Jun 26

Swanson Tax Case Explained

IRA Can Own 100% of a Newly Established Entity and be Managed by the IRA Holder and Not Trigger a Prohibited Transaction

Swanson V. Commissioner 106 T.C. 76 (1996).

The idea of using an entity owned by an IRA to make investments was first reviewed by the Tax Court in Swanson V. Commissioner 106 T.C. 76 (1996).

Underlying dispute.

The underlying facts involved James Swanson (the taxpayer’s) combined use of two entities owned exclusively by his IRAs to defer income recognition.

James Swanson was the sole shareholder of H & S Swansons’ Tool Company, an S corporation that builds and paints component parts for domestic and foreign equipment manufacturers. Following the advice of tax counsel, Swanson arranged in 1985 for the establishment of Swansons’ Worldwide, Inc. (“Worldwide”), a Domestic International Sales Company (“DISC”). A DISC is a domestic corporation, usually a subsidiary, that is typically used to defer tax on income generated by the entity.

Mr. Swanson appointed Florida National Bank as trustee and custodian of IRA #1, who retained the power to direct its investments. Mr. Swanson then directed Florida National to execute a subscription agreement to purchase 2,500 shares of Worldwide original issue stock. The shares were issued and IRA #1 became the sole shareholder of Worldwide.  Mr. Swanson then engineered a similar transaction with a second IRA at another bank.

The IRS Attack

The IRS issued a notice of deficiency to Mr. Swanson in June 1992. The IRS stated that prohibited transactions had occurred causing IRAs #1 and #2 to be terminated. The IRS made the following arguments:

  1. Mr. Swanson is a disqualified person within the meaning of section 4975(e)(2)(A) of the Code as a fiduciary because he has the express authority to control the investments of IRA#1.
  2. Mr. Swanson is also an Officer and Director of Swansons’ Worldwide. Therefore, direct or indirect transactions described by section 4975(c)(1) between Swansons’ Worldwide and IRA #1 constitute prohibited transactions.
  3. Mr. Swanson, as an Officer and Director of Worldwide directed the payment of dividends from Worldwide to IRA #1.
  4. At the time of the purchase of the Swanson Worldwide stock, Mr. Swanson was a fiduciary of his IRA and the sole director of Swansons’ Worldwide.
  5. The sale of stock by Swanson Worldwide to Mr. Swanson IRA constituted a prohibited transaction within the meaning of Section 4975(c)(1)(A) of the Code.

Mr. Swanson’s Position in Response to the IRS

Mr. Swanson took the position in their Tax Court petition that no prohibited transaction had occurred. Their position was that since the Worldwide shares issued to IRA #1 were original issue, no sale or exchange occurred. Also, they stated that as director and president of Worldwide, Swanson engaged in no activities on behalf of Worldwide that benefited him other than as beneficiary of IRA #1. Mr. Swanson made similar points with respect to IRA #2.

The IRS Concedes the Prohibited Transaction Issue.

The IRS conceded the prohibited transaction issue in the Swanson case on July 12, ’93 when it filed a notice of no objection to an earlier motion by the Swansons’ for partial summary judgment on that issue.

Mr. Swanson sought litigation costs against the IRS on the Prohibited Transaction Issue

The Tax Court Rebuffs IRS Arguments on IRA Prohibited Transaction Issue and Imposes Litigation Costs.

The IRS argued that its litigation position with respect to the IRA prohibited transaction issue was substantially justified. The Tax Court disagreed with the IRS’ position, finding that it was unreasonable for the IRS to claim that a prohibited transaction occurred when Worldwide’s stock was acquired by IRA #1 for the following reasons:

  1. The stock acquired was newly issued. Before that time, Worldwide had no shares or shareholders. A corporation without shares doesn’t fit within the definition of a disqualified person under the prohibited transaction rules. As a result, Mr. Swanson only became a disqualified person with respect to IRA #1 investment into Worldwide only after the Worldwide stock was issued to IRA #1.
  2. It was only after Worldwide issued its stock to IRA #1 that Mr. Swanson held a beneficial interest in Worldwide’s stock. Mr. Swanson was not a “disqualified person” as president and director of Worldwide until after the stock was issued to IRA #1
  3. The payment of dividends by Worldwide to IRA #1 was not a self-dealing  prohibited transaction under Internal Revenue Code Section 4975(c)(1)(E). The only benefit Mr. Swanson realized from the payments of dividends by Worldwide related solely to his status as beneficiary of IRA #1 which is not a prohibited transaction.
  4. It was only after Worldwide issued its stock to IRA #1 that Mr. Swanson held a beneficial interest in Worldwide’s stock. Therefore, the issuance of stock to IRA #1 did not, constitute a prohibited transaction.
  5. It was only after Worldwide issued its stock to IRA #1 that Mr. Swanson held a beneficial interest in Worldwide’s stock. Mr. Swanson’s only benefit would be as beneficiary of the IRA which is not a prohibited transaction.

The Tax Court reached similar conclusions with respect to IRA #2.

