Nov 09

Rules for a Self-Directed IRA when Investing in Real Estate

A Self-Directed IRA LLC offers one the ability to use his or her retirement funds to make almost any type of investment on their own without requiring the consent of any custodian or person. The IRS and Department of Labor only describe the types of investments that are prohibited, which are very few.

The basis of the prohibited transaction rules are based on the premise that investments involving IRA and related parties are handled in a way that benefits the retirement account and not the IRA owner. The rules prohibit transactions between the IRA and certain individuals known as “disqualified persons”. These rules can be found in Internal Revenue Code Section 4975. In general, 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.

Rules for a Self-Directed IRA when Investing in Real EstateThe IRS permits using a Self-Directed IRA LLC to purchase real estate or raw land. Since you are the manager of the Self-Directed IRA LLC, making a real estate investment is as simple as writing a check from your Self-Directed IRA bank account. The advantage of purchasing real estate with your Self-Directed IRA LLC is that all gains are tax-deferred until a distribution is taken. In the case of a Roth Self-Directed IRA, all gains are tax-free.

For example, if you purchased a piece of property with your Self-Directed IRA LLC for $100,000 and you later sold the property for $300,000, the $200,000 of gain appreciation would generally be tax-deferred. Whereas, if you purchased the property using personal funds (non-retirement funds), the gain would be subject to federal income tax and in most cases state income tax.

When it comes to using a self-directed IRA to purchase real estate, there are a number of rules that should be followed in order to make sure the real estate IRA investment does not violate any of the IRS prohibited transaction rules.

  • The deposit and purchase price for the real estate property should be paid using Self-Directed IRA LLC funds or funds from a non-disqualified third-party
  • No personal funds or funds from a “disqualified person” should be used
  • All expenses, repairs, taxes incurred in connection with the Self-Directed IRA real estate investment should be paid using retirement funds – no personal funds should be used
  • If additional funds are required for improvements or other matters involving the real estate investments, all funds should come from the Self-Directed IRA or from a non “disqualified person”
  • If financing is needed for a real estate transaction, only nonrecourse financing should be used. A nonrecourse loan is a loan that is not personally guaranteed and whereby the lender’s only recourse is against the property and not against the borrower.
  • The IRA holder or “disqualified person” in connection with the real estate investment should perform no services in connection with the use of self-directed IRA LLC. In general, other than standard management type of services (necessary and required tasks in connection with the maintenance of the LLC), no active services should be performed by the LLC manager or a “disqualified person” with respect to the real estate transaction.
  • Title of the real estate purchased should be in the name of the Self-Directed IRA LLC. For example, if Joe Smith established a Self-Directed IRA LLC and named the LLC XYZ, LLC, title to real estate purchased by Joe’s Self-Directed IRA LLC would be as follows: XYZ LLC
  • Although the use of a nonrecourse loan is permitted with a self-directed IRA when buying real estate, the use of a nonrecourse loan would impose a tax pursuant to IRC 514 on a percentage of the income generated by the IRA investment based off a percentage of the debt used in proportion to the amount of cash invested.
  • Keep good records of income and expenses generated by the real estate investment
  • All income, gains or losses from the Self-Directed IRA LLC real estate investment should be allocated to the IRA and be returned to the IRA LLC bank account
  • Make sure you perform adequate diligence on the property you will be purchasing especially if it is in a state you do not live in
  • Make sure you will not be engaging in any self-dealing real estate transaction which would involve buying or selling real estate that will personally benefit you or a “disqualified person”
  • If you need to make additional IRA contributions to your self-directed IRA, the contribution should be made to the IRA custodian/administrator and then the funds will be transferred to the IRA LLC.

Using a self-directed IRA LLC to buy real estate is quick and easy, however, there are a number of IRS rules and potential tax issues that must be addressed before making the self-directed IRA real estate investment.

For more information on using a self-directed IRA LLC to buy real estate, please contact a tax professional at 800-472-0646.

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Nov 01

Is Your Self-Directed IRA Protected from Creditors?

Retirement accounts have become many Americans’ most valuable assets. That means it is vital that you have the ability to protect them from creditors, such as people who have won lawsuits against you.

In general, the asset/creditor protection strategies available to you depend on the type of retirement account you have (i.e. Traditional, IRA, Roth IRA, or 401(k) qualified plan, etc), your state residency, and whether the assets are yours or have been inherited.

Using a Self-Directed IRA LLC will offer you the ability to make a wide range of traditional as well as non-traditional investments, such as real estate, in addition to offering you strong asset and creditor protection. In addition, by using an LLC wholly owned by your IRA, you will also gain another layer of limited liability protection. In this regard, using a Self-Directed IRA LLC to make investments offers you far greater asset and creditor protection versus making the investment personally. For this reason, growing and investing your retirement funds through a Self-Directed IRA LLC is a great tool to protect your retirement assets from creditors, inside or outside of bankruptcy.

Federal Protection for IRAs for Bankruptcy

Like 401(k) qualified plans, The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA” or the “Act”) effective for bankruptcies filed after October 17, 2005, gave protection to a debtor’s IRA funds in bankruptcy by way of exempting them from the bankruptcy estate. The general exemption found in sec­tion 522 of the Bankruptcy Code, 11 U.S.C. §522, pro­vides an unlimited exemption for IRAs under section 408 and Roth IRAs under section 408A. IRAs created under an employer-sponsored section 408(k) sim­plified employee pension (a “SEP IRA”) or a sec­tion 408(p) simple retirement account (a “SIMPLE IRA”), as well as pension, profit sharing, or qualified section 401(k) Plan wealth transferred to a rollover IRA.

Traditional and Roth IRAs that are created and funded by the debtor are subject to an exemp­tion limitation of $1 million in the aggregate for all such IRAs (adjusted for inflation and subject to increase if the bankruptcy judge determines that the “interests of justice so require”). It is understood that a rollover from a SEP or SIMPLE IRA into a rollover IRA receives only $1 million of protection since such a section 408(d)(3) rollover is not one of the rollovers sanctioned under Bankruptcy Code section 522(n).

Protection of IRAs from Creditors Outside of Bankruptcy

In general, ERISA pension plans, such as 401(k) qualified plans, are afforded extensive anti-alienation credi­tor protection both inside and outside of bankrupt­cy. However, these extensive anti-alienation protections do not extend to an IRA, including a Self-Directed IRA, arrangement under Code section 408. Therefore, since an individually estab­lished and funded Traditional or Roth IRA is not an ERISA pension plan, IRAs are not preempted un­der ERISA. Thus, for anything short of bankruptcy, state law determines whether IRAs (including Roth IRAs) are shielded from creditors’ claims.

Note – on June 12, 2014, the Supreme Court unanimously upheld a Seventh Circuit decision that said inherited IRAs do not enjoy the protections of IRAs in bankruptcy proceedings.

The following table will provide a summary of state protection afforded to IRAs, including Self-Directed IRAs, from creditors outside of the bankruptcy context.

