Tax Center

A prohibited transaction is any transaction that is forbidden by the IRS. These transactions include:

• Activities that could personally benefit the IRA account holder or other disqualified persons, such as buying or selling assets between the IRA and disqualified persons
• Using the IRA to provide personal loans
• Using an IRA-owned property for personal purposes.

Prohibited transactions can result in severe tax consequences, including IRA disqualification. 

The five-year rule determines when distributions of earnings from a Roth SDIRA become tax-free. It states that at least five years must have passed since the first contribution was made to the Roth SDIRA, and the distribution must also meet one of the following criteria:

• The individual is age 59½ or older.
• The distribution is due to disability.
• The distribution is made to a beneficiary after the account owner's death.
• The distribution is for a qualified first-time homebuyer expense (maximum $10,000 of earnings).

Adhering to the five-year rule allows individuals to enjoy tax-free withdrawals of the earnings generated by their Roth SDIRA. 

Unrelated Business Income Tax (UBIT) applies to income generated by an IRA from an active trade or business that is unrelated to the IRA's primary purpose of providing retirement income.

For instance, if your IRA owns 100% of a successful pizza parlor, then it may take in a generous revenue stream each month. This income is considered trade or business income, rendered taxable by the Internal Revenue Code. Otherwise, the store would be able to price its pizzas at a much lower rate, creating an anti-competitive environment.

However, if your IRA sold 100% of the shares in that pizza parlor, then any capital gains would not be taxed by UBTI. Capital gains are considered related to the IRA’s primary purpose.

UBIT is calculated based on the net income generated by unrelated business activity, and the tax is determined by trust tax rates. If the gross income is $1,000 or more, the IRA must file IRS Form 990-T.

Unrelated Debt-Financed Income (UDFI) applies to income generated from a debt-financed property within an IRA. UDFI is a type of UBTI. For example, if an IRA uses debt or leverage to acquire an investment property, the portion of income attributable to the financed portion is considered UDFI.

For instance, if your SDIRA purchased a condo for $100,000, using a non-recourse loan to pay 50% of the purchase price, then 50% of the net income will be subject to UDFI tax. 

Yes, barring some exceptions, you will have to pay a hefty penalty for taking a distribution prior to age 59½. The penalty is 10% of the taxable portion of the distribution amount, in addition to any applicable income taxes on a traditional SDIRA distribution.

If you have a Roth account, you may generally withdraw your original contributions at any time. However, you will pay taxes and penalties for a non-qualified distribution of earnings generated by the account. 

When you take a distribution from a traditional SDIRA, the amount withdrawn is generally subject to income tax. The distributions are taxed at your ordinary income tax rate in the year they are taken.

Qualified distributions from a Roth SDIRA are tax-free. To be considered qualified, the distribution must meet two conditions: (a) the Roth account must have satisfied the five-year requirement, and (b) you must be at least 59½ years old, deceased, disabled, or using the funds for a first-time home purchase (up to a $10,000 limit).

Note: in satisfying the five-year requirement, the five years start as of January 1st of the year for which any contribution was made. For instance, if you make your first contribution on December 31, 2023, the five-year rule will actually be satisfied in just over four years. 

If you’ve made only pre-tax contributions to your traditional IRA, the entire amount of the distribution is generally taxable as ordinary income.

If you made any after-tax (nondeductible) contributions to your traditional IRA, a portion of the distribution may be tax-free. The taxable portion is determined using the IRS Form 8606 and the pro-rata rule. Any earnings or growth within your traditional IRA are also taxable when distributed.

Qualified distributions from a Roth IRA are tax-free. You will only pay taxes on a Roth distribution if it’s nonqualified.