Category Archives: Self-Directed Traditional IRAs

Self-Directed IRA & Qualified Plan Information, Self-Directed Traditional IRAs

I want to use my IRA to help establish my online business

Question: Hello, I am in Austin and hoping to set up my own online business through my IRA.  I will be the sole owner.  Is this possible?  Do I need to form an LLC?  And lastly, if the business becomes profitable, would I be able to pay back the IRA and then run it as a regular business from which I can make personal use of the profits? 

Answer: Thank you for your inquiry.  First let me start by reiterating what it says below, which is that we do not provide tax, legal, accounting, investment or other professional advice.  Anything I say is merely educational in nature and you should absolutely consult your own advisors.   I have been asked similar questions many times.  First, let me answer your last question.  No, if your IRA owns the business, you would not be able to pay back the IRA and then run it as a regular business from which you can make personal use of the profits, unless of course you took the LLC as a distribution from your IRA and paid taxes and, if you’re under age 59 1/2, penalties on it.  To the extent your IRA has money in it you can always take a distribution of cash, provided you are willing to pay taxes and/or penalties.   Do you need an LLC to own a business in your IRA? It depends on the business, but under most circumstances an LLC would be a good idea, simply because of all the issues that an active business has to deal with, especially if you 
have any employees.  

Is it possible to set up an online business through your IRA where your IRA (not you) would be the sole owner?  Well, that the $64,000 question, as they say, isn’t it? 

There are several issues with doing this.  First of all, unless the business is set up to be owned by a taxable entity such as a C corporation or an LLC which elects to be treated as a C corporation, the profits from the business would be considered Unrelated Business  Income (UBI) to the IRA and as a result the IRA would owe Unrelated Business Income Tax (UBIT) on its profits.  This may take away some of the advantages you hoped to achieve by starting the business in your IRA.  You may want to review IRS Publication 598, which describes UBI in more detail.  Note that if the business pays its own income taxes (because it is a C corporation or other taxable entity), then the UBI would not pass through to the IRA.  The fact that a particular investment may cause your IRA to owe UBIT does not necessarily mean that you should not make that investment, but it certainly is a factor you will want to be very familiar with prior to entering into such an investment.  

Another issue with your plan is that the IRS may consider your services to the IRA owned business to be an excess contribution to your IRA under Internal Revenue Code Section 4973, or worse, a prohibited transaction under Internal Revenue Code Section 4975.  Your question reminds me of the facts of Chief Counsel Advice No.  200917030, which may be summarized as follows:

  •      Chief Counsel Advice (CCA) 200917030 involved a couple who formed a Roth IRA owned corporation into which they directed payments for consulting, accounting and bookkeeping services they provided to other individuals and businesses.  This was found to be a listed transaction similar to the one described in Notice 2008-4, which should have been reported by the taxpayers on Form 8886, Reportable Transaction Disclosure Statement.  The CCA said in this case, like the transaction in Notice 2004-8, the structure of the transaction purportedly allows a taxpayer or multiple related taxpayers to create a Roth IRA investment that avoids the contribution limits by transferring value to the Roth IRA Corporation comparable to a contribution to the Roth IRA, thereby yielding tax benefits that are not contemplated by a reasonable interpretation of the language and purpose of Code Sec. 408A (the Code section authorizing Roth IRAs). In this case, the value of the services provided was shifted from Taxpayers or their business to the Roth IRA Corporation when the Taxpayers provided services through the Roth IRA Corporation as 
    employees of the Roth IRA Corporation. Furthermore, the total value of services provided by Taxpayers to clients of the Roth IRA Corporation was not received by Taxpayers in the form of salary or other compensation from the Roth IRA Corporation. As in the Notice 2004-8 transaction, Taxpayers shifted the value of income or property from Taxpayers or a business of Taxpayers to the Roth IRA Corporation, thereby purportedly avoiding the contribution limitations applicable to Roth IRAs. Taxpayers or their business engaged in transactions with the Roth IRA Corporation by providing services to clients through the Roth IRA Corporation. Value was transferred from Taxpayers or their business to the Roth IRA Corporation comparable to a contribution to the Roth IRA whenever the Roth IRA Corporation received payment from clients as a result of the services provided by Taxpayers.  