State State Statute Special Statutory Provision State Traditional IRA Exemption from Creditors State Roth IRA Exemption from Creditors
Alabama Ala. Code §19-3B-508 Yes No
Alaska Alaska Stat. §09.38.017 The exemption does not apply to amounts contributed within 120 days before the debtor files for bankruptcy. Yes Yes
Arizona Ariz. Rev. Stat. Ann. § 33-1126C The exemption does not apply to amounts contributed within 120 days before a debtor files for bankruptcy. Yes Yes
Arkansas Ark. Code Ann. §16-66-220 Yes Yes
California Cal. Civ. Proc. Code § 704.115 Yes – IRAs are exempt only to the extent necessary to provide for the support of the judgment debtor when the judgment debtor retires and for the support of the spouse and dependents of the judgment debtor, taking into account all resources that are likely to be available for the support of the judgment debtor when the judgment debtor retires. No
Colorado Colo. Rev. Stat. §13-54-102 Yes Yes
Connecticut Conn. Gen. Stat. §52-321a Yes Yes
Delaware Del Code Ann. § 10-4915 Yes Yes
D.C. D.C. Code § 15-501(a)(9) & (10) Yes Yes
Florida Fla. Stat. Ann. §222.21 The debtor’s IRAs are exempt from creditors, but one Florida court has held that inherited IRAs are not exempt from creditors (Robertson v. Deeb, 16 So. 3d 936 (Fla. 2d Aug. 14, 2009). Yes Yes
Georgia Georgia Code Ann. § 44-13-100(a)(2.1) IRAs are exempt only to the extent necessary for the support of the debtor and any dependent. Yes No
Hawaii Hawaii Rev. Stat. § 651-124 The exemption does not apply to contributions made to a plan or arrangement within three years before the date a civil action is initiated against the debtor. Yes No
Idaho Idaho Code §§ 11-604A, 55-1011 Yes No
Illinois I.L.C.S. § 5/12-1006 Yes Yes
Indiana Ind. Code Ann. § 55-10-2(c)(6) Yes No
Iowa Iowa Code Ann. § 627.6(8)(e), (f) Yes Yes
Kansas Kan. Stat. Ann. § 60-2308 Yes Yes
Kentucky Ky. Rev. Stat. Ann. § 427.150(2)(f) The exemption does not apply to any amounts contributed to an individual retirement account if the contribution occurred within 120 days before the debtor filed for bankruptcy. The exemption also does not apply to the right or interest of a person in individual retirement account to the extent that right or interest is subject to a court order for payment of maintenance or child support. Yes Yes
Louisiana La. Rev. Stat. Ann. §§ 20:33(1), 13:3881(D) No contribution to an IRA is exempt if made less than one calendar year from the date of filing bankruptcy, whether voluntary or involuntary, or the date rights of seizure are filed against the account. The exemption also does not apply to liabilities for alimony and child support. Yes Yes
Maine Me. Rev. Stat. Ann. Tit. 14, § 4422(13)(E) Exempt only to the extent reasonably necessary for the support of the debtor and any dependent. Yes Yes
Maryland Md. Code Ann. Cts. & Jud. Proc. § 11-504(h)(1) Yes Yes
Massachusetts Mass. Gen. L. Ch. 235 § 34A; 236 § 28 The exemption does not apply to an order of court concerning divorce, separate maintenance or child support, or an order of court requiring an individual convicted of a crime to satisfy a monetary penalty or to make restitution, or sums deposited in a plan in excess of 7% of the total income of the individual within 5years of the individual’s declaration of bankruptcy or entry of judgment. Yes Yes
Michigan Mich. Comp. Laws Ann. §§ 600.5451(1), 600.6023(1)(k) The exemption does not apply to amounts contributed to an individual retirement account or individual retirement annuity if the contribution occurs within 120 days before the debtor files for bankruptcy. The exemption also does not apply to an order of the domestic relations court. Yes Yes
Minnesota Minn. Rev. Stat. Ann. § 550.37(24) Protection limited to $60,000 (adjusts for inflation). Yes Yes
Mississippi Miss. Code Ann. § 85-3-1(e)Applies to solo 401k plans Yes Yes
Missouri Mo. Ann. Stat. § 513.430.1(10)(e) and (f) Exemption limited to extent reasonably necessary for support. Yes Yes
Montana Mont. Code Ann. §§ 19-2-1004, 25-13-608, 31-2-106 Yes Yes
Nebraska Neb. Rev. Stat. § 25-1563.01 For IRAs – Limited to the extent reasonably necessary for support.Individual Retirement Accounts are generally protected from attachment and garnishment to the extent the funds contained therein are reasonably necessary for the support of the debtor or any dependent of the debtor. Novak v. Novak, 245 Neb. 366, 513 N.W.2d 303 (1994). Yes Yes
Nevada Nev. Rev. Stat. § 21.090(1)(q) The exemption is limited to $500,000 in present value held in an IRA. Yes Yes
New Hampshire N.H. Code Ann. § 511:2, XIX Yes Yes
New Jersey N.J. Stat. Ann. § 25:2-1(b) Yes Yes
New Mexico N.M. Stat. Ann. §§ 42-10-1, 42-10-2 Yes Yes
New York N.Y. Civ. Prac. L. and R. § 5205(c) Yes Yes
North Carolina N.C. Gen. Stat. § 1C-1601(a)(9) Yes Yes
North Dakota N.D. Cent. Code § 28-22-03.1(3) Retirement funds that have been in effect for at least one year, to the extent those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986. The value of those assets exempted may not exceed one hundred thousand dollars for any one account or two hundred thousand dollars in aggregate for all account. Yes Yes
Ohio Ohio Rev. Code Ann. § 2329.66(A)(10)(b) and (c) SEP and SIMPLE IRAs are not protected. Yes Yes
Oklahoma 31 Okla. St. Ann. § 1(A)(20) Yes Yes
Oregon 42 Pa. C.S. §§ 8124(b)(1)(vii), (viii), (ix) Yes Yes
Pennsylvania 42 Pa. C.S. §§ 8124(b)(1)(vii), (viii), (ix) 100%, except for amounts (1) contributed within 1 year (not including rollovers), (2) contributed in excess of $15,000 in a one-year period, or (3) deemed to be fraudulent conveyances. Yes Yes
Rhode Island R.I. Gen. Laws § 9-26-4(11), (12) Yes Yes
South Carolina S.C. Code Ann. § 15-41-30(12) IRA exemption limited to the extent reasonably necessary for support. For Solo 401(k) Plans, not limited to the extent reasonable necessary for support. Yes Yes
South Dakota S.D. Cod. Laws §§ 43-45-16

