Tag Archives: Publication 590

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

Can you write off large investment loses in an IRA?

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Question: I made a large (nearly 6 figure) investment in my self directed IRA account in an oil & gas investment (direct ownership WI in 3 oil wells). The entire investment is gone as the principals behind it scammed everybody & offshored most of the funds. Can you claim a loss on a IRA account investment gone bad?

Answer: I am sorry you experienced a loss in your IRA but thank you for your inquiry.  To answer your question, you may be able to claim some of your loss on your personal tax return in this case, but there are significant limitations.  The rules are discussed on page 41 of IRS Publication 590 for 2010 in the paragraph entitled “Recognizing Losses on Traditional IRA Investments” which you can download from www.irs.gov.  To summarize briefly the rule, you may deduct the difference between the total amount of your remaining after-tax contributions in the account (your basis) and the amount withdrawn from your traditional IRAs as a miscellaneous itemized deduction subject to the 2% of adjusted gross income floor on your Schedule A.  In other words, if the amount of non-deductible contributions in all of your IRAs was $10,000 and you closed all of your traditional IRAs down with zero money coming back to you, you would be able to claim the $10,000 on your Schedule A to the extent it exceeds 2% of your adjusted gross income for the year.  Any such deduction is not counted when calculating the Alternative Minimum Tax, so if you are subject to that tax it may not do you much good.  Note that it is only your unrecovered basis (after-tax contributions) in your IRAs that you can base the loss on, not the actual amount you lost in the deal.  If you had no unrecovered basis in your traditional IRAs, you cannot take the loss.  The rationale for this seemingly harsh rule is simple – if you never paid taxes on the money you lost you cannot deduct the loss from your taxable income.  Also, as noted above, the only way you can take such a loss is when all of the amounts in all of your traditional IRA accounts have been distributed to you and the total distributions are less than your unrecovered basis in the account.

As you can see from the answer to your question, the rules are a bit complex, so you will absolutely want to work with your CPA or other tax advisor to see the tax effect in your individual situation.  Although I can give you the general rule, I cannot give you tax advice.

In an unrelated issue, I wanted to make you aware that if you purchase a working interest in an oil and gas well (as opposed to a royalty interest) in your IRA in the future, any income may be subject to unrelated business income tax (UBIT), and your IRA would need to file IRS Form 990T.  While this does not mean that you should not make the investment necessarily, you should understand the tax implications for your IRA prior to entering into this type of investment.  A careful analysis may reveal that such investments are better made outside of the IRA, since there may be significant tax deductions available to you.  You may find more information on UBIT from IRS Publication 598.

If I can assist you in any other way, please let me know.  Have a great day!

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?

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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 Roth IRA, Self-Directed Traditional IRAs

Can I or When Can I Take Tax Free Penalty Free Distributions From My Converted Traditional to Roth IRA?

Question: My 35 year old son is converting $160,000 form a tradtitiional IRA to a Roth. Assuming a $50,000 tax bite, and assuming he pays the $50,000 with outside money so he converts the whole $160,000, can the $160,000 be accessed penalty free immediately because it becomes the basis and the tax has been paid?

Answer: Unfortunately not.  Assuming the conversion represents the only Roth money your son has, the conversion amount cannot be removed within 5 tax years without paying the premature distribution penalty of 10%.  The ordering rules for distributions from a Roth IRA are 1) contributions 2) conversions, and 3) profits.  So if your son has made contributions to a Roth IRA he can withdraw those at any time without penalty.  Beyond the contributions, conversions can be removed only after 5 years without penalty, unless he meets one of the other exceptions to the penalty rules (most commonly 59 ½).  Profits can only be withdrawn tax and penalty free as qualified distributions, meaning your son has had a Roth IRA somewhere for at least 5 years and meets one of four other tests (again, most commonly 59 1/2).  You may find the description of the ordering rules beginning on page 66 of IRS Publication 590, which you can review and download from the IRS at www.irs.gov.  Good luck with your investing!

Follow Up Question: Thank you for a quick response. I did go to the irs.gov. site. From the website and your email, this is what I understand. Please forgive any repetition. I have received very different answers from seminars and regional offices, so your  expert help is hugely valuable! I want my son to be clear and comfortable as he is concerned about accessible, penalty free rainy day money prior to age 59 1/2. I also want to be able to deliver correct information to other investors. Is this correct: if my son converts $160k of traditional IRA money and pays the taxes out of pocket, in 5 tax years he can access the $160k without penalty at approximately age 41?  He currently has $15k in an existing Roth he has had for 7 years. The contribution portion of the $15k can be taken today penalty free and the profit portion will be penalized if accessed prior to age 591/2. Correct? Any profit is subject to regular Roth rules and those conditions are clearly defined and I understand them. I will not continue to bother you, but knowledgeable experts are hard to find.

Follow Up Answer: Yes, according to the paragraphs describing the additional tax on distributions beginning on page 64 of the 2009 IRS Publication 590, your son must pay the 10% penalty for distributions of his conversion contribution from his Roth IRA made within 5 tax years of the conversion – in other words, if he converts in 2010 and takes a distribution before January 1, 2015 he will be subject to this penalty to the extent that this distribution exceeds his regular contributions to his Roth IRAs.  To figure the taxable part of any non-qualified distribution (as opposed to the penalty) use the Worksheet 2-3 on page 67 of Publication 590.  You will see from that worksheet that the amount of his regular Roth IRA contributions are not includible in income (line 12 subtracts these amounts out) and are therefore not subject to the 10% premature distribution penalty either (see the paragraph entitled Other Early Distributions  at the top of page 66, which indicates “you must pay the 10% additional tax on the taxable part of any distributions that are not qualified distributions”).

 
Having said this, as you know from the disclaimer at the bottom of my prior emails you are not able to rely on this email as tax advice, so you should absolutely contact your own tax advisor to verify the implications for your individual tax situation.  I would be curious to learn what you have heard from seminars and regional offices if you care to share it.  I know there is a lot of confusion out there on this topic, even by some professionals such as CPAs.  Perhaps the most confusing thing is the fact that there are 2 different 5 year clocks when it comes to Roth IRAs, one being the 5 years necessary for a distribution to be a qualified distribution and the other being the 5 year clock for conversion contributions before you can escape the 10% premature distribution penalty, as we have been discussing here.  Anyway, thank you for your question.  Let me know if I can assist you further. Have a great day!