Tag Archives: Prohibited Transaction

Self-Directed 401(k), Self-Directed IRA & Qualified Plan Information, Self-Directed Roth IRA, Self-Directed Traditional IRAs

Can I loan money to a company I own? And what about Rollover for Business Startup (ROBS)?

Question: A husband and wife both have a Roth IRA & husband has a 401(k). He plans to leave his corporate job & start his own business. If Roth & 401(k) funds are transferred to self-directed IRA, can husband & wife use IRA funds to loan start up money to husband’s new business, as along as they pay interest on the loan to IRA? Is this an acceptable or prohibited transaction and how should the loan be structured? If prohibited, is therea way to structure the loan so as to be an acceptable transaction?

Answer: Thank you for your inquiry.  The short answer to your question is no, neither the Roth IRAs nor your 401(k) which is rolled into an IRA can loan start up money for your new business venture.  There is a list of persons with whom the IRA is not permitted to do business, called disqualified persons.  A business owned entirely by you would be a disqualified person, and therefore the proposed loan would be a violation of Internal Revenue Code Section 4975(c)(1)(B), which says that the direct or indirect “lending of money or other extension of credit between a plan and a disqualified person” is a prohibited transaction.

I have heard of people using their 401(k) plans to start a new business by using what the IRS terms a ROBS arrangement (Rollovers for Business Startups), but the IRS clearly does not like these arrangements and believes that the way many of them operate result in a prohibited transaction.  I have attached some information in this regard.  If you do want to go down this path, be sure that whoever you choose is very familiar with the IRS position and that you feel they have adequately dealt with the issues.  Certainly there are many companies out there offering the ROBS set up.  It is fairly expensive to do, though, since it involves setting up a C corporation, having the C corporation adopt a 401(k) plan, rolling the IRA or former 401(k) into the 401(k) for the new company, and purchasing shares of the company as employer securities.  You cannot roll your Roth IRAs into the 401(k) plan, only traditional IRAs.

Finally, you should be aware that Quest IRA, Inc. cannot give you tax, legal or investment advice, and so we could never advise you on how to structure a particular investment or provide you with the forms to do so.  Good luck with your new business venture.  Have a great day!

IRS ROBS Paper

IRS ROBS Analysis

IRS ROBS Fail Paper

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

Can we partner with family members on an Oil & Gas project??

Leave a comment

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

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

Any Loops Holes Around Prohibited Transactions of Real Estate for Personal Use in an IRA?

Leave a comment

Question: I am looking for a custodian for a client who wants to make a real estate investment in his IRA.  Quest IRA, Inc. was referred to me by my accountant.  I have a couple questions about the limitations of use of the property by the owner.

Specifically, the accountant mentioned there are some tricky provisions about using the investment for personal use, but it would appear from the articles on the Quest IRA, Inc. site that the property cannot be used at all by the owner, as a vacation home for example.  Is that the bottom line on the issue or are there a few loopholes with the provision?

Answer: Thank you for your inquiry.  Unfortunately, no, there are no loop holes to the restrictions against personal use.  Statutorily, Internal Revenue Code Section 4975 contains the prohibited transaction rules, which prevent, among other things, the direct or indirect:

(c)(1)(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;

(c)(1)(C) furnishing of goods, services, or facilities between a plan and a disqualified person;

(c)(1)(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;

(c)(1)(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account;

Your client, as the owner of the account, is considered a fiduciary and a disqualified person, and of course the IRA is included within the definition of a plan under the statute.  Your client’s spouse, lineal ancestors (Mom, Dad, etc.) and lineal descendants (children, grandchildren, etc.) and their spouses, plus any corporation, partnership, trust or estate in which any of the above owns or controls 50% or more of are all disqualified persons and cannot enter into a transaction with or benefit from a transaction with your client’s IRA.

The prohibited transaction rules are intended to make sure that all transactions within the IRA are on an arms-length basis and that no disqualified person directly or indirectly benefits from the transaction except, of course the IRA owner when he or she takes a distribution from the IRA.

If we can assist you or your clients, please let me know.  Have a great day!

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

Would it be a prohibited transaction if I only owned 25% of the entity???

Leave a comment

Question:

I’ve just finished reading a 102 page pdf document which contained articles authored by you concerning Self-Directed IRAs.

I’m confused as to whether or not my particular circumstance would fall under the prohibited transaction category.

I’m employed by XYZ Company, a manager of commercial real estate assets.

XYZ Holdings is under contract to acquire a 50 unit student housing asset in Austin, TX for $4.65 million.  With closing costs and renovation costs, the total costs of the transaction are $5.0 million.  We are financing the acquisition with a $3.75 million loan from KeyBank, and raising the remaining $1.25 million through a friends and family private placement equity raise.

The loan from ABC Bank is an 18 month bridge loan which is full recourse to me and my partner.  However, once we implement some improvements to the asset and increase the net cash flow generated by the property, we will refinance into a non-recourse permanent loan.