S.D. Cod. Laws §§ 43-45- 17

Exempts “certain retirement benefits” up to $1,000,000. Yes Yes
Tennessee Tenn. Code Ann. § 26-2-105 Distributions 100% exempt to the extent they are on account of age, death, or length of service and debtor has no right or option to receive other than periodic payments at or after age 58. Yes Yes
Texas Tex. Prop. Code § 42.0021 Yes Yes
Utah Utah Code Ann. § 78-23-5(1)(a)(xiv) The exemption does not apply to amounts contributed or benefits accrued by or on behalf of a debtor within one year before the debtor files for bankruptcy. Yes Yes
Vermont 12 Vt. Stat. Ann. § 2740(16) Yes Yes
Virginia Va. Code Ann. § 34-34 Limited to interest in one or more plans sufficient to produce annual benefit of up to $25,000 (pursuant to actuarial table in statute). Yes Yes
Washington Wash. Rev. Code § 6.15.020 Yes Yes
West Virginia W. Va. Code § 38-10-4(j)(5) Principal 100% protected. Exemption for distributions limited to the extent reasonably necessary for support. Yes No
Wisconsin Wisc. Stat. Ann. § 815.18(3) Yes Yes
Wyoming Wy. Stat. Ann § 1-20-110(a)(i), (ii). No statutory exemption for IRAs. – only mentions retirement plans No statutory exemption for IRAs. – only mentions retirement plans No No

 

IRA Asset Protection Planning

The different federal and state creditor protection afforded to 401(k) qualified plans and IRA, including Self-Directed IRAs, inside or outside the bankruptcy context presents a number of important asset protection planning opportunities.

If, for example, you have left an employer where you had a qualified plan, rolling over assets from a qualified plan, like a 401(k), into an IRA may have asset protection implications. For example, if you live in or are moving to a state where IRAs are not protected from creditors or have in excess of $1million dollars in plan assets and are contemplating bankruptcy, you would likely be better off leaving the assets in the company qualified plan.

Note – If you plan to leave at least some of your IRA to your family, other than your spouse, the assets may not be protected from your beneficiaries’ creditors, depending on where the beneficiaries live. IRA assets left to a spouse would likely receive creditor protection if the IRA is re-titled in the name of the spouse. However, you will likely be able to protect your IRA assets that you plan on leaving to your family, other than your spouse, by leaving an IRA to a trust. To do that, you must name the trust on the IRA custodian Designation of Beneficiary Form on file.

The IRA Asset & Creditor Protection Solution

By having and maintaining an IRA, you will have $1 million of asset protection from creditors in a bankruptcy setting. However, the determination of whether your IRA will be protected from creditors outside of bankruptcy will largely depend on state law. As illustrated above, most states will afford IRAs full protection from creditors outside of the bankruptcy context.

Why Work 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. Over the years, we have helped thousands of clients establish IRS compliant Self-Directed IRA LLCs specifically for asset and creditor protection purposes. With our work experience at some of the largest law firms in the country, our retirement tax professionals’ tax and IRA knowledge in this area is unmatched.

To learn more about using a “Checkbook Control” Self-Directed IRA LLC to make real estate and other investments without tax, please contact one of our Self-Directed IRA Experts at 800-472-0646 for more information.

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Sep 05

Making Investments with Your Self-Directed IRA

A Self-Directed IRA LLC offers one the ability to use his or her retirement funds to make almost any type of investment on their own without requiring the consent of any custodian or person. The IRS and Department of Labor only describe the types of investments that are prohibited, which are very few.

The foundation of the prohibited transaction rules are based on the premise that investments involving IRA and related parties are handled in a way that benefits the retirement account and not the IRA owner. The rules prohibit transactions between the IRA and certain individuals known as “disqualified persons”. The outline for these rules can be found in Internal Revenue Code Section 4975. In general, 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.

The following are some examples of types of investments that can be made with your Self-Directed IRA LLC

  • Residential or commercial real estate
  • Domestic of foreign real estate
  • Raw land
  • Foreclosure property
  • Mortgages
  • Mortgage pools
  • Deeds
  • Private loans
  • Tax liens
  • Private businesses
  • Limited Liability Companies
  • Limited Liability Partnerships
  • Private placements
  • Precious metals and certain coins
  • Stocks, bonds, mutual funds
  • Foreign currencies

Real Estate

The IRS permits using a Self-Directed IRA LLC to purchase real estate or raw land. Since you are the manager of the Self-Directed IRA LLC, making a real estate investment is as simple as writing a check from your Self-Directed IRA bank account. The advantage of purchasing real estate with your Self-Directed IRA LLC is that all gains are tax-deferred until a distribution is taken (pre-tax 401(k) distributions are not required until the IRA holder turns 70 1/2). In the case of a Roth Self-Directed IRA, all gains are tax-free.

For example, if you purchased a piece of property with your Self-Directed IRA LLC for $100,000 and you later sold the property for $300,000, the $200,000 of gain appreciation would generally be tax-deferred. Whereas, if you purchased the property using personal funds (non-retirement funds), the gain would be subject to federal income tax and in most cases state income tax.

Helpful Tips :

  • The deposit and purchase price for the real estate property should be paid using Self-Directed IRA LLC funds or funds from a non-disqualified third-party
  • No personal funds or funds from a “disqualified person” should be used
  • All expenses, repairs, taxes incurred in connection with the Self-Directed IRA real estate investment should be paid using retirement funds – no personal funds should be used
  • If additional funds are required for improvements or other matters involving the real estate investments, all funds should come from the Self-Directed IRA or from a non “disqualified person”
  • If financing is needed for a real estate transaction, only nonrecourse financing should be used. A nonrecourse loan is a loan that is not personally guaranteed and whereby the lender’s only recourse is against the property and not against the borrower.
  • With a Self-Directed IRA the use of a nonrecourse loan would be subject to tax pursuant to Internal Revenue Code Section 514, which would not be the case with a Solo 401(k) Plan. This provides a very exciting investment opportunity for a self-employed individual or small business owner who is eligible for a Solo 401(k) Plan.
  • No services should be performed by the IRA holder or “disqualified person” in connection with the real estate investment. In general, other then typical trustee type of services (necessary and required tasks in connection with the maintenance of the plan), no active services should be performed by the plan participant or a “disqualified person” with respect to the real estate transaction.
  • Title of the real estate purchased should be in the name of the Self-Directed IRA LLC. For example, if Joe Smith established a Self-Directed IRA LLC and named the LLC XYZ, LLC, title to real estate purchased by Joe’s Self-Directed IRA LLC would be as follows: XYZ LLC
  • Keep good records of income and expenses generated by the real estate investment
  • All income, gains or losses from the Self-Directed IRA LLC real estate investment should be allocated to the IRA
  • Make sure you perform adequate diligence on the property you will be purchasing especially if it is in a state you do not live in
  • Make sure you will not be engaging in any self-dealing real estate transaction which would involve buying or selling real estate that will personally benefit you or a “disqualified person”

Tax Liens

The IRS permits the purchase of tax liens and tax deeds with a Self-Directed IRA. By using a Self-Directed IRA to purchase tax-liens or tax deeds, your profits are tax-deferred back into your retirement account until a distribution is taken (pre-tax IRA distributions are not required until the Plan Participant turns 70 1/2). In the case of a Roth Self-Directed IRA, all gains are tax-free.

