R. Klein, EA : Thank you for contacting me about your Tax issue. I will work hard to help you understand the issue clearly.
R. Klein, EA : Yes, if you have a prohibited transaction, your IRA would be considered closed on the date of the disqualifying transaction.
R. Klein, EA : that also means that all subsequent transactions would have been with disqualified money (the fruit of the poisoned tree theory).
R. Klein, EA : You would end up owing tax on the distribution, plus the 10% penalty! plus the taxes on all the other capital gains transactions afterward.
R. Klein, EA : So yes, this is VERY bad, and is why you must be very careful, especially with self directed IRAs.
R. Klein, EA : Now the good thing here is that your principal originally is within a ROTH, and therefore that amount is not subject to tax or penalty, but any growth is subject to tax.
R. Klein, EA : Since we are not discussing your potentially disqualifying transaction in this question, let's hope that this thing does not surface as a disqualifying transaction.
Thank you for your prompt response. To further elaborate, the opening balance and contributions to the account were made in the early years but realistically, 90% plus of the current balance is a result of growth. Total account balance exceeds 500k, so this would be disastrous for sure. Two follow-ups if I may:
1) I don't know of anyone who has had their IRA audited. I have been audited (business and personal) and the subject of my IRA's never came up. (I also have a large balance traditional). What circumstances triggers an audit of the IRA transactions (disqualifying or not) ?
2) Would it be reasonable as a precaution to stop all further activity in that IRA and open a 2nd Roth account that would be insulated from the potential past errors of the 1st Roth account? Am I required to have kept ALL documents relating to every transaction that occurred in my account? No three year rule?
Thank you for your time.