A recent Wall Street Journal article outlined the case of
two Colorado men whose self-directed IRA investments were deemed unlawful by
the IRS after they coupled a personal line of credit with an LLC they had created
with their IRAs to buy a business. The men were assessed $45,000 in penalties
and approximately $225,000 in taxes each.
According
to a U.S. Tax Court decision on May 9th cited in the WSJ piece:
“[The] two men each used
$309,000 of assets from their respective IRAs in August 2001 to buy two 50%
shares in a corporation. The corporation then paid $1.1 million to buy Abbot
Fire & Safety, a provider of fire alarms, sprinkler systems and related
equipment. The purchase price consisted of $400,000 of the taxpayers' IRA
assets, a bank loan and other funds, including a $200,000 promissory note
personally guaranteed by the two men. The note was secured by their homes.”
The
tax court ruled that the personally guaranteed notes constituted a prohibited
transaction. The notes guaranteed by the men were considered an “indirect
extension of credit,” thus forcing a termination of the IRAs when the men
bought the business. Therefore, the IRS sought to collect taxes on the
distribution of those IRA funds.
Because
a statute of limitations disallowed the IRS from collecting taxes when the
business began in 2001, the court ruled it could only seek taxes from when the
business dissolved in 2006. Those capital gains taxes amounted to $224,000 and
$243,000 for the respective men.
Although
this incident was unfortunate for the two men, many self-directed investors
have made prohibited transactions similar to this whether they knew what they
were doing or not. This case highlights the need for educating self-directed
investors and finding an SDIRA provider that will be an ally throughout the
investment process.
Self-directing
retirement funds into alternative assets can be a powerful investment tool.
When investors fail to abide by the laws, it is not an affirmation that SDIRAs
are high risk or require endless amounts of paperwork to be legal. The
investors in this case did not take the time to learn critical information
about their IRA investment structure.
At
New Direction, we have thousands of SDIRA investors that effortlessly abide by
rules. As a leading provider of SDIRAs, we focus on educating investors and
creating a comprehensive and complete paper trail of their transactions so that
they won’t commit prohibited transactions or other illegal activities.
Think
of it this way: the things in which you invest your retirement funds may be
high risk; that’s your prerogative. But the self-directed IRA itself is not
high risk if you’re with the right company.