More importantly, with a Self-Directed IRA, you, as manager of the Self-Directed IRA LLC, will have “checkbook control” over your retirement funds allowing you to make purchases on the spot without custodian consent. In other words, purchasing a tax-lien or tax deed is as easy as writing a check!

Helpful Tips :

  • The deposit and purchase price for the tax lien should be paid using Self-Directed IRA funds or funds from a non-disqualified third-party
  • No personal funds or funds from a “disqualified person” should be used
  • A check from the Self-Directed IRA account should be taking to auction or used for the tax lien purchase – no personal check or cash should be used
  • No credit card should be applied for in the name of the Self-Directed IRA as that would violate the IRS prohibited transaction rules. A pure debit card is allowable
  • All income, gains or losses from tax lien investments should be allocated to the Solo 401(K) Plan

Loans & Notes

The IRS permits using IRA funds to make loans or purchase notes from third parties. By using a Self-Directed IRA to make loans or purchase notes from third-parties, all interest payments received would be tax-deferred until a distribution is taken (pre-tax IRA) distributions are not required until the Plan Participant turns 70 1/2). In the case of a Roth Self-Directed IRA, all gains are tax-free.

For example, if you used a Self-Directed IRA to loan money to a friend, all interest received would flow back into your Self-Directed IRA tax-free. Whereas, if you lent your friend money from personal funds (non-retirement funds), the interest received would be subject to federal and in most cases state income tax.

Helpful Tips :

  • The loan or note amount should be paid using Self-Directed IRA funds or funds from a non-disqualified third-party
  • No personal funds or funds from a “disqualified person” should be used in the loan transaction
  • The loan or note should not involve a “disqualified person” directly or indirectly
  • The loan or note should have a stated interest rate of at least Prime as per the Wall Street Journal (4.25% as of 6/23/17)
  • All interest and principal associated with the loan or note should be allocated to the Self-Directed IRA
  • It is good practice to have the loan terms documented in a promissory note or loan agreement
  • If you will be acting as the lender, consider securing the loan with an interest or lien in an asset owned by the borrower
  • Make sure you will not be engaging in any self-dealing loan transaction which would involve a loan or note that will personally benefit you or a “disqualified person”

Private Businesses

With a Self-Directed IRA you are permitted to purchase an interest in a privately held business. The business to be purchased can be any entity other than an S Corporation (i.e. limited liability company, C Corporation, partnership, etc.). When investing in a private business using 401(k) funds, it is important to keep in mind the “Disqualified Person” and “Prohibited Transaction” rules under IRC 4975 and the Unrelated Business Taxable Income rules under IRC 512.

Helpful Tips :

  • The deposit and purchase price for the business should be paid using Self-Directed IRA or funds from a non-disqualified third-party
  • No personal funds or funds from a “disqualified person” should be used to purchase the business
  • The purchase of the stock or assets of the business should not directly or indirectly benefit the plan participant personally or any “disqualified person”
  • The purchase of a business operated via an LLC or partnership will potentially trigger the Unrelated Business Taxable Income rules under IRC 512 and a corresponding tax of approximately 40% for 2017 would be applied
  • Stock of an S Corporation should not be purchased with retirement funds as the S corporation rules only allow individuals to be S Corporation shareholders
  • The purchase of stock of a C Corporation would not trigger the application of the Unrelated Business Taxable Income rules under IRC 512
  • All income, gains or losses from the purchased business should be allocated to the Self-Directed IRA
  • The plan participant or any “disqualified person” should not have any ownership in the business being purchased and should not directly or indirectly personally benefit from the acquisition
  • Make sure to perform adequate diligence on the business you will be purchasing or investing in especially if you will be buying the stock/interests and not the assets
  • Make sure you will not be engaging in any business acquisition transaction which would involve buying or selling a business that will personally benefit you or a “disqualified person”

Precious Metals & Coins

The Self-Directed IRA structure allows for investments into precious metals and certain coins. The advantage of using a Self-Directed IRA to purchase precious metals and/or coins is that their values generally keep up with, or exceed, inflation rates better than other investments. In addition, IRS approved metals or coins, as defined under Internal Revenue Code Section 408(m) should be held an an approved depository or U.S. Bank.

Helpful Tips :

  • Only IRS approved metals or coins (bullion) may be purchases as per Internal Revenue Code Section 408(m)
  • The IRS approved precious metals or coins being purchased by the plan should be paid using Self-Directed IRA funds or funds from a non-disqualified third-party
  • With respect to IRS approved precious metals or coins(bullion), the metals or coins should not be held in the personal possession of any individual
  • With respect to the IRS approved precious metals or coins outlined in Internal Revenue Code Section 408(m), the bullion must be held in the “physical possession” of a U.S. depository or at a U.S. bank
  • An affidavit signed by the trustee of the plan confirming that the IRS approved precious metals or coins are being purchased and being held in the sole interest of the retirement account is good practice
  • All income, gains or losses from the purchased precious metals or coins should be allocated to the Self-Directed IRA
  • IRS approved precious metals or coins should not be held at a bank outside the United States
  • Perform adequate diligence on the dealer with which you will be transacting with for the purchase of IRS approved metals or coins

Foreign Currencies

The IRS does not prevent the use of IRA funds to purchase foreign currencies, including Iraqi Dinars. In fact, the Self-Directed IRA Plan structure permits the purchase of foreign currencies. Many believe that foreign currency investments offer liquidity advantages to the stock market as well as significant investment opportunities.

By using a Self-Directed IRA to purchase foreign currencies, such as the Iraqi Dinar, all foreign currency gains generated would be tax-deferred until a distribution is taken (pre-tax IRA distributions are not required until the Plan Participant turns 70 1/2). In the case of a Roth Self-Directed IRA, all gains are tax-free.

Helpful Tips :

  • Make sure you have a solid background in trading currencies – high volatile and significant risk
  • If you will be investing with a third-party, perform adequate diligence on the individual and make sure the individual has the knowledge to trade foreign currencies and all his/her securities licenses are in good standing.
  • Beware of leverage – it is allowable but it would trigger the application of the Unrelated Business Taxable Income rules under IRC 512 and thereby a corresponding tax
  • No personal guarantee of any leverage or loan obligation is permitted
  • All income, gains or losses from the foreign currency transactions should be allocated to the Self-Directed IRA

Stocks, Bonds, Mutual Funds, CDs

In addition to non-traditional investments such as real estate, a Self-Directed IRA may purchase stock, bonds, mutual funds, and CDs. The advantage of using a self-directed IRA is that you are not limited to just making these types of investments. With a Self-Directed IRA with “checkbook control” you can open a stock trading account with any financial institution as well as purchase real estate, buy tax liens, or lend money to a third-party. Your investment opportunities are endless! When purchasing stocks or securities with a Self-Directed IRA, all income and gains, including dividends, would flow back to the plan without tax. With a Roth Self-Directed, all gains are tax-free. Whereas, if you purchased stocks with personal funds, all income and gains would be subject to federal and in most cases state income tax would be subject to federal and in most cases state income tax.

