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 those involving disqualified persons and your IRA.
A disqualified person includes you, your beneficiary, a fiduciary (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 a disqualified 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
Using the IRA to invest 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.