Generally, amounts in your IRA are tax deferred until distributed. However, there is an exception to that rule when a participant is engaged in a prohibited IRA transaction. Such prohibited transactions are transactions involving disqualified persons and your IRA.
A disqualified person includes you, your beneficiary, a fiduciary- such as someone who provides investment advice for your IRA for a fee- and certain members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).
A prohibited transaction occurs if this person engages in certain transactions such as:
- Borrowing money from the IRA,
- Selling property to the IRA,
- Using the IRA as security for a loan,
- Using the IRA to buy property for personal use, or
- Investing in collectibles.
If any of these prohibited transactions occur with your IRA it could be treated as if you withdrew the entire balance, as of January 1 of the year the event occurred. However, if you pledged only a portion of your IRA as security for a loan, then only the pledged amount would be treated as a distribution to you. If you need assistance determining whether a transaction could be prohibited, or, if you think that your IRA might have been involved in a prohibited transaction, please contact your tax advisor.
If a prohibited transaction results in distribution of your funds, it will be reported on IRS Form 1099-R. For prohibited transactions, Code 5 is input in Box 7 of the Form 1099-R that is issued to report distribution from your IRA.
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