The penalties for failing to comply with the self directed IRA rules can be severe, so you should work with an IRA administrator that will help you steer clear of any self directed IRA pitfalls. These penalties can range from a penalty tax to forfeiture of your entire IRA plan. To develop a true understanding, let’s invent a hypothetical prohibited transaction. Assume you have a single family residence in State College owned by your self directed IRA plan. You are renting to your son and his friends while they attend college. The IRS sends you a notice explaining that you are involved in a prohibited transaction and gives you the opportunity to correct the situation. You then find your son a new apartment and get a new, unrelated tenant for your rental property.
Assume the same set of circumstances, but in this case you ignore the IRS’ notice and continue to let your son rent the house. The IRS will send you a notice stating that your failure to comply has resulted in the forfeiture of your investment property. The IRS seizes your real estate, removes your son from it, and sells the property. The proceeds of the sale go into the US Treasury and your once-substantial IRA is now gone. The best way to avoid this type of situation is to make sure you have a solid team of advisors helping you navigate the process.