OVERVIEW & FAQ

  • What is a prohibited transaction? It’s a transaction between your Solo 401k and a disqualified person that the IRS doesn’t allow.
  • Who counts as a disqualified person? You, your spouse, parents or grandparents, children or grandchildren (and their spouses), and any person who owns 50% or more of your business, fiduciaries of the plan, and certain service providers.
  • Why do prohibited transaction rules exist? To prevent Solo 401k owners from using their plan for personal benefit or to bypass taxes.
  • What are the penalties for violating the rules? The IRS imposes a 15% excise tax on the amount involved. If the issue isn’t corrected within the taxable period, the penalty increases to 100%.

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*Solo 401(k) eligibility and contribution limits depend on IRS rules. Carry does not provide tax advice, consult a tax advisor. Carry Advisors LLC, an SEC-registered investment adviser, provides investment advisory services for discretionary and non-discretionary accounts (e.g., Solo 401(k), IRA, taxable brokerage accounts). Bank and trust accounts are not advised by Carry Advisors. Brokerage accounts are introduced by Global Carry LLC and carried by DriveWealth LLC, both members FINRA/SIPC. Advisory fees may apply and additional disclosures are described in our Form ADV and CRS.

A Solo 401k offers wide flexibility in what you can invest in, but that freedom comes with strict IRS boundaries about who the plan can transact with. The assets are owned by the Solo 401k trust—not by you or your business.

When you open a Solo 401k, the plan gets its own Employer Identification Number (EIN). It uses this EIN to open bank and brokerage accounts. Everything purchased through the plan is held under the trust, which is treated as a separate legal entity.

Because of this structure, you cannot use your Solo 401k plan to benefit yourself, your family, or your business. 

That’s where the concept of prohibited transactions comes in.

These rules may seem technical, but they’re essential. Read on to understand what a disqualified person is, the different types of prohibited transactions, real-world examples, and what penalties to expect if you break the rules.

Table of contents

Who Is a Disqualified Person?

A disqualified person is someone the IRS prohibits from transacting with your Solo 401k. These restrictions are in place to prevent self-dealing and protect the tax-advantaged status of your plan.

Under IRC § 4975(e)(2), the following people are considered disqualified:

❌ You, as the plan participant

❌ Your spouse

❌ Your lineal ascendants (parents, grandparents)

❌ Your lineal descendants (children, grandchildren)

❌ Spouses of your lineal descendants (such as your son-in-law or daughter-in-law)

❌ Fiduciaries of the plan (anyone who makes investment decisions or has control over plan assets)

❌ Anyone who provides services to your plan (including financial advisors, accountants, or custodians)

❌ Highly compensated employees of your business

❌ Any person or entity that owns 50% or more of the business sponsoring the Solo 401k

❌ Companies owned 50% or more by you, your spouse, or your lineal ascendants or descendants

❌ Officers, directors, or 10% or more shareholders of a disqualified corporation

📝 Note: The IRS does not consider the following people to be disqualified: your siblings, aunts, uncles, cousins, step-parents, stepchildren, and friends.

What Is a Prohibited Transaction?

A prohibited transaction happens when your Solo 401k plan engages in a transaction with a disqualified person. In simple terms, you cannot use your Solo 401k in a way that directly benefits you, your immediate family, or your business.

The plan must operate solely to support your retirement, not to provide personal or business advantages before you retire.

Why These Rules Exist

The IRS created prohibited transaction rules to prevent people from using retirement plans to avoid taxes or gain early access to funds.

For example, if you wanted to take $10,000 from your Solo 401k before reaching the eligible withdrawal age, you’d normally pay income tax and a 10% early withdrawal penalty. But without these rules, someone could try to bypass that by paying the money to a spouse, who then returns it personally. Or they might try to hire themselves as a contractor and pay themselves through the plan.

These loopholes would allow people to sidestep IRS rules and drain retirement funds early without consequences. Prohibited transaction restrictions help close those gaps and preserve the tax-deferred nature of retirement savings.

Types of Prohibited Transactions

Under IRC 4975(c)(1), the IRS defines several types of prohibited transactions. These rules apply when a Solo 401k plan interacts improperly with a disqualified person.

