Disqualified persons: who your IRA cannot deal with

The disqualified person list is short, and the hardest thing about it is that it does not match anyone's intuition about family.

The list

• You, the account owner, as a fiduciary of your own IRA.
• Your spouse.
• Your lineal ascendants: parents, grandparents, and up.
• Your lineal descendants: children, grandchildren, and down.
• Spouses of your lineal descendants: sons in law, daughters in law.
• Any fiduciary of the account, which includes anyone with discretionary authority over it and anyone providing investment advice for a fee.
• Any person providing services to the account, which pulls in the custodian, the administrator, and potentially a property manager or an adviser being paid by the account.
• Any entity in which disqualified persons hold 50% or more of the capital interest, profits interest, beneficial interest, or voting stock.
• Officers, directors, 10% or more shareholders, and highly compensated employees of such an entity, plus partners with a 10% or greater interest.

Who is not on it

This is the part worth memorizing, because it is where the real planning flexibility lives and also where people invent rules that do not exist:

• Siblings. Brothers and sisters are not disqualified persons.
• Aunts, uncles, nieces, nephews, cousins.
• Step-relatives who are not lineal descendants by blood or adoption, though this gets fact specific and deserves a professional read.
• Parents in law. Your spouse's parents are not on the list. Your own parents are.
• Friends, colleagues, business partners below the ownership thresholds.

The shape of it

The family tree rule runs vertically, not horizontally.

Straight up: parents, grandparents, disqualified. Straight down: children, grandchildren, and the people they married, disqualified. Sideways: siblings, cousins, the rest, not disqualified.

There is a logic to it. Congress was worried about value being passed up and down a family line in a way that defeats the purpose of a retirement account. A sibling was treated as a genuinely separate economic actor. Whether that is good policy is beside the point. It is the rule as written.

The 50% entity test, which catches people

An entity becomes disqualified when disqualified persons collectively own 50% or more. Collectively is the operative word, and there are attribution rules that can pull in ownership you would not count intuitively.

Some examples of how this plays out:

• You own 100% of an LLC. The LLC is a disqualified person. Your IRA cannot buy from it, sell to it, lend to it, or rent from it.
• You own 30% and your daughter owns 25%. That is 55% between two disqualified persons. The entity is disqualified.
• You own 30% and your brother owns 25%. Your brother is not a disqualified person, so only your 30% counts. The entity is not disqualified on that basis.
• You own 20% of a company but you are an officer of it. You are captured through the officer provision even though your ownership is below the threshold.

Anything near the line needs a professional to run the actual test, including attribution. This is not a place for a good-faith estimate.

Where the real risk lives

Most people can recite the list after reading it once. The violations still happen, because the failures are rarely about the list.

They are about the second layer, the self-dealing and benefit provisions. Your IRA can transact with a non-disqualified person and still create a prohibited transaction if you, a fiduciary, are dealing with the account's assets in your own interest.

Two people each direct their IRA to buy the other's property at inflated prices. Neither is a disqualified person to the other's account. Both have a problem, because each fiduciary used plan assets to obtain a personal benefit.

The list tells you who you cannot deal with. It does not tell you that any deal is fine as long as the counterparty is off the list. The benefit provisions are the broader constraint.

The practical test

Before any transaction, write down every person and entity involved, including the property manager, the lender, the contractor, and anyone getting paid. Then ask, for each one:

1. Are they on the list?
2. Do they control, or are they controlled by, anyone on the list?
3. Would this deal exist on these terms if I had no relationship with them?

The third question is the one that catches self-dealing, and it is the one worth sitting with longest.