So here comes TC Memo 2013-245. For all of those people out there that enter into a Self-Directed IRA, this Tax Court Memo is for you. There is a preconceived notion that you as the taxpayer can do pretty much whatever you want in these arrangements.
A Self-Directed IRA is most common with real estate. You take your 401(k) and roll it into another retirement plan. Typically this is accomplished by opening a Limited Liability Company that holds the asset. What your current financial planner doesn’t tell you is that you can invest in pretty much anything in your IRA. Real estate, businesses, gold bullion, anything. People that know this start something called a Self-Directed IRA, and invest their money anyway that they want. The problem with this strategy is that under IRC § 4975, there are things that you specifically cannot do.
IRC § 4975 states the following:
(c) Prohibited transaction.
(1) General rule.
For purposes of this section , the term "prohibited transaction" means any direct or indirect-
(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;
(B) lending of money or other extension of credit between a plan and a disqualified person;
(C) furnishing of goods, services, or facilities between a plan and a disqualified person;
(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;
(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or
(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.
That is a lot of stuff you can’t do.
In TC Memo 2013-245, there is a guy by the name of Mr. Ellis. Mr. Ellis, organized CST, LLC. The operating agreement of CST was signed by Ellis on behalf of the Terry Ellis IRA, an entity that did not yet exist. The agreement listed the original members of CST as the Terry Ellis IRA, owning 980,000 membership units or 98% in exchange for an initial capital contribution of $319,000, and a member not a party to the case owning the remaining 20,000 membership units or 2%.
This business was formed so that Mr. Ellis could sell used cars. He transferred $319,000 from his 401(k) account to fund the business. Where he made a mistake is that he paid himself $9,754 as compensation for his role as general manager of CST. IRS issued Mr. and Mrs. Ellis a notice of deficiency. IRS's determinations in the notice was based on the premise that at one of the following alternative points, Ellis engaged in a prohibited transaction under IRC § 4975 with his IRA: (1) when Ellis caused his IRA to engage in the sale and exchange of membership interests in CST; or (2) when Ellis caused CST, an entity owned by his IRA, to pay him compensation. He personally benefited from the transaction.
The Court stated that, if, during any tax year of an individual for whose benefit any IRA is established, that individual or his beneficiary engages in a prohibited transaction under IRC § 4975 , the account will cease to be an IRA as of the first day of the tax year. In such a case, the IRA in question will no longer be exempt from tax under IRC § 408(e)(1) . Further, where such an account ceases to be an IRA by reason of IRC § 408(e)(2)(A) , the account is deemed to have been distributed on the first day of the tax year in an amount equal to the fair market value of all the assets of the account on that first day; Reg. § 1.408-4(d)(1)
So Mr. Ellis lost his case. For all of you with a Self-Directed IRA, be wary of this.
If you need help contact me. We can go over it.
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If you have any questions you can email Craig W. Smalley E.A., C.E.P.®, C.T.R.S.®
Admitted to Practice Before the Internal Revenue Service
Certified Estate Planner®
Certified Tax Resolution Specialist®
Author of the books:
- It Starts With an Idea – Tax Tips for Small Businesses
- The Ultimate Real Estate Investor Tax Guide
- The Complete Guide to the New Tax Law – American Taxpayer Relief Act of 2012
- Everything You Wanted to Know about the IRS – Audits, Appeals and Collections
- Tax Avoidance is Legal! The Complete Guide to Individual Income Tax
- The Complete Guide to the Affordable Care Act’s Tax Provisions
- The Complete Guide to Retirement Plans for Small Businesses
- The Complete Guide to Estate, Gift and Trust Taxation
- The Complete Guide to Hiring an Accountant
- The Complete Guide to Subchapter S-Corporations,
- Free Money
All available exclusively on Kindle