How do you correct a prohibited transaction?

The correction of the prohibited transaction requires cancelling the transaction as far as possible and, in any case, “requiring the entire plan or account concerned to take into account any losses resulting from the transaction, returning to the affected plan or account any benefits obtained through the prohibited use of the assets”. A disqualified person who has participated in a prohibited transaction can avoid the 100% tax by correcting the transaction as soon as possible. Correcting the transaction means undoing it as far as possible without putting the plan in a worse financial situation than if it had acted under the highest fiduciary standards. Basically, to correct a prohibited transaction within a retirement account, you must undo it as soon as possible.

One of the most common cases is when you sell an investment from your self-directed IRA and the funds go directly to you (or another IRA and depositary). Since they didn't go to the original custodian first, this is a prohibited transaction. To correct this, you (or the new custodian) would have to return the funds to the investment. In turn, the investment would send them to the correct IRA and to the depositary.

You can then choose what to do with the funds. Prohibited fiat transactions appear to be the most common type of prohibited transaction in the context of self-directed IRAs. If the beneficiary of the owner of an IRA makes a prohibited transaction with the account, the account no longer qualifies as an IRA. If you or your IRA beneficiary make a prohibited transaction, the IRA will lose its tax-exempt status.

Correcting the prohibited transaction means cancelling the transaction as far as possible and, in any case, paying off any losses resulting from the transaction to the plan or account concerned, returning to the plan or affected account any benefits obtained through the use of the plan's assets.