Helpful Tips :

  • If you will be investing with a third-party, perform adequate diligence on the individual and make sure the individual has the knowledge to trade stocks or securities and all his/her securities licenses are in good standing.
  • Beware of promoters who are promising high returns and that do not work at reputable financial institutions – high likelihood of fraud
  • Beware of leverage – it is allowable but it would trigger the application of the Unrelated Business Taxable Income rules under IRC 512 and thereby a corresponding tax
  • No personal guarantee of any leverage or loan obligation is permitted
  • Open up a brokerage account in the name of the Self-Directed IRA – not a personal account
  • All income, gains or losses from the stock investments should be allocated to the Self-Directed IRA

If you have any questions about whether your specific Self-Directed IRA transaction would potentially be in violation of IRS rules, please contact a tax professional at the IRA Financial Group at 800-472-0646.

 

Aug 28

Peer to Peer Lending with a Self-Directed IRA

IRA Financial Group, the leading provider of self-directed IRA LLC and solo 401(k) plan solutions has designed a cost effective solution for peer-to-peer lenders looking to generate tax-deferred or tax-free returns without high annual IRA custodian costs.

As a result of the very strong demand from peer-to-peer IRA investors looking to have more control over the loan process without the high transaction fees, we have developed a special self-directed IRA LLC solution specifically tailored for peer-to-peer investors. Because of the attractive returns that many peer-to-peer investors have generated over the last several years, a growing number of peer-to-peer lenders are eager to use their IRA or 401(k) funds to make loans and generate tax-deferred income or gains.

Peer to Peer Lending with a Self-Directed IRAA Self-Directed IRA LLC offers one the ability to use his or her retirement funds to make almost any type of investment, including peer-to-peer lending, on their own without requiring the consent of any custodian or person in a tax-efficient manner. The IRS only describes the type of investments that are prohibited, which are very few. The main advantage of using a Self Directed IRA LLC to make peer-to-peer lending investments is that the loan can be made by simply writing a check. In addition, all income and gains associated with the self directed IRA hard money loan would grow tax-deferred.

With IRA Financial Group’s self directed IRA hard money lending solution, traditional IRA or Roth IRA funds can be used to make secured or unsecured private loans to small business owners or home builders.

IRA Financial Group’s Self-Directed IRA for hard money investors, is an IRS approved structure that allows one to use their retirement funds to make hard money loans, either secured or unsecured, to any non-disqualified third-party by simply writing a check. The Self-Directed IRA LLC involves the establishment of a limited liability company (“LLC”) that is owned by the IRA (care of the IRA custodian) and managed by the IRA holder or any third-party. As manager of the IRA LLC, the IRA owner will have control over the IRA assets to make traditional as well as non-traditional investments, such as hard money loans by simply writing a check.

IRA Financial Group is the market’s leading provider of “checkbook control” Self Directed IRA 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

For additional information on the advantages of using a Self-Directed IRA LLC with “Checkbook Control” to make investments, please contact one of our IRA Experts at 800-472-0646.

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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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Dec 09

What’s the Difference Between a Self-Directed IRA with Checkbook Control and a Regular IRA?

An Individual Retirement Account (IRA) is a tax-deferred retirement account for an individual that permits individuals to set aside money each year, with earnings tax-deferred until withdrawals begin at age 59 1/2 or later (or earlier, with a 10% penalty).

The Difference Between a Traditional IRA and a Checkbook Control Self Directed IRAMany “traditional IRA” custodians advertise themselves as offering a Self Directed IRA with “checkbook control”, but what that really means is that you can direct your IRA as long as you direct into one of their offerings. In other words, in a “traditional IRA” with no “checkbook control”, you are generally only permitted to invest your IRA funds in investments in equities, mutual funds, bonds or investments offered by the custodian. Whereas, in the case of a “truly” Self Directed IRA LLC with “checkbook control”, a limited liability company (“LLC”) is established that is owned by the IRA account and managed by the IRA account holder. The IRA Holder’s IRA funds are then transferred by the Custodian to the LLC’s bank account providing the IRA holder with a “truly” Self Directed IRA LLC.

With a “truly” Self Directed IRA LLC, you will have total control over your IRA funds and you will no longer have to get each investment approved by the custodian of your account like in a “traditional IRA”. Instead, all decisions are truly yours. When you find an investment that you want to make with your IRA funds, simply write a check or wire the funds straight from your Self Directed IRA LLC bank account to make the investment. A “truly” Self Directed IRA allows you to eliminate the delays associated with an IRA custodian, enabling you to act quickly when the right investment opportunity presents itself.

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

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Oct 27

Investing in Hedge Funds with a Self Directed IRA

The Internal Revenue Code does not describe what a Self Directed IRA can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain type of transactions. The purpose of these rules is to encourage the use of IRAs for accumulation of retirement savings and to prohibit those in control of IRAs from taking advantage of the tax benefits for their personal account.

When it comes to using retirement funds to invest in a hedge fund, it is important to be mindful of the IRS prohibited transaction rules under Internal Revenue Code Section 4975. In general, the IRS has restricted certain transactions between the IRA and a “disqualified person”. 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 (i.e. parents, children, spouse, daughter-in-law, or son-in-law), and entities in which the IRA holder or a disqualified person holds a controlling or management interest. Furthermore, Internal Revenue Code Section 4975(c)(1)(D) and (E) outlines rules that relate to self-dealing or conflict of interest transactions that involves an investment that could directly or indirectly personally benefit a disqualified person. The self-dealing or conflict of interest prohibited transaction rules have the broadest application especially when it comes to hedge fund type investments.

A hedge fund is an alternative investment vehicle available only to sophisticated investors, such as institutions and individuals with significant assets. In general, retirement funds are permitted to invest in hedge funds. The prohibited transactions rules tend to become more of an issue when the person using the IRA funds or any disqualified person related to the IRA owner has a personal interest or relationship with the hedge fund investment. In other words, an IRA can generally make an investment into a hedge fund in which neither the IRA holder nor any disqualified person has any personal ownership or relationship with. The issues begin to arise from an IRS prohibited transaction standpoint when the IRA owner wishes to use retirement funds to invest in a hedge fund where her or she or a disqualified person is either an owner, employee or, in some cases, has a professional relationship with the fund in question.

In general, if structured correctly, there may be a way for one to use their retirement funds to invest in a hedge fund that one is personally involved in.  The key is to make sure that the IRA investment into the hedge fund will not directly or indirectly personally benefit the IRA owners since that type of investment would likely trigger a prohibited transaction.

Generally, hedge funds are structured as limited partnerships or LLCs. In the case of a limited partnership, a general partner (“GP”) is created that tends to perform all the hedge fund management tasks. The GP generally owns a small percentage of the partnership. The investors are limited partners (“LP”) of the partnership. A typical fee structure for a hedge fund is the 2 and 20 model, which means the hedge fund manager will take a 2% management fee of all assets under management and then take 20% of the profits generated by the fund after the LP investors have received their money they invested back and, in some cases, a preferred return on the money invested is also returned to the investor.