THE TAX COURT AGREED WITH SWANSON THAT THE IRS ARGUMENT THAT AN IRA CANNOT OWN A NEW ENTITY TO MAKE AN INVESTMENT IS A FRIVOLOUS POSITION THAT SHOULD BE SANCTIONED AND SUBJECT TO LITIGATION FEES

“We must apportion the award of fees sought by petitioners (Swanson) between the DISC (IRA) issue, for which respondent (IRS) was not substantially justified”
-Tax Court in Swanson V. Commissioner 106 T.C. 76 (1996).

What did we learn from the Swanson Tax Court case?

An IRA can own an Interest in a New Entity managed by the IRA holder

The Swanson case helped establish that an IRA holder is permitted to establish a new entity wholly owned by his or her IRA in order to make IRA investments.  The Swanson case makes it clear that only after the IRA has acquired the stock of the newly established entity does the entity become a disqualified person.

An IRA Holder can manage the newly formed entity owned by the IRA

The Swanson case makes it clear that an IRA holder may serve as manager, director, or officer of the newly established entity owned by his or her IRA.   The Tax Court held that Mr. Swanson was not a “disqualified person” as president and director of Worldwide until after the stock was issued to IRA #1. In other words, by having the IRA invested in an entity such as an LLC of which the IRA owner is the manager, the Swanson Case suggests that the IRA holder can serve as manager of the LLC and have “checkbook control” over his or her IRA funds.

The Tax Court in Swanson made it clear that it was only after Worldwide issued its stock to IRA #1 that Mr. Swanson held a beneficial interest in Worldwide’s stock.  Therefore, the Tax Court is arguing that only once the IRA funds have been invested into the newly established entity does the analysis begin whether an IRA transaction is prohibited.  Said another way, the Tax Court is contending that the use of an entity owned wholly by an IRA is not material as to whether a prohibited transaction occurred.  The use of a wholly owned entity to make an investment is essentially no different if the IRA made the investment itself with respect to the prohibited transaction rules.

For more information about this case and others, please contact an IRA Expert @ 800.472.0646.

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Jun 22

Hard Money Loans for Real Estate Investors Becoming Hot Investment Option for Self-Directed IRA Investors in 2017

Significant demand for hard money financing from real estate developers attracting self-directed IRA real estate investors

IRA Financial Group, the leading provider of self-directed IRA LLC solutions, announces the findings of an internal report that shows that hard money lending for real estate has become a popular investment option for self-directed IRA investors. The IRS has always permitted an IRA to lend money to non-disqualified persons. The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest “With IRA Financial Group’s checkbook control self-directed IRA LLC solution, one can use their retirement funds to make IRA hard money loans, either secured or non-secured, to non-disqualified persons and generate tax-deferred or tax-free returns in the case of a Roth IRA,” stated Jen Burris, a self-directed IRA specialist with the IRA Financial Group. “As the manager of your checkbook control IRA LLC, the IRA holder will have control over his or her IRA funds so that making a hard money loan can be made through a local bank account with no transaction costs or annual account valuation fees,” stated Ms. Burris. The primary advantage of making hard money loans with retirement funds is that all rental income generated by the investment is tax-deferred until a distribution is taken or tax-free in the case of a Roth IRA.

Hard Money Loans for Real Estate Investors Becoming Hot Investment Option for Self-Directed IRA Investors in 2017With IRA Financial Group’s self directed IRA LLC solution, traditional IRA or Roth IRA funds can be used to buy real estate throughout the United States and globally in a tax-deferred account by simply writing a check and without the need of custodian consent or steep custodian fees. “Of course one must due their diligence on the real estate note their self-directed IRA is purchasing, but, in general, purchasing real estate notes is a great way to get into the real estate market as a passive investor using IRA funds,” stated Adam Bergman, a tax partner with the IRA Financial Group.

The IRA Financial Group was founded by a group of top law firm tax and ERISA lawyers who have worked at some of the largest law firms in the United States, such as White & Case LLP, Dewey & LeBoeuf LLP, and Thelen LLP.

IRA Financial Group is the market’s leading provider of self-directed IRA LLC and Solo 401(k) plans. IRA Financial Group has helped thousands of clients take back control over their retirement funds while gaining the ability to invest in almost any type of investment, including real estate without custodian consent.

To learn more about the IRA Financial Group please visit our website at http://www.irafinancialgroup.com or call 800-472-0646. To learn more about establishing a self-directed IRA account with the IRA Financial Trust Company please visit http://www.irafinancialtrust.com or call 800-472-1043.

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Jun 19

What Determines Whether a Real Estate Transaction is Subject to UBTI?

In Mauldin v. Comr. 195 F.2d 714 (10th Cir. 1952), the court explained that there is no fixed formula or rule of thumb for determining whether property sold by a taxpayer was held by him primarily for sale to customers in the ordinary course of his trade or business. Each case must rest upon its own facts. The court identified a number of helpful factors to point the way, among which are the purposes for which the property was acquired, whether for sale or investment; and, continuity and frequency of sales as opposed to isolated transactions. However, in Adam v. Comr. 60 T.C. 996 (1973), acq., 1974-1 C.B. 1., the Tax Court analyzed the following factors in determining whether the taxpayer was engaged in the operation of a trade or business:

1. The purpose for which the asset was acquired: Examples of good facts that support the conclusion that the sale of property is excluded from unrelated business taxable income is when the property was originally acquired to further the organization’s tax-exempt purpose – in the case of a Self-Directed IRA – investment.

