Posted almost 6 years ago

Disqualified Person in a Self-Directed IRA or 401k

Plan owners of the Solo 401k and self-directed IRA need to be aware of Prohibited Transactions. These transactions usually involve a disqualified person and are not allowed by the IRS. Engaging in a prohibited transaction can lead to expensive tax charges and fines. In severe cases, the self-directed retirement plan may even be disqualified. Account owners are encouraged to understand the concept of a Solo 401k / IRA disqualified person and follow the IRS regulations closely.

Definition of a Disqualified Person

A disqualified person is usually someone who owns the retirement plan, who provides services to the plan, or who may become the beneficiary of the plan. The IRS defines different categories of disqualified person in the Internal Revenue Code, Section 4975. These categories are:

  • The plan owner of a Solo 401k or IRA
  • The spouse of the plan owner
  • The ancestors and descendants of the plan owner, such as their parents and children. The children’s spouses are also disqualified.
  • The fiduciaries of the plan, such as the plan trustee or custodian
  • The fund managers or financial advisors
  • Entities in which any of the above holds at least 50% interest, including businesses (corporations, LLC, or partnership), trusts, or estate.

What a disqualified person cannot do

Generally, a Solo 401k / IRA disqualified person is not allowed to enter a transaction with the retirement plan. They cannot extend credit or guarantee a loan for the plan. Also, they cannot personally benefit from the plan’s investments, such as getting a commission for a real estate purchase within the IRA or Solo 401k.

Related: Warning: Investing in Real Estate with a Self-Directed IRA

Who is not a disqualified person

In the Internal Revenue Code Section 4975, the definition of a disqualified person does not include step-parents, step-children (not adopted), siblings, aunts, uncles, cousins and friends.

Comments (4)

  1. I am also a real estate agent and wanted to get into some real estate flips with my own self directed IRA.  Would I be able to do my own deals if I don't take a commission or is there another way I could work my own deals without becoming a disqualified person?

    1. Jason, you need to be aware of couple things:

      1. 1) Flipping is an active business, therefore if you engage in flipping activity with your IRA on regular and repetitive basis the profits from such will result in Unrelated Business Income Tax (UBIT). Please be sure to consult with experienced tax professional before you decide to go this route.
      2. 2) As a disqualified person you are not allowed to provide any services to the plan, paid or unpaid. When you buy a property inside of your retirement account you don't have to have an agent represent you, this way you could negotiate lower purchase price by not having buyers side commissions. 

      Hope this helps.

  2. @Dmitriy Fomichenko  I am a real estate agent and investor.  My Dad has a self directed 401K.  He wants me to assist him in getting his money into real estate.  I got on BP tonight just to start researching how to help him.  What I'm reading here tells me that the IRS says I can't.  Am I correct?  Any way around it with my own LLC in play?

    1. Hello Tobi,

      It depends on what you mean by "assist". I see that you are licensed real estate agent. So if you assist your dad by offering him your real estate agent services to locate and purchase an investment property - that would not be allowed. You are considered to be a 'disqualified person' to your father's IRA and therefore are not allowed to provide any goods or services.

      On the other hand you could 'assist' your dad by recommending him the best agent who could assist your dad and help him decide on the best investment, for example: single family residence vs. duplex, select best part of the town to own an investment property, etc.

      Using an LLC that you own would not help, because you own the LLC and that makes it also a 'disqualified'. The bottom line is trying to bend the rules so that you can make the appearance for a transaction to be allowable that would otherwise be 'prohibited' is still a 'prohibited transaction'. There are so many legal ways to make money in real estate, it's not worth the risk to violate the rules. You can be successful by following the rules.

      Feel free to call my office to schedule a call with me, sometimes that is all you need - someone looking at the issue from a different perspective, there could even be a better way of doing it, and doing it right.