Advanced Underwriting Consultants

Question of the Day – March 13

Ask the Experts!

Here’s the question of the day.

Question: My client wants to roll his pension money into a self-directed IRA, so he can invest that money in real estate.  Is that allowed?

Answer: Maybe, if the client is not using the real estate personally.  The client needs to make sure he’s not violating any prohibited transaction rules or rules against self-dealing.

The prohibited transaction rules and rules against self-dealing mean the property cannot be purchased from the IRA owner or family member and once purchased, cannot be used to benefit the IRA owner or family member.  The investment must be a strictly arms-length transaction not involving the IRA owner or family member.

In ERISA Opinion Letter 2011-04, the taxpayer sought a ruling that his IRA could purchase the note and mortgage on an eight-unit apartment building owned by the taxpayer’s living trust.  The apartment building had been financed originally through a personal loan taken from a bank by the taxpayer and his wife, and secured by a deed of trust on the property.  

The taxpayer argued that an IRA could purchase a note and mortgage already in existence from the bank and this would not constitute a new loan from the IRA or other extension of credit to a disqualified person.  The Department of Labor did not agree.  It held that although the IRA would acquire the note and deed of trust from the bank, an otherwise unrelated party, the IRA would hold the note and receive payments on the note from the taxpayer and his wife, who are disqualified persons.  Buying the note and mortgage from the bank would constitute an indirect loan to the IRA owner, and was thus prohibited.

The consequences of engaging in a prohibited transaction are catastrophic.  Code Section 4975(a) imposes an excise tax equal to 15% of the amount involved with respect to the prohibited transaction for each year (or part thereof) in the taxable period.  In addition, Section 4975(b) imposes a 100% excise tax if the prohibited transaction is not corrected within the taxable period.

In addition to the excise taxes, under Code Section 408(e)(2), an IRA is disqualified if it engages in a prohibited transaction.  If an IRA is disqualified, income taxes and a 10% penalty if the owner is under age 59-1/2 will be due on the entire balance of the IRA.

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