2. The frequency, continuity, and size of the sales: This factor is particularly significant in determining whether the sale constitutes a trade or business that is regularly carried on, within the meaning of Internal Revenue Code Section 512. It may range from a one-time sale of a parcel of land to many sales over a long period. If sales are infrequent, not continuous, and small, the organization will not likely be viewed as similar to a taxpayer in the trade or business of selling real estate. Conversely, as sales become more frequent, more continuous, and larger, they are more likely to be considered a trade or business that is regularly carried on, comparable to the commercial activity of a taxpayer in the trade or business of selling real estate.

What Determines Whether a Real Estate Transaction is Subject to UBTI?However, in PLR 9247038, the IRS issued a favorable ruling to an organization that planned to sell land in up to 15 sales spread over a five- to 10-year period. The reason for the number of sales over the time period was that the value of the land was such that it was unlikely a single purchaser would be able to acquire the entire parcel. Also, market conditions dictated this sales process for the organization to receive maximum value, and keep control of the pace and type of development that would occur after the sales. Similarly, in PLR 9017058, where the exempt organization was engaged in selling 45 of 68 lots, such sales were deemed to meet the exception from unrelated business income under Internal Revenue Code Section 512(b)(5). Although this quantity of sales is admittedly significant, external forces essentially dictated the high number of sales. The organization first tried to sell the property in one block but was unsuccessful due to the high cost of developing the property in order to comply with local ordinances. According to the IRS, had these two facts been absent, i.e., (1) the organization had attempted to sell the entire property as a whole, and (2) local ordinances required certain development prior to sale as residential property, it is possible that the high number of sales in this case would have resulted in unrelated business taxable income.

Thus, a limited number of sales is usually a “good fact” for purposes of the facts and circumstances test. However, one should not assume that a set limit applies such as, for example, 15 sales. Rather, one should remember that factors such as that frequency of sales and cost of the property to be sold and market conditions play a part in the number of sales allowed and the time frame of the sales allowed. If an organization has significant amounts of acreage, or the cost of the property precludes finding one purchaser, then it is more likely that the organization will be permitted to sell the property in more than one transaction, and still comply with the requirements of Internal Revenue Code Section 512(b)(5).

3. The activities of the seller in the improvement and disposition of the property: The smaller the extent of improvements by the organization to the property, the more likely the sale will fall under the exclusion for unrelated business income under Internal Revenue Code Section 512(b)(5). In PLR 8043052, an organization proposed to sell a parcel of undeveloped raw land . The fact that the land had remained undeveloped was significant in determining that gains from the proposed transaction would not constitute unrelated business taxable income. In PLR 8522042, the property in question consisted of both developed and undeveloped lands. The developed lands included residential land improved with single-family dwellings or condominium apartments. However, all the improvements were constructed by unrelated third parties. The absence of development activity by the organization demonstrated that it was not holding property for sale to customers in the ordinary course of trade or business.

4. The extent of improvements made to the property; The more minimal the activities of the owner in improving and disposing of property, the more likely its sale will meet the exclusion from unrelated business taxable income under Internal Revenue Code Section 512(b)(5). Of course, the greater the number of improvements allowed, the greater the likelihood of maximizing gain from the sale. So there is a balancing act that organizations must exercise when preparing land for disposition in order to maximize its return, while not acting too much like a dealer and triggering UBIT.

The IRS ruled favorably on improvements made to property in accordance with city or local ordinances requiring the organization to construct a street as well as curb, gutter, sidewalk, drainage, and water supply improvements in order to subdivide the property for sale.

Retaining limited control of the redevelopment project before the land is eventually sold also has been an acceptable activity by a tax-exempt organization when the organization is not involved in any way with advertising, marketing, or otherwise attempting to sell the lots. In PLR 200544021, an organization maintained control over the development process to ensure a compatible environment for the adjoining high school. The IRS recognizes that even though an organization is concerned with receiving a high yield from the sale, it may be equally concerned that the property be developed in keeping with the surrounding features of the property. In addition, an organization’s interest in preserving the natural beauty of a tract of land to be developed is not generally indicative of a normal sales transaction.

In PLR 8950072, a tax-exempt foundation’s largest asset was a parcel of unimproved real estate. The foundation was examining four ways of using the property: (1) continue leasing the property; (2) sell the property as is; (3) complete some preliminary development work — obtaining permits and approvals — and sell the property; or (4) completely develop the property before sale. The last alternative would provide the highest return. The IRS ruled that the first three alternatives would not subject the foundation to UBIT or adversely affect its exempt status. However, the last alternative, to assume all the responsibilities of development, would result in UBTI , but would not affect the foundation’s exempt status. Alternative 4 is very similar to the situation in Brown v. Comr. Like that case, the taxpayer intended to subdivide and develop the property for sale to the general public. Such sales would not be isolated or casual transactions. The organization planned to be extensively involved in both development and marketing activities. Thus, the IRS concluded that the property will be held primarily for sale to customers in the ordinary course of trade or business and not subject to the exclusion from unrelated business income of Internal Revenue Code Section 512(b)(5).