Investing in Hedge Funds with a Self Directed IRA LLCA popular question is whether an individual who is a principal or in a management position with the hedge fund can use their retirement funds to invest in the fund. To begin with, the use of the retirement funds cannot be invested into the GP entity since that is the entity where the services are generally being performed on behalf of the hedge fund and where the management fee and carried interest are typically being directed as investing IRA funds into a company where the IRA holder has a personal ownership or is performing services as an employee would likely violate the IRS prohibited transaction rules. Therefore, the question then becomes can the IRA holder who has some personal ownership in the hedge fund use retirement funds to invest as an LP of the fund? The answer generally depends on the facts and circumstances involved in the transaction. However, in general, there are ways that one can properly structure an investment of retirement funds into a hedge fund in which the IRA holder has some personal interest. The main question that needs to be asked and answered positively is if the IRS looked at the transaction, could they argue that the IRA owner has in any way directly or indirectly personally benefited by the IRA investment. If the IRA owner cannot prove that he or she did not receive any direct or indirect personal benefit from the IRA investment into the hedge fund, then the IRS would likely argue that the investment triggered a prohibited transaction. Since the onus is always on the taxpayer to disprove a claim made by the IRS, it is crucial that the IRA owner that is seeking to make a retirement investment into a hedge fund in which he or she has some personal connection to be extremely confident that he or she can prove, if requested, that no personal benefit was derived from the retirement account investment, either directly or indirectly. Accordingly, when it comes to using retirement funds to make investments into a hedge fund in which the IRA owner has a personal relationship with, issues such as the management fee and carried interests are items that need to be taken into account when structuring the self-directed IRA hedge fund investment.

The Tax Court in Rollins v. Commissioner, a 2008 Tax Court case, offers some insight as to how the IRS looks at transactions that involve investments into entity’s where the IRA owner has a small ownership interest in. Even though the Rollins case not involve using retirement funds to invest in a hedge fund, it nevertheless offers some insight as to the IRS thoughts on the application of the IRA self-dealing and conflict of interest rules. The Rollins case is especially helpful in examining how the IRS could look at a transaction involving the use of retirement funds into a hedge fund in which the IRA owner has some personal relationship or ownership interest. Mr. Rollins was a CPA who had an ownership in several companies. One of the companies, in which he owned less than 10%, served as a director, but received no compensation, was in financial trouble and needed additional funds. Mr. Rollins decided to use his 401(k) plan funds to lend the company money at prevailing interest rates. The IRS audited the transaction and argued that the loan from Mr. Rollins 401(k) plan to the company was a prohibited transaction as the loan personally benefited him. The Tax Court agreed and basically stated that even though the company was not itself a disqualified person because Mr. Rollins owned less than 50% of the company, nonetheless he could not provide that he did not directly or indirectly personally benefit from the loan made to the company by his 401(k) plan. Clearly the Tax Court felt that Mr. Rollins personally benefited from the loan since without the loan his personal investment would have been lost. The Rollins case is a good illustration as to how the IRS could view an investment into a hedge fund by an IRA owner who has some personal interest in the hedge fund below the 50% ownership threshold.

Below are several examples that highlight the complexities involved in structuring an investment of retirement funds into a hedge fund in which the IRA owner has some personal relationship or ownership:

1. Joe is looking to start a hedge fund and needs $100,000 to begin operations. The hedge fund would be a limited partnership and Joe would be charging a traditional 2% management fee and 20% carried interest on fund profits. Joe will own 100% of the general partner of the hedge fund and is looking for investors to invest in the hedge fund. Joe wishes to use his IRA funds to invest in his hedge fund.

Issues for Joe to consider: Joe would clearly not be able to use his IRA funds to invest in the general partner since he will own 100% of that entity personally and that would likely trigger a prohibited transaction. What if Joe wanted to invest the funds as a limited partner of the fund? Unfortunately, there is no clear answer to this question as the answer is generally dependent on the facts and circumstances involved in the transaction. For example, if the only way Joe could attract investors to the fund is to show he also has invested in the fund and the only funds he had available to invest were IRA funds, the IRS could argue that the use of his IRA funds would personally benefit him since without his IRA funds being used he would not be able to attract investors to his fund and derive a personal financial return from owning the fund.

2. Ben is a 2% partner at a hedge fund that has $500 million under management. The hedge fund is set-up as a limited partnership. The hedge fund has a traditional fee model of 2% management fee and 20% carried interest. The hedge fund is looking to raise an additional $250 million and Ben is seeking to use $250,000 from his IRA to invest as a limited partner of the fund. His limited partnership interest would be 2.5% of the total fund.

Issues for Ben to consider: Ben is clearly a disqualified person because he is the IRA holder, but the hedge fund he is a partner at would likely not be since he owns just 2% of the fund, pursuant to Internal Revenue Code Section 4975(e)(2). However, the self-dealing or conflict of interest rules under Internal Revenue Code Section 4975(c)(1)(D) and (E) could treat Ben’s investment into the fund as a prohibited transaction. The question Ben must ask himself is whether he would receive any personal benefit, either directly or indirectly, from making the fund investment with his IRA funds. For example, would the fund be in financial trouble without Ben’s investment? Will Ben receive a salary bonus if he invests in the fund? Or what if, Ben is required to invest in the fund in order to maintain his position as partner of the fund? These are some of the facts that would need to be examined before determining whether Ben’s investment would rise to the level of a prohibited transaction.

3. Steve is a 99% owner of hedge fund A, which has over $750 million in assets under management. The hedge fund is set-up as a limited partnership. The hedge fund has a traditional fee model of 2% management fee and 20% carried interest. The hedge fund is looking to create fund B, which will be exclusively investing in a pool of loans. Fund B will be looking to raise $500 million from outside investors. Steve and a number of hedge fund A executives want to invest their retirement funds into fund B, but expect to own less than 5% of fund B. Fund A will be charging a management fee and carried interest on the limited partners of fund B.

Issues for Steve to consider: Since Steve owns 99% of hedge fund A and hedge fund A will be receiving a fee from the limited partners of fund B, a management fee and carried interest allocated to Steve’s IRA and potentially his executives could violate the prohibited transaction rules under Internal Revenue Code Section 4975. Fees paid by Steve’s IRA to a company he owns 99% of could be considered a prohibited transaction. What if Steve and his executives were able to have their IRAs exempted from the management fee and carried interest going to the general partner of fund A or were able to buy a different membership class of fund B, which did not have to pay any fees to hedge fund A. Because of Steve’s large ownership interest in hedge fund A, it is especially important that he focuses on the self-dealing and conflict of interest prohibited transaction rules to make sure his IRA investment into fund B could not be viewed as personally benefiting him directly or indirectly.

Unrelated Business Taxable Income

After examining the IRS prohibited transaction rules in order to determine whether an IRA investment into a hedge fund could be made, another set of IRS rules must be reviewed in order to verify whether a tax would be imposed on the income allocated to the IRA from the hedge fund investment.

