdrafts and the crediting of dividends and other minor accompaniments, but not indemnification obligations assumed by a disqualified person.

Best interest contract exemption. In conjunction with its 2016 promulgation of a final regulation redefining what counts as investment advice that makes one a fiduciary, the DOL issued the best interest contract (BIC) exemption, which will permit IRA investment advisors to receive third-party compensation, such as commissions and revenue sharing from funds in which the IRA invests. Because the final regulation doesn’t become applicable until April 10, 2017, reliance on the BIC exemption before then isn’t required. During a transition period from that date through the end of 2017, only some of the BIC exemption conditions must be met.

Other class exemptions. Additional class exemptions provide conditional relief for disqualified persons other than IRA owners in some situations in which the disqualified person is a counterparty to an IRA transaction, or it or an affiliate provides an additional service, such as brokerage, for a separate fee.

• Individual exemptions. On application to and grant by the DOL, a disqualified person may obtain an individual exemption for a transaction that the DOL finds is administratively feasible, in the interest of the IRA, its owner and beneficiaries, and protective of the rights of the IRA owner and beneficiaries. A grant isn’t automatic, and conditions are usually imposed. Those considering an application for such an exemption should review the list on the DOL website to determine whether it has granted exemptions in like circumstances.

This is an abbreviated and adapted version of the author's original article in the June issue of Trusts & Estates.

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