The bottom line is that the IRS naturally wants to collect taxes on services you provide.  And an IRA is intended to be used for arms-length investments, not to derive a current benefit.  To the extent you change either of those basic premises you may get into trouble with the IRS if they review the transaction. Having said this, does it mean that you cannot own a business in your IRA?  No, it does not mean that at all.  It means that you cannot provide personal services to that IRA-owned business.  In other words, the business must be an investment only.  You may of course invest in a business which you know someone else is starting, assuming the person starting the business is not otherwise a disqualified person.  Also, as mentioned above, you will want to investigate the tax structure of the business to see if it will subject your IRA to UBIT, and if it does, whether the after-tax profits you expect your IRA to receive are higher than other investments your IRA might make.   If your need is for current income, some people consider doing what the IRS refers to as a ROBS arrangement (Rollover for Business Startups).  

The IRS has concerns about this set up, and you may find tons of information on the internet about these types of arrangements.  This typically involves 1) setting up a brand new C corporation, 2) appointing yourself as director and President of that corporation, 3) adopting a 401(k) plan for the corporation with you as trustee of the plan, 4) rolling your IRA into the 401(k) plan, and 5) as trustee of the 401(k) plan investing in all the shares of the corporate as employer securities.  The set up is fairly expensive, but there are many firms who offer to set up a ROBS arrangement on your behalf who swear by its legitimacy.  If you decide to go that route then by all means make sure whoever you go to for the plan is aware of the concern and satisfy yourself that they have met those concerns.  

I am aware that this information probably conflicts with a lot of the information out there on the world wide web, where anything is possible and you can avoid all these pesky prohibited transaction rules by simply starting an IRA-owned LLC, or what is sometimes referred to as a checkbook control IRA. Unfortunately, the prohibited transaction rules still apply in almost all cases, and so if you cannot do it directly in your IRA then you cannot do it simply by imposing an LLC in between the IRA and the transaction.   I hope that somewhat answers your question, although I realize that such a response often creates more questions than it does give answers.  Good luck with your investments, and if you need assistance with a self-directed IRA (emphasis on the self-directed part) please feel free to let us know.

Self-Directed IRA & Qualified Plan Information, Self-Directed Roth IRA, Self-Directed Traditional IRAs

How do I Calculate Required Minimum Distributions (RMD)s and What is the Penalty for not taking the RMD?

Question:  I have been delinquent in requesting the RMD’s for the years since my father’s death on December 19, 2006.  At that time I was 49 years of age.

 Now it is at the 5 year mark and I don’t wish to incur a 50% penalty.  Attached is the signed document authorizing withdrawal as RMD for these years MINUS 2009, as the RMD was not required in that year.  It is absolutely my intent to use this email to provide additional instruction and provide authorization for this purpose.

 I’ve copied my attorney on this email, as he is also doing my taxes this year and needs to know immediately the withdrawal amount and information for tax purposes.  Please feel free to reply to both of us with all correspondence on this request.

 Please note that I’ve not completed the withdrawal amount; I request that you/Quest calculate this based on my age at the time of my father’s death and withdraw the appropriate amount.  I acknowledge that time is very short, as 2010 taxes are due this coming Friday.  I’m traveling on business this week, but can be available by phone and email to resolve this, this week. 

Answer:  I would be happy to help as far as I can, but there are limits on what I can do at this point.  The way the rules work for Required Minimum Distributions (RMDs) from IRAs inherited from non-spouses is that you must take distributions either based on your life expectancy beginning in the year following your father’s death or you can wait as long as 5 years and then take the entire amount out.  As you know, if you fail to take the RMD there is a 50% penalty on the amount you should have taken.  To calculate the amount to be taken requires you to take the balance in the account at the end of the prior year and divide it by a factor which is initially retrieved from IRS Publication 590, Appendix C, Table I, and in subsequent years is reduced by one.  In your case, since you turned age 50 in 2007, your initial factor would be 34.2 (see page 88 of IRS Publication 590 for 2010 tax returns).  So your factors for the years 2007 through 2011 would be as follows:

 2007 – 34.2

2008 – 33.2

2009 – 32.2

2010 – 31.2

2011 – 30.2

 An example of how you make the calculation is as follows, assuming that the balance in your IRA was $100,000 at the end of the prior year each year:  $100,000 /34.2 = $2,923.98 for 2007, $100,000/33.2 = $3,012.05 for 2008, etc.