Aside from development activities, the lack of marketing of the property by the organization helps differentiate it from a taxpayer in the trade or business of selling real estate. For example, in PLR 8522042, an organization’s lack of promotional or development activity in connection with the proposed sale demonstrated that it was not holding property for sale to customers in the ordinary course of a trade or business. Moreover, the use of real estate brokers or other independent contractors is not determinative. Rather, the pertinent facts involve the extent of the activities of the organizations themselves in promoting and marketing the property.

5. The proximity of sale to purchase: In evaluating this factor, generally the longer the period between purchase and sale, the more likely the sale will be excluded from UBTI . For example, in PLR 9505020, the fact that a school received land by bequest and held it for a significant period of time was considered a favorable factor, and the IRS did not impose UBIT on the sale of the land when the school was facing condemnation proceedings and it did not actively advertise the sale.

6. The purpose for which the property was held during the taxable year: In evaluating this factor, generally the longer the period between purchase and sale, the more likely the sale will be excluded from UBTI . For example, in PLR 9505020, the fact that a school received land by bequest and held it for a significant period of time was considered a favorable factor, and the IRS did not impose UBIT on the sale of the land when the school was facing condemnation proceedings and it did not actively advertise the sale.
In Adam and subsequent cases, the Tax Court found that no single factor is controlling but all are relevant facts to consider in determining whether the sale of property occurred in the regular course of the taxpayer’s business. In numerous private letter rulings, the IRS cites and applies these same Adam factors. The IRS has characterized these factors as a “facts and circumstances test.” The IRS has even applied these same factors when analyzing the activities of an exempt organization that are carried out through a limited partnership between the exempt organization and the developer.

Please contact one of our Self Directed IRA Experts at 800-472-0646 for more information.

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Jun 16

How Does a Roth IRA Contribution Work?

Assume individual Jane decides to set aside $1,000 of her pretax income for an IRA contribution. She could contribute the entire $1,000 to a traditional IRA because the deduction for the contribution would effectively eliminate any current tax on the $1,000. Since a contribution to a Roth IRA is not deductible, she could contribute to a Roth IRA only the amount remaining after paying tax on the $1,000. Assume T is, at all times, taxed at a flat 30 percent. She could therefore make a Roth IRA contribution of $700 ($1,000 less 30 percent thereof).

For 2017, the maximum you can contribute to a Roth IRA is $5,500, or $6,500 if you are age 50 or older.

How Does a Roth IRA Contribution Work?

Please contact one of our Roth IRA Experts at 800-472-0646 for more information.

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Jun 13

Tax Treatment Of Cryptocurrencies Creating Opportunities For IRA Investors

For a growing number of investors, cryptocurrency is not only the future of money, but also an attractive and potentially profitable investment asset, though highly risky and volatile.  Bitcoin has become the public’s most visible and popular cryptocurrency and it is also among the oldest, having first emerged in 2009.  Over one year, the market capitalization for bitcoin has increased enormously, from around $7.16 billion in May 2016 to $27.9 billion today.  As the price of bitcoin has risen over the last year or so, so has the confidence among investors, including retirement account investors.

The process of buying cryptocurrency is still somewhat unclear for a lot of people. It’s not a stock or a traditional investment.  For most people in the U.S., Coinbase would be the easiest option to buy cryptocurrency, such as bitcoin, Ethereum, or Litecoin.  After verifying the account, the investor can add a number of payment methods including credit or debit cards, U.S. bank accounts, or even wire transfers of funds.  Cryptocurrency transactions are not anonymous and the identify of the currency owner can be traced back to a real-world identity.

As a cryptocurrency, bitcoin is generated through the process of “mining”—essentially using your computer’s processing power to solve complex algorithms called “blocks.”  One can buy and sell bitcoin on an exchange, much like a physical currency exchange, converting wealth from bitcoin to US dollars to other national currencies, back to dollars or bitcoin. And that’s how money is made.

Tax Treatment Of Cryptocurrencies Creating Opportunities For IRA InvestorsEven though bitcoin is labeled as a “cryptocurrency”, from a federal income tax standpoint, bitcoin and other cryptocurrency are not considered a “currency”.  On March 25, 2014, the IRS issued Notice 2014-21, which, for the first time, set forth the IRS position on the taxation of virtual currencies, such as bitcoin.  According to the IRS Notice, “Virtual currency is treated as property for U.S. federal tax purposes.” The Notice further stated “General tax principles that apply to property transactions apply to transactions using virtual currency.”  In other words, the IRS is treating the income or gains from the sale of a virtual currency, such as bitcoin, as a capital asset, subject to either short-term (ordinary income tax rates) or long term capital gains tax rates, if the asset is held greater than twelve months (15% or 20% tax rates based on income).  By treating bitcoins and other virtual currencies as property and not currency, the IRS is imposing extensive record-keeping rules—and significant taxes—on its use.

The IRS tax treatment of virtual currency has created a favorable tax environment for Self-Directed IRA investors.  In general, when a retirement account generates income or gains from the purchase and sale of a capital asset, such as stocks, mutual funds, real estate, etc., irrespective of whether the gain was short-term (held less than twelve months) or long-term (held greater than twelve months), the retirement account does not pay any tax on the transaction and any tax would be deferred to the future when the retirement account holder takes a distribution (in the case of a Roth IRA no tax would be due if the distribution is qualified).  Hence, using retirement funds to invest in cryptocurrencies, such as bitcoin, could allow the investor to defer or even eliminate in the case of a Roth, any tax due from the investment.  Note – retirement account investors interested in mining bitcoins versus trading, could become subject to the unrelated business taxable income tax rules if the “mining” constituted a trade or business.

