Prohibited Transactions Make Your IRA Vulnerable - Even to Creditors

Patricia McCrystal

July 27th, 2015

In a bankruptcy court ruling in Arkansas on May 25^th, 2015, a debtor was forced to forfeit his IRA’s tax-deferred status and give bankruptcy trustees access to the IRA account assets. This ruling marked an historic turn in legal proceedings for  IRA owners, as this was the first time a creditor successfully investigated the propriety of a debtor’s IRA transactions, and used evidence of a prohibited transaction to pierce the bankruptcy protection that IRA account assets typically enjoy.

Debtor Barry Kellerman and his wife Dana Kellerman created a partnership with Barry’s IRA account to purchase and develop land. The Kellermans owned 50% of the partnership, while Barry Kellerman’s IRA owned the other 50%. Instead of funding the purchase of the land with a proportionate split in cash between the Kellermans and the IRA account, Barry Kellerman directed his IRA to cover the entire purchase. The agreement required the Kellermans to match the amount funded by the IRA account after the land was sold at some future date.

An article on Wealth Management.com details the court ruling as follows:

“The Bankruptcy Court held that debtor Barry Kellerman and his wife Dana Kellerman used the income and assets of an IRA for their benefit, violating Internal Revenue Code Section 4975(c)(1)(D).  The court found that Barry alternatively dealt with the IRA income or assets as a fiduciary for his own interest, violating IRC Section 4975(c)(1)(E).  As a result, the IRA lost its tax-exempt status because of prohibited transactions engaged in by disqualified persons, and the Kellermans were unable to claim any tax-exempt interest” (June 1 2015).

What does this mean for my IRA?

The Kellerman court ruling is a tangible example of the consequences that can befall IRA account holders should  they fail to exercise due diligence with their self-directed IRA investment ventures. An IRA account administrator’s primary duty is to provide bookkeeping and custodial services for your investment decisions as the account holder. Some providers attempt to help clients identify potential prohibited transactions. However, an IRA provider cannot alert an account holder about a prohibited transaction if the IRA holder does not transparently communicate their investment intentions to their administrator.

Every self-directed IRA account provider works from the same set of IRS rules and codes; though these codes are not always clear. As such, IRA account holders may wish to call their provider or attorney and provide a detailed description of their investment ideas to make sure their proposed transactions are not prohibited. Before moving forward with investment decisions, it’s wise for self-directed IRA account holders to assess their own risk tolerance on possible prohibited transactions and risky investment choices.

Education about the rules and regulations of IRA account investments is a key aspect of making wise investment choices. New Direction IRA emphasizes an educational business model that empowers clients to confidently make knowledgeable assessments about potential investment opportunities. Call New Direction IRA today for more information about self-directed IRA investment parameters and proceedings.