 You are correct when you state that no RMDs were required for 2009, but the factor still was reduced by one in that year, as it is in all years.  Unfortunately, I do not have all the information needed to calculate your RMDs.  For 2007, you would need to provide us with a statement dated 12/31/2006 from your prior custodian, since you didn’t open the account until March, 2007.  In subsequent years, you will need to provide me with a Fair Market Value form as of 12/31 each year signed by you and a qualified third party appraiser so that I can adjust the value of your account each year before making any calculations.  In reviewing your file I see no updates to the value since the initial investment of $100,000.  I have attached the needed form and the instructions.

 When you do arrive at a figure you will need to submit a revised and legible Distribution form.  I cannot complete the amount for you, and the form must be legible because we have to transmit it to our central processing facility.  Unfortunately, the one you submitted was not legible.  I’m not sure why, perhaps the ink was not a color that scanned well or something.

 I hope that helps get you started.  Fortunately, this year the tax filing deadline is April 17, not April 15.  Good luck, and let me know if you have any further questions.

Self-Directed IRA & Qualified Plan Information, Self-Directed Traditional IRAs

Valuation for 1099R Purposes

Question: “I converted a traditional IRA to a Roth IRA in which I have several non-traditional / alternative investments (REITs, private placement, etc) which have liquidity and marketing restrictions thereby limiting their current valuation. How / where do the FMVs I am getting from a outside valuation specialist get entered on Federal taxes? I received a 1099-R from the custodian for the distribution from the Traditional IRA to the Roth IRA and it lists the full initial purchase value of these alternative assets under gross distribution and checks the box “taxable amount not determined” but then lists the same gross distribution amount as the taxable amount. Would the appraised FMV instead get entered as the taxable amount and attach the valuation statement to the tax form? Thanks for any insights you can offer.”

Answer: All distributions should be reported at the fair market value at the time of distribution.  This includes conversions of assets in a traditional IRA to a Roth IRA.  Therefore, normally your outside valuation would have been used to adjust the value of your assets prior to the conversion, which should have resulted in a number on your 1099R that matched the value of your assets as of the date of the conversion.  This is the same concept as adjusting the value of a stock or mutual fund to reflect the current value prior to conversion.  If the number on your 1099R is the full historical value instead, you may want to check with your custodian to see why they did not adjust the value of your assets prior to the conversion.  It is possible that your custodian will need to file a corrected 1099R showing the reduced value according to your third party appraisal.  You should realize that valuations of non-traditional assets in self-directed IRAs are often difficult to assess, and so different custodians may have widely varied policies regarding what they accept to adjust valuations prior to distribution or conversion. 

Good luck, and let me know if I can answer any more questions.

Self-Directed IRA & Qualified Plan Information, Self-Directed Roth IRA, Self-Directed Traditional IRAs

Tax Treatment of Flipping Promissory Notes in an IRA

Question: The debate continues:)  I actually have an account with another SDIRA company in FL. I use their company website as a resource but, it does not seem to give much information regarding the the tax treatment of Flipping notes in an IRA:  I am networking with a lot of younger investors and there seems to be a lot of questions and little information.  When we ask our tax professionals they “look at us like-you can’t do that.”  Most tax and legal professionals do not seem to understand much, if anything about Self Directed Investing.  So here is a follow up to the conversation if you can help us clear this up.  Just to put this into context, the original question was, “what would you do with $50k in a Self Directed IRA.”  I would say the average reader is in their late 30’s. 

Investor: I find it very hard to believe that flipping notes could be considered appreciably different than transacting stocks quickly.

Tax Professional: I don’t think we are saying that they are “appreciably” different, just that the two investment options (stocks on public market vs. private market notes) are different in other means. I have no idea which is the correct and legal answer, but in my opinion, I see how one can argue that notes sold/transfered from flipping which deal with a buyer and a seller who negotiate between themselves and have contact between them in a private manner is functionally different than flipping stocks in a public market where the buyer and seller never negotiate and never have contact. To add to the confusion, what if you bought and immediately sold an actual business inside your 401k/IRA. Would UBIT apply?

Investor: Flipping stocks doesn’t just magically occur either. A buyer and a seller still have to agree on a price for a transaction to occur. There may be fewer things to negotiate in these transactions, but I don’t see how they are really different from a “business standpoint.” What about trading something on the pink sheets? Is that somehow different still?

Tax Professional: I almost always agree with you, but will have to agree to disagree on this. Regardless of who is right, as no final evidence has been discovered clearly (and may never be clear), we just have two different thoughts on this. I see a difference in stocks vs. flipping notes as explained, you do not as explained. No problem.  Not only that, when they discuss the fact that the IRA can use debt leverage on a rehab, it makes no mention of UDFI which also triggers UBIT (unless debt is paid off 365 days before sale). As I have mentioned in the past, unfortunately, find details are often missing from TPA’s such as the one you are dealing with.