As I mentioned earlier, cryptocurrency investments, such as bitcoin, are risky and highly volatile.  Any investor interested in learning more about bitcoin should do their due diligence and proceed with caution.

For more information about using your IRA to invest in cryptocurrencies, please contact us @ 800.472.0646.

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Jun 12

Can You Use an IRA to Flip Houses?

Since the creation of IRAs back in the early 1970s, the IRS has always permitted an IRA to purchase, hold, or flip real estate.  In fact, it states it right on the IRS website. By using a Self-Directed IRA to buy real estate, you will be able to purchase raw land, domestic or foreign real estate, residential or commercial property, flip homes, and much more tax-free and without requiring custodian consent!

Flipping a Home is as Simple as Writing a Check

With a Self-Directed IRA with checkbook control, flipping homes or engaging in a real estate transaction is as simple as writing a check. As manager of your Self-Directed IRA LLC, you will have the authority to make real estate investment decisions on behalf of your IRA on your own without needing the consent of an IRA custodian. One of the true advantages of a checkbook control IRA is that when you want to Can You Use an IRA to Flip Houses?purchase a home with your self-directed IRA, you can make the purchase, pay for the improvements, and even sell or flip the property on your own without involving the IRA custodian.  In other words, with a checkbook control IRA LLC, you will have the power to flip homes or do multiple real estate transactions on your own without requiring the consent of a custodian. One additional important advantage of purchasing real estate with a Self-Directed IRA is that all income and gains are tax-deferred until a distribution is taken (Traditional IRA distributions are not required until the IRA owner turns 70 1/2). In the case of a Self-Directed Roth IRA LLC, all gains are tax-free.

Flip a Home without Requiring the Consent of a Custodian

A Self-Directed IRA with checkbook control is the most efficient and cost effective vehicle for doing house flips with retirement funds.  With a Self-Directed IRA with checkbook control, you will be able to use your IRA or 401(k) funds to purchase real estate and engage in flipping homes tax-free and without custodian consent.  A traditional IRA custodian (financial institution) will not allow you to purchase real estate using your IRA or retirement funds.  Therefore, in order to have the ability to engage in house flipping transactions using retirement funds, a Self-Directed IRA LLC with Checkbook Control is the answer.

Control the Entire House Flipping Transaction

Unlike a conventional Self-Directed IRA which requires custodian consent and requires high custodian fees, a Self-Directed IRA LLC with Checkbook Control will allow you to buy real estate by simply writing a check.  With a traditional custodian controlled self-directed IRA, you will have total control to make a real estate purchase, pay for improvements, and then sell the property without ever talking to the IRA custodian.  Since all your IRA funds will be held at a local bank in the name of the Self-Directed IRA LLC, all you would need to do to engage in a house flipping transaction is write a check straight from the IRA LLC account or simply wire the funds from the IRA LLC bank account.  No longer would you need to ask the IRA custodian for permission or have the IRA custodian sign the real estate transaction documents.  Instead, with a Checkbook Control IRA, as manager of the IRA LLC, you will be able to execute the real estate transaction by simply writing a check.

Use a Self-Directed IRA and Flip a Home Tax-Free

One major advantage of flipping homes with a Self-Directed IRA is that all gains are tax-deferred until a distribution is taken (Traditional IRA distributions are not required until the IRA owner turns 70 1/2). In the case of a Self-Directed Roth IRA LLC, all gains are tax-free. In other words, all gains attributable to the house flipping transaction will flow-back to your IRA LLC tax-free!

IRA Financial Group will take care of setting up your entire Self-Directed IRA LLC “Checkbook Control” structure. The whole process can be handled by phone, email, fax, or mail and typically takes between 7-21 days to complete, the timing largely depending on the state of formation and the custodian holding your retirement funds. Our IRA experts and tax and ERISA professionals are onsite greatly reducing the setup time and cost.

The IRA Financial Group was founded by a group of top law firm tax and ERISA lawyers who have worked at some of the largest law firms in the United States, such as White & Case LLP, Dewey & LeBoeuf LLP, and Thelen LLP.

To learn more about the advantages of using a Self-Directed IRA LLC to purchase real estate and flip homes tax-free, please call an IRA Expert at 800-472-0646 or visit www.irafinancialgroup.com.

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Jun 07

Rick Siskey Fraud Case Shows Why This Type of Retirement Account Can Be a Red Flag

Here’s a recent article from the Charlotte Observer speaking about the pitfalls of fraud with Self-Directed IRAs. –

The unraveling of an alleged Ponzi scheme run by Charlotte businessman Rick Siskey highlights a risk with a type of investment typically seen as safe and conservative: Individual Retirement Accounts, or IRAs.

Rick Siskey took his own life in December, days after court filings gave the first public indication that he was under investigation for fraud. An FBI affidavit unsealed in January alleged he was operating a Ponzi scheme for years.

Bankruptcy court filings show that more than 100 investors have submitted claims exceeding $49 million, including funds that came from IRAs they’d entrusted to Siskey. The documents indicate that at least two trust companies that specialize in so-called self-directed IRAs were the custodians of some of the investors’ money.

