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Prohibited Transactions and Solo 401ks: the Least You Need to Know

Or how to keep your Solo 401k compliant so you can keep your retirement funds

In many ways, the Solo 401k is the ultimate investment vehicle.

With the ability to invest freely in precious metals, private equity, even real estate, and virtually anything else without the fees and delays associated with working through a custodian, the Solo 401k offers an ideal setup for investing your retirement dollars.

However, it’s important to know what you can and can’t do with a Solo 401k plan. Certain types of transactions are prohibited with a Solo 401k and, while you can invest in almost anything with a Solo 401k, investing in certain assets isn’t allowed.

Solo 401k prohibited transactions


Before getting into prohibited transactions, it’s important to understand what a disqualified person is. That’s because the involvement of ‘disqualified persons’ in a Solo 401k investment is the deciding factor which determines if a transaction is prohibited.

What is a ‘disqualified person’?


A disqualified person is generally defined as you (the account owner), a family member, or any other person or entity directly or indirectly connected to the Solo 401k plan such as a corporation or estate that is 50% or more controlled by either you or a family member.


Most notably under these specifications is family. Both ancestors (father, mother, grandparents, etc.) and direct lineal descendants (your children, grandchildren, etc.) are considered disqualified persons.


However, it’s important to note that indirect descendants and non-relatives such as close friends are not prohibited. Most notably, this includes your siblings, aunts, uncles, nieces, nephews, cousins, spouse’s same indirect relatives (not children, grandchildren), and stepchildren.


(The plan fiduciary is also considered a disqualified person. However, with a self-directed Solo 401k you are the fiduciary of your own plan and you are already a disqualified person as the account owner, so this restriction is redundant.)


With that out of the way, let’s talk about what a Solo 401k prohibited transaction is.

What is a prohibited transaction?


A Solo 401k prohibited transaction is a transaction between a retirement plan - in this case the Solo 401k - and a disqualified person or persons that personally benefits those disqualified persons in some way.


To put it simply, any transaction that not only benefits your solo 401k, but also you personally or someone you know such as a family member who is defined as a disqualified person by the IRS will be deemed prohibited.


To give you an idea of exactly what this looks like, according to the IRS, a prohibited transaction generally involves one of the following:

  • The sale, exchange, or leasing of property between a Solo 401k and a disqualified person.
  • The lending of money or another extension of credit between a Solo 401k and a disqualified person.
  • The furnishing of goods, services, or facilities between a Solo 401k and a disqualified person.
  • Transfer of Solo 401k income or assets to a disqualified person.
  • The act by the account owner (you) whereby he / she deals with income or assets of the Solo 401k in his / her own interest or for his / her own account.
  • Receipt of any consideration by you and any party dealing with the Solo 401k in connection with a transaction involving income or assets of the plan.

The purpose of prohibited transaction rules is to make sure the IRS and Treasury receive the taxes they believe are due to them for said retirement distributions (in other words, they want their money). In the above-prohibited scenarios, you avoid having to pay taxes and penalties which is taking money out of the IRS’ pocket.

Note: the distributed transaction rules do not apply to any funds which you take a distribution from the plan or that you loan to yourself from the plan. In the case of a distribution, as long as you pay any applicable taxes or penalties associated with the distribution, you can do whatever you like with the funds. Likewise, for a loan, as long as you are compliant in paying back the loan to yourself, you can use the funds as you see fit.

Examples of prohibited transaction


Below are several examples of prohibited transactions with a Solo 401k:


1. The sale, exchange, or leasing of property between a Solo 401k and a disqualified person

Prohibited transaction examples:

  • You sell (or lease) an interest in a property owned by your Solo 401k to your son.
  • You use your Solo 401k to funds to purchase an interest in an LLC owned by your father.
  • You use personal funds to pay taxes and expenses related to your Solo 401( k) plan real-estate investment.