It seems like there is a lot of mis information and confusion out there regarding the subject.  I certainly appreciate your thoughts, time and any information you can cite to help us clear this up.  Please note that am not asking for advice-just information on where we can find facts in regards to this subject. 

Quincy’s Answer: I think you’re trying to over analyze this and impose rationality and reason on the US government, which is of course quite impossible.  Step back and ask yourself one question while forgetting entirely about the IRA aspect of it – would note flipping be considered a trade or business if you did it personally?  If the answer is yes, then it is, by definition, a trade or business within the IRA as well, and it will generate UBIT, assuming it is “regularly carried on.”  If the answer is no, then it should not generate UBIT.  Whether something else like day trading stocks is or isn’t a trade or business is irrelevant.  You are focusing on the IRA aspect of it when you should be focusing on whether or not it is a trade or business.  In general terms, anything that you buy as “inventory” for resale to the public is going to be considered a trade or business, whether it is real estate, notes, widgets or anything else.  Unfortunately, the standard of when you cross the line from being an investor to being in a trade or business is fuzzy at best and depends on many factors.  Oh well, that’s the world we live in.

 I have attached my short paper on UBIT.  You may also find more information on UBIT in IRS Publication 598.  The Internal Revenue Code sections dealing with UBIT are 26 USC 511-514.  I hope that helps some.  Good luck!

Response: Thank you for taking the time to help me out with this.  It seems to me that it is best to error on the side of caution with this since the penalties can be so steep.  I see a lot of guys buying and flipping homes in IRA’s.  These guys are considered “Dealers” because they also buy and flip properties outside of IRA’s.  I would say since these are bought with the intention of immediately offering them for sale to the public that they would then be subject to UBIT.  The same would hold tru for a note that is immediately flipped.  When you say “regulatory carried on,” do you mean this is something you do inside the IRA X amount of times per year, X amount of times during the life if the IRA? 

Quincy’s Answer to Reponse: Review Page 3 of IRS Publication 598, which states:  “Business activities of an exempt organization ordinarily are considered regularly carried on if they show a frequency and continuity, and are pursued in a manner similar to comparable commercial activities of nonexempt organizations.”  An example is given in the publication.  I agree that intent is very important.  I’m not sure that an occasional flip in an IRA among many other investments will cause UBIT, but certainly if that’s all that the IRA invests in and the IRA owner also flips properties outside of his or her IRA that would weigh heavily in the consideration of whether the IRA had dealer income.  While IRAs are very rarely audited, it is always important to give the IRS what they are due, because they have what it takes to take what you have. 

One thing I would caution you about is not to confuse the payment of UBIT with the penalties associated with prohibited transactions.  It is perfectly legal to make investments which subject your IRA to taxation, but if you do a prohibited transaction it blows up your entire IRA and you and others may owe excise taxes and penalties as well.  The two subjects are completely separate, but many people, even educated ones, get them mixed together in their minds.

Self-Directed IRA & Qualified Plan Information, Self-Directed Roth IRA, Self-Directed Traditional IRAs

Temporary relief for IRA owners who entered broker indemnification agreements

Quincy Says: As I predicted long ago, the IRS will not invalidate millions of IRAs because of the indemnification and cross-collateralization clauses in a typical brokerage style of IRA.  In at least some brokerage accounts, the account agreement calls for the assets of the IRA to indemnify any other losses from individual accounts at that brokerage and vice versa.  This of course has never been a problem with self-directed IRAs because we have no cross-indemnification clause.  However, there were people who then used this to scare people into paying them thousands of dollars to apply for an individual prohibited transaction exemption.  I maintained that if there was a problem with brokerage IRAs because of these clauses the solution would be a global solution in the form of a class prohibited transaction exemption, not an individual exemption for each IRA. 

See below.  Now the IRS has granted temporary relief from the scary scenario of a disqualified IRA simply for signing the typical brokerage account agreement in anticipation of a class exemption request expected to be submitted to the Department of Labor. 

Make no mistake, this is big news in the IRA world.  It is worthy of an article in any newsletter that is sent out, etc.  While not a permanent solution yet, the light can be seen at the end of the tunnel and the immediate threat has been removed.

If you do not understand the background of this announcement and need any clarification, please feel free to contact me at Quincy@questira.com. Have a great day!