A self-directed IRA is different from the IRAs offered by most banks and brokerage houses. The latter type generally offers investments in stocks, bonds and mutual funds. Self-directed IRAs, on the other hand, allow investors to put money into a wider range of assets – real estate, promissory notes, private placement securities and other options that may promise higher returns but also more risk.

The U.S. Securities and Exchange Commission and state securities regulators have warned investors of the potential for fraud in these investments, saying they have investigated numerous cases where self-directed IRAs were used to build credibility for investment schemes.

The firms that serve as custodians of these investments – handling administrative tasks such as issuing statements and tax documents – have limited obligations to investors and generally don’t evaluate the actual investments, the regulators warn. They can include banks, trust companies or other entities approved by the IRS to act as a custodian.

With self-directed IRAs, “folks think there is protection there when there isn’t,” said North Carolina Secretary of State Elaine Marshall, whose office regulates the securities industry in the state. “They are not validating. They are not doing any due diligence. They are not looking at the investment.”

Investors used IRA funds

Siskey, a well-known financial planner in Charlotte since the 1980s, took in investors’ money for years, but apparently did little actual investing, according to an FBI affidavit filed in federal court. Instead, he used the money for personal purposes, such as gambling, and to pay off investors who asked for their money back.

The FBI affidavit also said Siskey made some payments on behalf of investors to an unnamed trust company that advertised itself as a “leading custodian of self-directed IRAs.” The individuals appeared to have been investing their retirement accounts with Siskey, the affidavit states.

Bankruptcy and other court documents indicate companies handling the IRAs included Mainstar Trust (previously known as First Trust Company of Onaga) and Sterling Trust (now part of Equity Trust).

In one claim submitted against Siskey’s estate in Mecklenburg County probate court, a Charlotte couple said they invested about $200,000 of rollover IRA money with Siskey. The funds, the claim says, were invested through Mainstar Trust, after being previously invested through Sterling Trust.

“To date, these funds are frozen and claimant has not received these funds,” say the documents, filed in March.

On its website, Ohio-based Equity Trust describes itself as “a leading custodian of truly Self-Directed IRAs,” while Kansas-based Mainstar calls itself a self-directed IRA custodian.

In documents obtained from one investor, a Mainstar account agreement emphasizes the account holder has the “sole responsibility” for directing the investment and the company has no “liability for any taxes, loss, or damage” that may result. A Sterling account application states that the company has “no duties or responsibilities with respect to the investments of the funds” in the customer’s account.

Equity Trust said as a matter of policy it doesn’t comment on pending litigation. Mainstar did not respond to requests for comment.

The Retirement Industry Trust Association, an industry trade group, says it’s important for investors to understand that self-directed IRA custodians have very limited duties. These firms handle chores such as reporting tax information to the IRS and following instructions from investors to move money, but they don’t recommend investments or do any reviews of the actual investments.

The companies “that administer self-directed IRAs do not do any due diligence,” said Mary Mohr, executive director of the trade group. “That’s not their job.”

If an investment adviser is offering unrealistic returns, investors should be wary, she said. “The burden of education,” Mohr said, “is on the shoulders of the investor, not the directed custodian.”

In 2015, state securities agencies around the country opened 44 investigations into complaints stemming from third-party custodians, including those who handle self-directed IRAs, and initiated 19 formal enforcement actions, according to the North American Securities Administrators Association. That compared with 63 investigations opened and nine formal enforcement actions in 2014.

The association in 2014 issued an advisory to help investors better understand the role of these custodians.

“If it’s too good to be true, check with us,” Marshall, the North Carolina secretary of state, said. “All that kind of advice applies in the IRA category just like in other offerings a person may be presented with.”

What’s next for Siskey investors?

Meanwhile, Siskey’s investors are still waiting to see how much money they will get back as former Siskey companies move through bankruptcy court.

Joseph Grier, a court-appointed trustee, is now examining investor claims and Siskey’s remaining assets. The final deadline for claims is Aug. 23, he said.

After all claims are made, Grier will determine what assets are available to distribute. Siskey’s widow, Diane, has pledged to set aside $37.5 million of the $47 million in life insurance proceeds from her husband’s death for investors, but attorneys for investors have said that might not be enough.

“What we can say is we anticipate making a substantial distribution,” Grier said. “But until we know what the claims are and what the assets are we’re not going to be able to say what that distribution will be.”

In addition to determining payouts, Grier said he is also investigating “everything about Rick Siskey and that includes who knew what when and who was involved.”

His current focus is on making payments to investors, but after that he will determine whether to bring litigation against any parties, he said.

At that time, “hopefully we will be further down the road in our investigation,” Grier said, “and know who, if anybody, we ought to sue.”

The Siskey case shows why you should always use a trusted adviser with Self-Directed IRA plans.  For more information, please contact an IRA Expert from the IRA Financial Group @ 800.472.0646.

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Jun 06

What Types of Transactions Are Subject to the UBTI Tax?

In general, most passive investments that your Self-Directed IRA LLC might invest in are exempt from unrelated business taxable income, or UBTI. Some examples of exempt type of income include: interest from loans, dividends, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate.