Here are the main types:

🚫Selling, exchanging, or leasing property between the Solo 401k and a disqualified person

🚫Lending money or extending credit between the plan and a disqualified person

🚫Providing goods, services, or facilities between the plan and a disqualified person

🚫Using plan income or assets for the benefit of a disqualified person

🚫A fiduciary using plan assets in their own interest or for their own account

🚫A fiduciary receiving compensation from someone dealing with the plan in a transaction involving plan assets

Examples of Prohibited Transactions

Understanding what counts as a prohibited transaction can be confusing. IRS rules are written in complex legal language, and the boundaries are not always clear, especially when real estate is involved.

Here are practical examples to help clarify each type:

❌ Sale, Exchange, or Lease of Property

  • You cannot sell a property to your Solo 401k or buy one from it.
  • Your plan cannot lease property to or from a disqualified person.
  • Asset trades between your plan and a disqualified person are also not allowed.

❌ Lending or Extending Credit

  • A disqualified person cannot lend money to your Solo 401k, and the plan cannot lend to them.
  • A disqualified person cannot co-sign or guarantee any debt related to your plan.

❌ Furnishing Goods, Services, or Facilities

  • A disqualified person cannot act as a contractor or service provider for a property owned by your plan.
  • They cannot furnish that property using their own items.
  • They cannot serve as the realtor or help with administrative tasks like pulling permits or insuring the property.

❌ Using Plan Assets for Personal Benefit

  • A disqualified person cannot stay in a vacation home owned by the Solo 401k, even for free.
  • They cannot use or hold plan-owned funds in a personal account.

❌ Fiduciary Self-Dealing

  • Fiduciaries, such as accountants managing the plan, cannot borrow from or use the plan for personal gain.

❌ Receiving Compensation from Plan Transactions

  • A disqualified person who is a fiduciary cannot receive commissions or payments from any transaction involving the plan.
  • Your plan cannot invest in a company just to help you get a job or promotion. For example, if you’re asked to buy into a company to become a partner, you cannot use Solo 401k funds for that investment.

Penalties for Prohibited Transactions

Violating the prohibited transaction rules can lead to steep penalties.

Under IRC § 4975(a), a disqualified person must pay a 15% excise tax on the amount involved in the transaction. If the violation is not corrected within the required timeframe, the penalty increases to 100% of the amount involved.

✏️ Hypothetical Example: If your Solo 401k used $100,000 to buy your parent’s house, that would trigger a prohibited transaction. The initial penalty would be $15,000. If the issue is not corrected in time, you could owe the full $100,000 to the IRS.

How  Can You “Fix” the Prohibited Transaction?

The IRS expects the disqualified person to undo the transaction as much as possible, without leaving the Solo 401k in a worse financial position than if it had been managed under the highest fiduciary standards.

When Does the Taxable Period End?

The taxable period starts on the date the transaction occurred. It ends on the earliest of the following:

  • The date the IRS sends a notice of deficiency
  • The date the IRS assesses the tax
  • The date the transaction is corrected

How Do You Pay the 15% Penalty?

To pay the 15% penalty, use the IRS Form 5330.

The IRS typically identifies prohibited transactions. If a potential violation is found, the case may be referred to the Department of Labor (DOL), which makes the final determination.

📌 Also Read: Solo 401k Controlled Group Rules for Multiple Business Interests

Final Thoughts

Understanding Solo 401k prohibited transactions is important for staying compliant and protecting your retirement funds. Even unintentional mistakes could lead to costly tax penalties. If you’re ever unsure about a transaction, it may be worth consulting a qualified professional. A bit of caution today could save you from expensive consequences later.

For more Solo 401k insights, feel free to check out our other articles:

Disclaimer:

The Carry Learning Center is operated by The Vibes Company Inc. (“Vibes”) and contains generalized educational content about personal finance topics. While Vibes provides educational content and technology services, all investment advisory services discussed on this website are provided exclusively through its wholly-owned subsidiary, Carry Advisors LLC (“Carry Advisors”), an SEC registered investment adviser. The information contained on the Carry Learning Center should not be construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security or engage in a particular investment, accounting, tax or legal strategy. Vibes is not providing tax, legal, accounting, or investment advice. You should consult with qualified tax, legal, accounting, and investment professionals regarding your specific situation.

The accounts, strategies and/or investments discussed in this material may not be suitable for all investors. All investments involve the risk of loss, and past performance does not guarantee future results. Investment growth or profit is never a guarantee. All statements and opinions included on the Carry Learning Center are intended to be current as of the date of publication but are subject to change without notice.

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