Temporary relief for IRA owners who entered broker indemnification agreements

Ann. 2011-81, 2011-52 IRB

IRS has provided temporary relief for IRAs where the owner has signed an indemnification agreement with a broker or other financial institution, or granted certain security interests in other accounts held by the institution, that may result in a prohibited loan transaction under Code Sec. 4975.

Background. If an IRA engages in a prohibited transaction under Code Sec. 4975, it ceases to be considered an IRA and loses its tax-exempt status. (Code Sec. 408(e)(2)) The direct or indirect lending of money, or other extension of credit, between a plan and a disqualified person is a prohibited transaction. (Code Sec. 4975(c)(1)(B))

For these purposes, a “plan” includes an IRA. (Code Sec. 4975(e)(1)(B)) The term “fiduciary” includes any person who exercises any discretionary authority or discretionary control over management of a plan, or who exercises any authority or control over management or disposition of plan assets. (Code Sec. 4975(e)(3)) A “disqualified person,” includes a fiduciary, and members of the family of a fiduciary. (Code Sec. 4975(e)(2))

Department of Labor (DOL) Prohibited Transaction Exemption 80-26– is a class exemption that permits interest-free loans and extensions of credit to a plan from a party in interest in instances in which the plan faces a temporary cash shortage. If certain requirements are met, these loans won’t result in a prohibited transaction.

Previous guidance. In ERISA Op Letter No 2011-09A, 2011, the Department of Labor’s (DOL’s) Employee Benefits Security Administration (EBSA) determined that where a broker required an indemnification agreement in order for an IRA owner to open a futures trading account in his IRA, Prohibited Transaction Exemption 80-26– was not available to save the agreement from being a prohibited loan under Code Sec. 4975(c)(1)(B).

Notably, EBSA found that granting the broker a security interest in the assets of the IRA owner’s personal accounts to cover the IRA’s debts to the broker would be akin to the IRA owner guaranteeing those debts. Thus, DOL concluded that the grant of the security interest in non-IRA assets would amount to a prohibited extension of credit under Code Sec. 4975(c)(1)(B) (see article in Federal Taxes Weekly Alert 11/19/2009).

Similarly, in ERISA Op Letter No 2009-03A, 2009, EBSA issued an earlier advisory opinion to this same requester holding that an individual’s grant to a brokerage firm of a security interest in the assets of the individual’s non-IRA accounts as a requirement for the individual’s establishment of an IRA with the broker would be a prohibited loan.

Now, EBSA has advised IRS that it is considering further action regarding these agreements (collectively known as cross-collateralization agreements), including consideration of a class exemption request expected to be submitted to EBSA.

Temporary relief. In response to these developments and pending further action by EBSA, IRS says it will determine the tax consequences relating to an IRA without taking into account the consequences that might otherwise result from a Code Sec. 4975 prohibited transaction from entering into any indemnification agreement, or any cross-collateralization agreement, similar to the agreements described in ERISA Op Letter No 2011-09A, 2011 and ERISA Op Letter No 2009-03A, 2009.

This relief is available only if there has been no execution or other enforcement under the agreement against the assets of an IRA account of the individual granting the security interest or entering into the cross-collateralization agreement. IRS advises that no inference with respect to the application of any Code section other than Code Sec. 4975 should be drawn from this announcement.

Self-Directed IRA & Qualified Plan Information, Self-Directed Roth IRA, Self-Directed Traditional IRAs

Quest IRA, Inc. in 2012 – What to Watch For?

2011 was a great year that allowed Quest IRA, Inc. to be created and just like it has been since we opened the office in 2003, we had another great growth year. But the growth we have experienced over the past 9 years will pale in comparison to the exponential growth we will see in 2012!

 There are many changes that are coming to Quest IRA for our clients, prospects and business partners that will allows Quest IRA to be the leader in timely opening, processing, and funding transactions while still be the national leader in localized education for each community. The website, education classes, networking events, webinars, and many other aspects Quest IRA has spent hundreds of thousand of dollars improving for you, the client.

Another BIG change to Quest IRA, Inc. will be that we will be attending many more seminars, workshops, association and organization meetings nationally and not just throughout Texas. Since we already have a office in Michigan with another office expected to be open in Seattle, WA by the end of 2012 you can expect Quest IRA to show up in your city or town very soon.

Should you have an event you would like Quest IRA to attend, sponsor, and/or present information on self-directed IRAs, please contact Ryan Kimura (ryan@questira.com or 800.320.5950 x 3584)