When an exempt organization such as an IRA undertakes any development activities in connection with selling real estate, beyond passively placing the property for sale either directly or through a broker, the issue arises under Internal Revenue code 512(b)(5)(A) whether the real estate is “property held primarily for sale to customers on the ordinary course of the trade or business.” An organization that engages in the sale of property to customers in the ordinary course of the trade or business is characterized as acting as a “dealer.”

What Types of Transactions Are Subject to the UBTI Tax?Fundamental to considering whether an exempt organization is a “dealer” of real property is whether the property itself is held “primarily” for resale to customers in the ordinary course of a trade or business. In Malat v. Riddell, 393 U.S. 569 (1966), the U.S. Supreme Court interpreted the meaning of the phrase “held primarily for sale to customers in the ordinary course of trade or business” under Internal Revenue Code Section 1221(1). The IRS has often applied the principles derived under Internal Revenue Code Section 1221 to rulings interpreting the language of Internal Revenue Code Section 512(b)(5). The Court interpreted the word “primarily” to mean “of first importance” or “principally.” By this standard, ordinary income would not result unless a sales purpose is dominant. Both the courts and the IRS concluded that a taxpayer may make “reasonable expenditures and efforts” (such as subdividing land , construction of streets, the provision of drainage, and furnishing of access to such a necessity as water, as part of the “liquidation” of an investment asset without being treated as engaged in a trade or business.

The UBTI generally applies to the taxable income of “any unrelated trade or business…regularly carried on” by an organization subject to the tax. The regulations separately treat three aspects of the quoted words—“trade or business,” “regularly carried on,” and “unrelated.”

Trade or Business: In defining “unrelated trade or business,” the regulations start with the concept of “trade or business” as used by Internal Revenue Code Section 162, which allows deductions for expenses paid or incurred “in carrying on any trade or business.” Although Internal Revenue Code Section 162 is a natural starting point, the case law under that provision does little to clarify the issues. Because expenses incurred by individuals in profit-oriented activities not amounting to a trade or business are deductible under Internal Revenue Code Section 212 , it is rarely necessary to decide whether an activity conducted for profit is a trade or business. The few cases on the issue under Internal Revenue Code Section 162 generally limit the term “trade or business” to profit-oriented endeavors involving regular activity by the taxpayer.

Regularly Carried On: The UBIT only applies to income of an unrelated trade or business that is “regularly carried on” by an organization. Whether a trade or business is regularly carried on is determined in light of the underlying objective to reach activities competitive with taxable businesses. The requirement thus is met by activities that “manifest a frequency and continuity, and are pursued in a manner generally similar to comparable commercial activities of nonexempt organizations.” Short-term activities are exempted if comparable commercial activities of private enterprises are usually conducted on a year-round basis (e.g., a sandwich stand operated by an exempt organization at a state fair), but a seasonal activity is considered regularly carried on if its commercial counterparts also operate seasonally (e.g., a horse racing track). Intermittent activities are similarly compared with their commercial rivals and are ordinarily exempt if conducted without the promotional efforts typical of commercial endeavors. Moreover, if an enterprise is conducted primarily for beneficiaries of an organization’s exempt activities (e.g., a student bookstore), casual sales to outsiders are ordinarily not a “regular” trade or business.

Before it can be determined whether an activity is seasonal or intermittent, the relevant activity must be identified and quantified, a step that is often troublesome.

The type of income that generally could subject a Self-Directed IRA LLC to UBTI is income generated from the following sources:

  • Income from the operations of an active trade or business
  • Income earned from a convenient store
  • Income earned from a manufacturing business
  • Business income generated via a passthrough entity, such as an LLC or partnership
  • Income earned through an active business owned by an LLC in which the IRA is an investor
  • Unrelated Debt Financed Income
  • Using a nonrecourse loan to purchase a property
  • Using margin on a stock purchase
  • Income from a real estate investment that is treated as a business (inventory) instead of as an investment

Examples could include:

  • In Brown v. Comr, 143 F.2d 468 (5th Cir. 1944), the exempt taxpayer owned 500 acres of unimproved land used for grazing purposes within its tax-exempt mission. Taxpayer decided to sell the land and listed it with a real estate broker. The exempt organization instructed the broker to subdivide the land into lots and develop it for sale. The broker had the land plotted and laid into subdivisions with several lots. Streets were cleared, graded and shelled; storm sewers were put in at street intersections; gas and electric lines were constructed; and a water well was dug. Each year 20 to 30 properties were sold. The court held that the taxpayer was holding lots for sale to customers in the regular course of business. The court identified the sole question for its determination as whether the taxpayer was in the business of subdividing real estate. The fact that the taxpayer did not buy additional land did not prevent the court from finding that the sales activities resulted in an active trade or business.
  • In Farley v. Comr., 7 T.C. 198 (1946), the taxpayer sold 25 lots out of a tract of land previously used in his nursery business but now more desirable as residential property. Because the taxpayer made no active efforts to sell and did not develop the property, the court described the sale as “in the nature of the gradual and passive liquidation of an asset.” Therefore, the income derived from the sales represented capital gains income, rather than ordinary income from the regular course of business as in the Brown case.
  • Dispositions of several thousand acres of land by a school over a period of twenty-five years does not constitute sale of land held primarily for sale to customers in the ordinary course of business and thus gains are excludable under Internal Revenue Code Section 512(b)(5) (Priv. Ltr. Rul. 9619069 (Feb. 13, 1996)).
  • Developing or subdividing land and selling a large number of homes or tracts of land from that development in a given period.
  • Buying a property/home rehabbing it and then selling it immediately thereafter when this was your sole intent (note: The activity must manifest a frequency and continuity, and are pursued in a manner generally similar to comparable commercial activities of nonexempt organizations). It is unclear whether the purchase and sale of one or two homes in a given year that were held for investment purposes would trigger UBTI.

