Question: In 2008 an oil company drilled a successful oilwell (30 BOPD, 100 barrels saltwater/day) on my mother’s land and she owns the mineral rights.They were disposing of the saltwater by vacuum truck and hauling to another location.Before the oil company could drill a saltwater(produced ) water disposal well, they went bankrupt. My mother now owns the well, the borehole. My brother and I are both experienced in the oilfield. My brother and I want to go into business together to drill a new disposal well or re-enter an old well in order to get the oil well producing again. Can my brother and I go into business together to get this well producing and make a profit. My brother will fund his 50% of the expenses with his own private funds. I want to use my self directed IRA to fund the other 50% of the expenses. My brother will receive 50% of the profits and my IRA will receive the other 50% of the profits. Of course, my mother will receive her share of the royalties. Is this legal?
Answer: Thank you for your inquiry. There are a number of problems associated with using your IRA in this transaction. First of all, you would not be able to fund expenses personally for an investment which your IRA owns. Second, your mother is a disqualified person as to your IRA, and the investment by your IRA clearly would benefit her, in as much as she receives royalties as a result of making the well produce again. This would make your proposal a prohibited transaction. Third, your brother, while not a disqualified person to your IRA, is someone in whom you may have an interest which would affect your best judgment as a fiduciary for your IRA. If true, it could be argued that a benefit to your brother may be deemed to be an indirect benefit to you, which again, could make this a prohibited transaction. Fourth, using your own talents to make the deal work may be considered a prohibited transaction or at least an excess contribution to your IRA. Additionally, as a working interest in an oil well the transaction would likely produce Unrelated Business Taxable Income (UBTI) on which your IRA would owe taxes, assuming the investment made money. While making an investment in your IRA which causes it to pay taxes on its UBTI does not necessarily mean you shouldn’t do any particular deal, it is something that you must take into account when deciding if a transaction is right for your IRA.
The bottom line is that based on the facts stated in your email I would not think your proposed investment is a wise one in your self-directed IRA, although I cannot give you tax, legal or investment advice. If you have any further questions, or if you can locate an investment involving non-disqualified persons, we would be very happy to assist you with self-directed IRA services. Have a great day!
Also, replay H. Quincy Long’s Prohibited Transactions Webinar