As compensation for finding this transaction and sponsoring the deal, my partner and I will receive 25% of the ownership in the entity which owns the asset.  The equity investors who invest the $1.25 million of equity will receive the remaining 75% of ownership in the entity which owns the asset.

XYZ Management Company will manage the asset at some point in the future, but not initially.  I’m technically an employee of XYZ Management Company, but not an owner of XYZ Management Company.

I would like to invest an existing traditional IRA of mine, which has a balance of approximately $160,000, as a portion of the $1.25 million of required equity capital, thus giving me a limited partner position in the ownership entity, in addition to my sponsorship promote equity position.

Is the proposed IRA investment acceptable, or would this be considered a prohibited transaction?

Thank you for your assistance on this issue.

Answer:

Unfortunately, this would be a prohibited transaction.  You cannot use your IRA for your personal benefit now, and clearly having your IRA invest in a  project that you receive a 25% personal interest in would violate the rules.  The goal of the prohibited transaction rules overall is to make sure that transactions in your IRA are on an arms-length basis.  We would love to assist you with your self-directed IRA needs if you identify an investment that fits within the parameters of the law.  Good luck with your project, and have a great day!

(Quincy’s Most Frequently Read Articles)

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

Questions about Real Estate in a self-directed IRA and about paying or receiving management fees?

Leave a comment

Question:

I have done a pretty good amount of learning about self-directed IRA’s and investing locally in real estate and have talked extensively with Equity Trust and Pensco.  Just learned about your company through a Sacramento real estate investing club and perused a powerpoint you put together.

I had 2 questions for you:

1) I have heard mixed things about whether or not you can pay yourself a management fee from property you purchased with your own self-directed ira funds.  Do you have some clarification as to the perception of the IRS on this issue?  I’ve heard that you can get a letter from a local respected industry professional to verify the amount but I’ve also read this could be perceived as commingling.  (I am aware of the strict rules of keeping all funds separate in all other regards).

2) How does your company compare to Equity Trust with regard to monthly and other fees?

Answer:

Thank you for your inquiry.  The answer to your first question is no, you absolutely may not take any kind of management fees for property owned by your IRA.  When people tell you that, they are misunderstanding Internal Revenue Code Section 4975(d)(2), which is often referred to as the “reasonable compensation exception.”  They may also be looking at IRS Publication 590, which in attempting to explain in plain English the rules makes the statement that taking unreasonable compensation for managing an IRA is a prohibited transaction.  This statement is simply a summary of 4975(d)(2), which many people misinterpret.  What people conveniently tend to ignore is that you have to read the whole statute to understand the rules, and 4975(d) starts out with the phrase “except as provided in subsection (f)(6)…”  Unfortunately, 4975(f)(6) voids the reasonable compensation exception for IRA beneficiaries, which means you are not able to take advantage of the reasonable compensation exception for your own IRA property.  Some people still want to cling to this idea anyway, but the Treasury Regulations for Section 4975 explicitly state “However, section 4975(d)(2) does not contain an exemption for acts described in section 4975(c)(1)(E) (relating to fiduciaries dealing with the income or assets of plans in their own interest or for their own account) or acts described in section 4975(c)(1)(F) (relating to fiduciaries receiving consideration for their own personal account from any party dealing with a plan in connection with a transaction involving the income or assets of the plan).  Such acts are separate transactions not described in section 4975(d)(2).”  Sections 4975(c)(1)(E)-(F) make it a prohibited transaction for a fiduciary to directly or indirectly benefit from the income or assets of the IRA, and you are a fiduciary of your self-directed IRA.  The final result of this legal somersaulting is that the IRA owner cannot be compensated.  Anyone advising you otherwise does not fully comprehend the rules.

The details of the above analysis and many other things you need to know about self-directed IRAs may be found in the book that I co-wrote with Dyches Boddiford and George Yeiter entitled “Real Estate Investment Using Self-Directed IRAs and Other Retirement Plans.”  You may want to obtain a copy of the book for your future reference. Contact Ryan Kimura (Ryan@QuestIRA.com) for a copy. It retails for $19.99 including shipping and handling.

With regards to your second question, I refer you to our fee schedule, which is included in the EZ IRA Starter kit attached.  In some instances we would be cheaper than Equity Trust Co. and in others we would be more expensive.  However, we feel that our knowledge base and more personal service cannot be beat at any price.

Quest IRA, Inc. Application with Fee Schedule

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

Has my Self-Directed IRA been “invalidated”?

Leave a comment

Question:

Dear Mr. Long,

You are probably going to receive quite a few emails on this subject today.  An “IRA Expert” Tax Attorney (Tim Berry) gave a webinar last night stating that most IRAs (99%) have engaged in a “prohibited transaction” causing them to lose their tax-deferred IRS status and be deemed “fully distributed!”

Naturally, this news was quite disconcerting.  The “prohibited transaction” being an extension of credit between the IRA and a “disqualified person.”  This sentence in the IRA Application is the supposed culprit:

“I agree to release, indemnify, defend and hold the Administrator and/or Custodian harmless from any claims, including, but not limited to, actions, liabilities, losses, penalties, fines and/or third party claims. ansing out of my account and/or in connection with any action taken in reliance upon my written instructions, designations and representations, or in the exercise of any right. power or duty of Custodian and/or Administrator, its agents or assigns.”

