Advanced Underwriting Consultants

Ask the Experts – June 20, 2014

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: Can my client invest his IRA funds in real estate?

Answer: It depends on the IRA custodian. As long as the rules prohibiting self-dealing are followed, there’s nothing in the tax code that disallows an IRA from investing in non-traditional investments like land or a business. However, as evidenced by a recent Tax Court case, Dabney v. Commissioner, T.C. Memo. 2014-108 (6/5/14), the IRA custodian will have the last word as to what the IRA may purchase.

In Dabney, the taxpayer owned a traditional IRA which he rolled over to a self-directed IRA with Charles Schwab. The taxpayer was interested in buying a piece of real estate with the funds in his IRA, but Charles Schwab did not allow what it referred to as “alternative investments,” including real property.

The taxpayer was aware of Charles Schwab’s refusal to allow investments in real estate, but he nevertheless transferred the IRA funds directly to the seller of the real estate, who was instructed to name his IRA as the owner of the property. (The seller accidentally titled the property to the taxpayer himself, but the court held that either way, the transaction results in an early distribution of the IRA funds.)

The court held that although IRAs are perfectly capable of investing in real estate, a trustee typically has broad powers that are only limited by statute or the terms of the trust, and “IRA trustees and custodians generally have broad latitude to direct or limit the investment of funds in an IRA.” Since Charles Schwab has the power to prohibit the purchase of real property, the taxpayer’s IRA was not capable of holding real property, and therefore the IRA did not purchase the property.

The result is that the money transferred to the seller of the real property was treated as a normal distribution, subject to both income taxes and the 10% penalty since the taxpayer was younger than 59 ½.

The Tax Court noted that if the taxpayer had instead transferred the IRA funds from Charles Schwab to a different IRA that permitted the purchase and holding of real property, he would have achieved his goal without any unintended tax consequences.

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