In general, when it comes to using a Self Directed IRA to make investments most investments are exempt from federal income tax. This is because an IRA is exempt from tax pursuant to Internal Revenue Code 408 and Section 512 of the Internal Revenue Codes exempt most forms of investment income generated by an IRA from taxation. However, in the case of the use of margin, nonrecourse debt, or income generated from an active trade or business conducted via an LLC or partnership, a tax would be imposed on a percentage of the income generated. These rules have become known as the Unrelated Business Taxable Income rules or UBTI or UBIT. If the UBTI rules are triggered, the income generated from that activities will generally be subject to close to a 40% tax for 2016. 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.” In the case of an IRA, all active business activities will be treated as unrelated.

So why have I never heard of these rules before? The reason is that since most Americans with retirement funds invest in publicly traded stocks or mutual funds, which are often structured as a “C” Corporation, an entity subject to tax. A “C” corporation is also known as a blocker corporation. Unlike an LLC, which is treated as a passthrough entity, income from a “C” Corporation is blocked or stays in the “C” Corporation and does not flow to the shareholder. Whereas, income from an LLC passthrough the to the member/owner of the LLC – there is no entity tax with an LLC or partnership. Hence, any income allocated to an IRA via an LLC or passthrough entity would not be subject to an entity level tax and could be subject to the UBTI tax if the LLC was engaged in an active trade or business or margin or debt was used by the LLC. In other words, if one buys stock of a “C” corporation with a retirement account, the UBTI tax rules would not apply. Whereas, if one purchased an interest in a passthrough entity, such as an LLC, with IRA funds and the LLC was engaged in an active trade or business, used margin, or acquired debt, then the income allocated to the IRA could be subject to the UBTI tax.

In the case of an IRA investment into a hedge fund, if the hedge funds activities rise to the level of a trade or business, or if margin or debt is used in the hedge funds trading activities, then even though the investment may not violate the IRS prohibited transaction rules, the income could be subject to the UBTI tax rules. Since most hedge funds are structured as passthrough entities, gaining a solid understanding of the UBTI tax rules is extremely important.

Using retirement funds to invest in a hedge fund is not on its face a prohibited transaction, however, when the IRA owner has some personal involvement with the hedge fund, the IRS prohibited transaction rules must be closely examined to make sure the investment would not trigger a prohibited transaction.

The tax professionals and CPAs of the IRA Financial Group have helped hundreds of hedge fund investors use their retirement funds to make hedge fund related investments, including in their own funds, and have significant experience in this area.

To speak with an IRA Financial Group tax professional, please contact us at 800-472-0646.

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Oct 11

IRA Prohibited Transaction with Disqualified Persons

In general, the type of transactions that could fall under the prohibited transaction rules pursuant to IRS Code Section 4975 can be viewed in the context of three unofficial categories:

Direct Prohibited Transactions

4975(c)(1)(A): The direct or indirect Sale, exchange, or leasing of property between an IRA and a “disqualified person”

  • Ben leases an interest in a piece of property owned by his Self Directed IRA to his son
  • Jen sells real estate owned by her Self-Directed IRA to her father
  • Todd sells real estate he owns personally to his Self-Directed IRA
  • Carl transfers property he owns personally to his Self-Directed IRA
  • Mary Purchases real estate with her IRA funds and leases it to her mother
  • Kevin uses his Self-Directed IRA funds to purchase an interest in an entity owned by his wife
  • Peter Transfers property he owns personally subject to a mortgage to his Self-Directed IRA.
  • Tracy uses personal funds to pay expenses related to her Self Directed IRA real estate investment
  • Lara uses personal funds to pay taxes and expenses related to her Self-Directed IRA real estate investment

4975(c)(1)(B): The direct or indirect lending of money or other extension of credit between an IRA and a “disqualified person”

  • Keith lends his son $4,000 from his IRA
  • Joe Uses the assets of his Self-Directed IRA as security for a loan
  • Mr. Peek and Mr. Fleck personally guarantee a business loan owned by their self-directed IRA
  • Tammy personally guarantees a bank loan to her Self-Directed IRA
  • Bill uses his personal assets as security for an Self-Directed IRA investment
  • Allan uses Self-Directed IRA funds to lend an entity owned and controlled by his father $25,000
  • Terry acquires a credit card for his Self-Directed IRA LLC bank account

4975(c)(1)(C): The direct or indirect furnishing of goods, services, or facilities between an IRA and a “disqualified person”

  • Dan purchases real estate with his Self-Directed IRA funds and personally makes repairs on the property
  • Larry purchases a condo with his Self-Directed IRA funds and paints the walls without receiving a fee
  • Kris buys a piece of property with his Self-Directed IRA funds and hires his son to work on the property
  • Karen buys a home with her Self-Directed IRA funds and her son makes repairs for free
  • Lisa owns an office building with her Self-Directed IRA and hires her son to manage the property for a fee
  • Shari owns an apartment building with her Self-Directed IRA funds and has her father manage the property for free
  • Joe receives compensation from his Self-Directed IRA for investment advice
  • Troy acts as the real estate agent for his Self Directed IRA

4975(c)(1)(D): The direct or indirect transfer to a “disqualified person” of income or assets of an IRA

  • Steve uses a house owned by his Self Directed IRA for personal uses
  • Tim deposits Self-Directed IRA funds in to his personal bank account
  • Pat is in a financial jam and takes $12,000 from his Self-Directed IRA to pay a personal debt
  • Mark buys precious metals using his Self-Directed IRA funds and uses them for personal gain
  • Jack purchases a vacation home with his Self-Directed Self Directed IRA funds and stays in the home on occasion
  • Amy buys a cottage on the lake using her Self Directed IRA and rents it out to her daughter and son-in-law
  • Sylvia purchases a condo on the beach with her Self Directed IRA funds and lets her son use it for free
  • Richard uses his Self-Directed IRA to purchase a rental property and hires his friend to manage the property. The friend then enters into a contract with Richard and transfers those funds back to Richard
  • Pam invests her Self-Directed IRA funds in an investment fund and then receives a salary for managing the fund.
  • Charles uses his Self-Directed IRA funds to purchase real estate and earns a commission as the real estate agent on the sale
  • Keith uses his Self-Directed IRA funds to lend money to a company he owns and controls
  • John invests his Self-Directed IRA funds into a business he owns 75% of and manages

Self-Dealing Prohibited Transactions

4975(c)(1)(E): The direct or indirect act by a “Disqualified Person” who is a fiduciary whereby he/she deals with income or assets of the IRA in his/her own interest or for his/her own account