By signing the application containing the word “indemnify,” it does seem that I have extended credit on my IRA to a disqualified person, ie: Quest IRA, Inc. as custodian.  Apparently, there was a ruling from the Department Of Labor dated October 2009 clarifying that this is considered a “personal guarantee.”

As an attorney, I hope you are aware of this issue.  The status of my IRA is of great concern and I need to have this issue clarified.  I realize that the attorney giving the webinar was trying to scare us and it worked!  For $1,995 he will go to the IRS, request clemency and get clients’ IRA accounts “re-validated.”  Seems like a bargain considering the taxes and penaties can be up to 60% of the account’s value.  He also stated that the custodian firms were liable for bringing accounts back into compliance.

Please let me know your thoughts on this as soon as possible.  I look forward to hearing from another attorney’s point of view.

Answer:

Thank you for your email.  I understand your concern, but the ruling that is the basis of these claims is NOT the same facts as we have here at Entrust.  If you read the full sentence below, you will clearly see that you are only indemnifying the Administrator against any of your own written instructions, etc.  In other words, all the sentence you refer to says is that if you instruct us to take some action then you cannot turn around and blame us for following your instructions.  I have attached the actual ruling which I believe forms the basis of the statements by Mr. Berry and others.  Read the clause being referred to as the problem.  It has to do with granting a security interest in all accounts held by that individual at the brokerage firm.  Specifically, the language reads:

“All securities and other property now or hereafter held, carried or maintained by us in our possession or control, for any purpose, in or for the benefit of any of your Accounts, now or hereafter opened, including any Account in which you may have an interest, shall be subject to a continuing first lien and first priority perfected security interest in favor of us for the discharge of all indebtedness and your obligations to us, and are to be held by us as security for the payment of any liability or indebtedness of yours to us in any of your accounts.

You authorize us the right to transfer securities and other property so held by us from or to any other of your Accounts held by us, whenever, in our judgment, we consider such transfer necessary for our protection… .”

As you can see, the situation described in the Opinion Letter is not even close to the situation here at Entrust.  Unlike in the brokerage application, you are not granting a security interest in your account to us or extending your credit in any way to your IRA.  Since Quest IRA, Inc. does not handle any accounts other than IRAs, and since the language in our application clearly does not grant a security interest in your IRA for payment of any liability or indebtedness of yours, the ruling should not apply to your IRA at Entrust.

Other facts which you should be aware of when considering Mr. Berry’s offer include the fact that Advisory Opinion letters from the Department of Labor only apply to the person asking for the ruling.  It is not legal precedent, but rather an interpretation based on the particular facts represented to the Department of Labor for that situation.

Finally, if you step back and think logically about what is being represented by Mr. Berry and others, do you honestly think that the lobbyists for the retirement industry and the politicians would allow the IRS to declare millions of IRAs to be invalidated?  This person is attempting to sell you a “service” that is not necessary, at least in your situation.  If anything, the solution to the problem of the language would be a company-wide one for each custodian, not a case by case solicitation of a prohibited transaction exemption.  It is interesting that all of a sudden Mr. Berry and others are attempting to be so helpful when the ruling has been out since October of 2009.  Have you heard news stories of the IRS sweeping in and declaring millions of IRAs invalid in the last year and a half?  I haven’t either.

Link: http://www.dol.gov/ebsa/regs/aos/ao2009-03a.html

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

Prohibited Transaction Question

Leave a comment

Question:

I have a house I directly own outside of an IRA, and I want to sell it to my self directed IRA. I understand that I am a prohibited party and can’t do this directly. HOWEVER, what if I sell it to my mother in law for, say, 30 days, and then she turns around and sells it to my IRA? Is this permissible as somewhat akin to a wash sale, in which I have technically removed myself from the transaction and I’m not running afoul of any IRS rules? Or is the IRS going to view this as a sham/straw transaction and get me in hot water?”

Quincy’s Answer:

Mr. Lambeth, thank you for your inquiry below.  You are correct when you state that you are a prohibited party (disqualified person) as to your IRA and therefore cannot sell property to it which you now own.  Unfortunately, the prohibited transaction rules include both direct and indirect actions, which in this case would mean that to sell it to a non-disqualified third party for 30 days who would agree to sell it back to your IRA would almost certainly be viewed as a prohibited transaction and would definitely, as you say, get you in hot water with the IRS if they discovered it. 

 Also, I would caution you about involving your mother-in-law in transactions with your IRA.  Although she is not a disqualified person as to your IRA (although you ARE a disqualified person as to her IRA since you are married to her daughter), she is a person in whom you have an interest which may affect your best judgment as a fiduciary for your IRA.  Therefore, directing your IRA to enter into a transaction with her could, under certain circumstances, be deemed to be an indirect personal benefit to you and therefore a prohibited transaction.