Please contact one of our Self Directed IRA Experts at 800-472-0646 for more information.

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Jun 01

The Law Concerning the Rollover Business Startup Solution

You may use your retirement funds to start your own business using the Rollover Business Startup Solution, also known as ROBS.  The Internal Revenue Code and ERISA have firmly codified the ability to use retirement funds to invest in the stock of a sponsoring company as long as certain IRS and ERISA rules are followed.

Internal Revenue Code Section 4975(c) includes a list of transactions that the IRS deems “prohibited”. However, Internal Revenue Code Section 4975(d) lists a number of exemptions to the prohibited transaction rules. Specifically Internal Revenue Code Section 4975(d)(13) lists an exemption for any transaction which is exempt from section 406 of the Employee Retirement Income Security Act of 1974 (ERISA) by reason of section 408(e) of such Act.

The Law Concerning the Rollover Business Startup SolutionSection 408(e) provides that section 406 shall not apply to the acquisition or sale by a plan of qualifying employer securities (as defined in section 407(d)(5), provided that: (1) the acquisition or sale is for adequate consideration; (2) no commission is charged with respect to the acquisition or sale; and (3) the plan is an eligible individual account plan (as defined in section 407(d)(3)). A 401(k) plan fits in to this definition.

Pursuant to ERISA Section 406, the acquisition or sale must be for “adequate consideration.” Except in the case of a “marketable obligation”, adequate consideration for this purpose means a price not less favorable than the price determined under ERISA § 3(18),subject to a requirement that the acquisition or sale must be for “adequate consideration.” An exchange of company stock between the plan and its employer-sponsor would be a prohibited transaction, unless the requirements of ERISA § 408(e) are met.

The exemptions in 4975(d) shall not apply to items described in Internal Revenue Code Section 4975(f)(6). Section 4975(f)(6)(A) states that the exemption of 4975(d) shall not apply in the case of a trust described in Internal Revenue Code Section 401(a), which is part of a plan providing contributions or benefits for employees some or all of whom are owner-employees (other than paragraphs (9) and (12)) shall not apply to a transaction in which the plan directly or indirectly— (i) lends any part of the corpus or income of the plan to, (ii) pays any compensation for personal services rendered to the plan to, or (iii) acquires for the plan any property from or sells any property to, any such owner-employee, a member of the family of any such owner-employee, or any corporation in which any such owner-employee owns, directly or indirectly, 50 percent or more of the total combined voting power of all classes of stock entitled to vote or 50 percent or more of the total value of shares of all classes of stock of the corporation. Therefore, since the Plan will be purchasing “qualified employer securities” directly from the newly formed corporation, the purchase of corporate stock will not be treated as a prohibited transaction pursuant to Internal Revenue Code Section 4975.

ERISA Section 407(b)(1) generally places limitations on the acquisition and holding of Qualifying Employer Securities (normally 10% of plan assets). However, the Section includes an exception for “eligible individual account plans” (ERISA 407(b)(1)). As set forth in ERISA Section 407(d)(3), a qualified profit sharing plan is included in the definition of “eligible individual account plans”. In addition, pursuant to ERISA Section 404(a)(2), these plans do not violate ERISA’s diversification and, to the extent it requires diversification, prudence requirements.

Call us today at 800-472-0646 to learn more about how you can use your retirement funds to start a new business or grow an existing business tax-free, in full IRS compliance, and without penalties!

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May 30

How Does a Small Business Owner Set Up a SEP IRA?

A SEP, or Simplified Employee Pension, is established by adopting a SEP agreement and having eligible employees establish SEP-IRAs. There are three basic steps in setting up a SEP, all of which must be satisfied.

A formal written agreement must be executed. This written agreement may be satisfied by adopting an Internal Revenue Service (IRS) model SEP using Form 5305-SEP, Simplified Employee Pension – Individual Retirement Accounts Contribution Agreement. A prototype SEP that was approved by the IRS may also be used. Approved prototype SEPs are offered by banks, insurance companies, and other qualified financial institutions. Finally, an individually designed SEP may be adopted.

How Does a Small Business Owner Set Up a SEP IRA?Each eligible employee must be given certain information about the SEP. If the SEP was established using the Form 5305-SEP, the information must include a copy of the Form 5305-SEP, its instructions, and the other information listed in the Form 5305-SEP instructions. If a prototype SEP or individually designed SEP was used, similar information must be provided.

A SEP-IRA must be set up for each eligible employee. SEP-IRAs can be set up with banks, insurance companies, or other qualified financial institutions. The SEP-IRA is owned and controlled by the employee and the employer sends the SEP contributions to the financial institution where the SEP-IRA is maintained.

Please contact one of our IRA Experts at 800-472-0646 for more information.

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