  • Sara makes an investment using her Self-Directed IRA funds into a company she controls which will benefit her personally
  • Jason uses his Self-Directed IRA funds to invest in a partnership with himself personally in which he and his family will own greater than 50% of the partnership
  • Helen uses her Self-Directed IRA funds to invest in a business she and her husband own and operates and her and her husband earns compensation from the business
  • Steve uses his Self-Directed IRA funds to lend money to a business in which he controls and manages
  • Victor invests his Self-Directed IRA funds in a trust in which Victor and his wife would gain a personal benefit
  • Brenda uses her Self-Directed IRA funds to invest in a real estate fund managed by her Son. Brenda’s son receives a bonus for securing her investment.
  • Frank invests his Self-Directed IRA funds into a real estate project that his development company will be involved in order to secure the contract
  • Ryan uses his Self-Directed IRA funds to invest in his son’s business that is in financial trouble
  • David uses his Self-Directed IRA funds to buy a note on a piece of property for which he is the debtor personally

Conflict of Interest Prohibited Transactions

Subject to the exemptions under Internal Revenue Code Section 4975(d), a “Conflict of Interest Prohibited Transaction” generally involves one of the following:

4975(c)(i)(F): Receipt of any consideration by a “Disqualified Person” who is a fiduciary for his/her own account from any party dealing with the IRA in connection with a transaction involving income or assets of the IRA

  • Jay invests his Self-Directed IRA funds into a corporation in which he manages and controls but owns a small interest in
  • Betty uses her Self-Directed IRA funds to loan money to a company she owns a small interest in but manages and controls the daily operations of the company
  • Sally uses her Self-Directed IRA to lend money to a business that she works for in order to secure a promotion
  • Lance uses his Self-Directed IRA funds to invest in a real estate fund that he manages and where his management fee is based on the total value of the fund’s assets.

For more information on prohibited transactions, please contact an IRA Expert at 800-472-0646.

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Sep 12

Adam Bergman, IRA Financial Group Partner, Authors Article on Holding IRS Approved Coins and Precious Metals in a Self-Directed IRA for Forbes

Adam Bergman is a contributor to Forbes.com on the topic of retirement taxation, with attention to the self-directed IRA rules and investments

Adam Bergman, partner with the IRA Financial Group, authors an article on Forbes.com titled, “Buying Gold Or Coins In An IRA Creates Possession Issues”. Thanks to significant advertising by precious metals and coin dealers, it has become widely known that gold, silver, palladium bullion, as well as certain coins can be purchased with retirement account funds, such as a self-directed IRA gold. However, there has been great degree of attention on the subject of how one is able to hold IRS approved coins and precious metals/bullion. “I felt it was important to write an article that offered an in-depth analysis of the rules involved in owning and holding IRS approved coins and precious metals as per IRC Section 408(m).” stated Adam Bergman, IRA Financial Group Partner.

Mr. Bergman has writing about various items involving the taxation of retirement funds, particularly on the matters of Self-Directed IRAs and Solo 401K Plans. For example, Mr. Bergman recently wrote a blog about the self-directed Solo 401(k) Plan as well as the impact of the Greek financial crisis on retirement accounts. Mr. Bergman has just contributed an article to Forbes.com on the topic of retirement tax planning tax-planning opportunities for the millennials or Generation Y.

Adam Bergman, IRA Financial Group Partner, Authors Article on Holding IRS Approved Coins and Precious Metals in a Self-Directed IRA for ForbesAdam Bergman is a partner with the IRA Financial Group, LLC, the markets leading provider of Self-Directed IRA LLC and Solo 401(k) plans. Mr. Bergman is also the President of the IRA Financial Trust Company, a self-directed IRA custodian. In addition, Mr. Bergman is a recognized expert on IRAs and 401(k) Plans and is the founder of the BergmanIRAReport.com and the Bergman401KReport.com. Mr. Bergman is the author of six books on self-directed retirement plans, such as “Going Solo: America’s Best Kept Retirement Secret For the Self-Employed, The Checkbook IRA, Self-Directed IRA in a Nutshell, In God We Trust – In Roth We Prosper, and Turning Retirement Funds in” available on Amazon, and is a frequent contributor to Forbes. Mr. Bergman has advised over 12,000 clients on the Self-Directed IRA LLC and Solo 401(k) Plan solutions.

Mr. Bergman has been quoted in a number of major publications on the area of self-directed retirement plans. Mr. Bergman has been interviewed on CBS News and has been quoted in Businessweek, CNN Money, Forbes, Dallas Morning News, Daily Business Review, Law.com, San Francisco Chronicle, U.S. Tax News, the Miami Herald, Bloomberg, Arizona Republic, San Antonio Express, Findlaw, Smart Money, USA Today, Houston Chronicle, Morningstar, and American Lawyer on the area of retirement tax planning.

Prior to joining the IRA Financial Group, LLC, Mr. Bergman worked as a tax and ERISA attorney at White & Case LLP, Dewey LeBoeuf LLP, and Thelen LLP, three of the most prominent corporate law firms in the world. Throughout his career, Mr. Bergman has advised thousands of clients on a wide range of tax and ERISA matters involving limited liability companies and retirement plans. Mr. Bergman received his B.A. (with distinction) from McGill University and his law degree (cum laude) from Syracuse University College of Law. Mr. Bergman also received his Masters of Taxation (LL.M.) from New York University School of Law.

Mr. Bergman is recognized as a leading retirement tax-planning expert and has lectured attorneys on the legal and tax aspects of Self-Directed IRA LLC and Solo 401(k) Plans. Mr. Bergman is a member of the Tax Division of the American Bar Association and New York State Bar Association.

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 “checkbook control Self Directed IRA and Solo 401(k) Plan provider. 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 800-472-06

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Aug 15

The SDIRA Operating Agreement

The LLC Operating Agreement is the core document that is referred to when issues concerning the LLC need to be resolved. The LLC Operating Agreement is the most important document for your Self Directed IRA. It is extremely important that you create an Operating Agreement for your Self Directed IRA LLC.

The SDIRA Operating AgreementThe standard LLC Operating Agreement will not meet the requirements for your Self-Directed IRA LLC. In general, a self directed IRA LLC Operating Agreement should include special tax provisions relating to “Investment Retirement Accounts” and “Prohibited Transactions” pursuant to Internal Revenue Code Sections 408 and 4975. In addition, since the LLC will be managed by a manager and not the member, the Operating Agreement would need to include special management provisions.

It is extremely important to have a properly prepared Operating Agreement to fit the needs of your LLC and meet the requirements of the Internal Revenue Service for a Self Directed IRA LLC. In fact, a copy of the LLC Operating Agreement will be required by the Custodian and also by the bank where you will have your LLC’s checking account.

IRA Financial Group will generate a special purpose self-directed IRA LLC Operating Agreement that has been approved by all IRA passive custodians. The special purpose self-directed IRA LLC operating agreement has been drafted by tax professionals who worked at some of the largest law firms in the country such as White & Case LLP, Dewey & LeBoeuf LLP, and Thelen LLP. With our work experience at some of the largest law firms in the country, our tax knowledge in this area is unmatched.

Our low one time service fee includes not only the special purpose self-directed IRA LLC operating agreement, but also includes the setting up of the entire Self Directed IRA LLC structure for you, including LLC formation, acquiring a Tax ID#, assisting with the completion of all transfer documents, and self-directed IRA tax advisory service from our in-house tax and ERISA professionals.

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

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