2. The lending of money or another extension of credit between a Solo 401k and a disqualified person


Prohibited transaction examples:

  • You lend your spouse funds from your Solo 401k (if they are not a member of the plan)
  • You use assets from your Solo 401k as security for a loan taken out in your name
  • You acquire a credit card for your Solo 401k bank account.


3. The furnishing of goods, services, or facilities between a Solo 401k and a disqualified person


Prohibited transaction examples:

  • You purchase a property with your Solo 401k and hire a direct family member to work on the property.
  • You purchase apartments with your Solo 401k and hire your parents to manage the property.


4. Transfer of Solo 401k income or assets to a disqualified person


Prohibited transaction examples:

  • You take out funds from your Solo 401k to pay a personal debt (without taking a Solo 401k loan).
  • You invest your Solo 401k funds in a real estate fund and receive a salary from managing the fund.
  • You deposit Solo 401k funds into your personal bank account.
  • You use your Solo 401k funds to lend money to a company you have partial or full ownership in.  


5. The act by the account owner (you) whereby he / she deals with income or assets of the Solo 401k in his / her own interest or for his / her own account.


Prohibited transaction examples:

  • You use your Solo 401k to purchase property and you, as a real estate agent, earn a commission from the sale.
  • You make an investment in a company you control a portion of using your Solo 401k.
  • You use your Solo 401k to lend money to a business you partly control and manage.
  • You use your Solo 401k funds to invest in your son’s business.


6. Receipt of any consideration by you and any party dealing with the Solo 401k in connection with a transaction involving income or assets of the plan.


Prohibited transaction examples:

  • You use your Solo 401k funds to loan money to a company you manage and own a small interest in.
  • You use your Solo 401k to loan money to a business you work for to secure a promotion.
  • You use your Solo 401k funds to invest in a fund you manage, where your management fee increases as the total value of the fund increases.

How to figure out if a Solo 401k transaction is prohibited


It can be a bit confusing to figure out all of the various prohibited transaction rules. However, there’s a simple way to tell if a transaction with your Solo 401k is prohibited.

To know if a transaction is likely prohibited, simply determine all parties involved in a potential investment, identify any of those as disqualified persons, and ask this question:

Will any of the listed disqualified persons or parties directly or indirectly benefit from the investment?

It’s important to ask this question to determine if a Solo 401k transaction is prohibited before doing anything that could result in additional taxes and penalties you can otherwise avoid.


Investing with your Solo 401k


In addition to prohibited transactions, it’s important to know that there are certain assets which a Solo 401k can’t invest in.

It’s true that with a Solo 401k plan you can invest in virtually anything, including:

  • Real estate
  • Stocks and bonds
  • Precious metals
  • Private equity & debt
  • Life insurance
  • And more


However, there are two exceptions:


1. Disallowed assets: Collectibles


Collectibles account for the only group of assets you can’t use a Solo 401k to invest in (however, there are exceptions here as well).


Collectibles include:

  • Any work of art
  • Rugs
  • Antiques
  • Metals
  • Gems
  • Stamps
  • Certain coins
  • Alcoholic beverages
  • Musical instruments
  • Other tangible property


The one notable exception here is with coins. Coins of the below specific purities may be held in a Solo 401k plan, including:

  • Gold: 99.5% purity and above
  • Silver: 99.9% purity and above
  • Platinum: 99% purity and above
  • Palladium: 99.95% purity and above


2. S Corporation Stock


In addition to collectibles, there’s one more notable exception to what a Solo 401k can invest in– S corporation stock.

According to IRC Section 4975, a retirement account can’t own stock in an S corporation. That’s because trusts aren’t permitted shareholders with S corps, while a Solo 401k (and other retirement plans including IRAs) is considered a trust for federal income-tax purposes.


Now you know

The Solo 401k is a powerhouse retirement and investment vehicle that offers a more convenient option for investing in real estate, precious metals, stocks and bonds, and much more.

However, it’s important to know what you can and can’t do with a Solo 401k to avoid unnecessary taxes and penalties.

Have a question this didn’t answer? Contact us here with any question you may have or click here to set up an account.  

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