by Mat Sorensen | Apr 5, 2016 | Uncategorized
I hear a radio ad every week that says, “there is a loophole that allows you to use your IRA to buy physical gold “tax-free” and that you can EVEN store this gold in your home.” If these radio ads were on T.V., there’d probably be an image of Scrooge McDuck swimming in gold at his McMansion. These ads cause much concern as they give some misleading information. The good news is that you really can use your IRA to invest in gold. In fact, I have many clients who like to buy actual physical gold with their IRAs. And we’re not talking about gold funds or gold ETFs, but actual solid gold. You can also own silver, platinum, and palladium with your IRA so long as those metals meet certain legal requirements. Here’s the catch though and what the radio ads are missing, you can only own precious metals that meet certain legal requirements and you cannot personally store the metals. Don’t count on someone who sells precious metals to be an expert on IRA rules. They make money when you buy precious metals and they have no training or license to properly advise you, so get your legal and tax advice from a competent lawyer or tax adviser.
LEGAL RULES FOR IRA OWNED PRECIOUS METALS
Precious metals have been a popular investment for retirement plans since the financial market collapse in 2008. Most standard IRAs with financial institution custodians will typically only offer precious metals through funds or other complex structures whereby the IRA does not directly own the precious metals. A self-directed IRA can hold actual precious metals as long as those metals are not considered collectibles under law and as long as they are properly stored.
Only precious metals which meet the requirements of IRC § 408(m)(3) may be owned by an IRA. All other metals or coins are considered collectible items and cannot be held by an IRA. IRC § 408(m)(2)(C), and (D).
There are two categories of approved precious metals. The first category are specifically approved coins, such as American Gold or Silver eagles. The second category is bullion (e.g bars, or coin form bullion) that is gold, silver, platinum, or palladium, AND that meets certain purity requirements. The purity requirements are outlined below.
- Gold, meeting minimum fineness requirements of 99.5%.
- Silver, meeting minimum fineness requirements of 99.9%.
- Platinum, meeting minimum fineness requirements of 99.95%.
- Palladium, meeting minimum fineness requirements of 99.95%
Precious metals must be stored with a “bank” (eg. bank, credit union, or trust company). Personal storage of precious metals owned by an IRA is not allowed. A broker-dealer, third-party administrator, or any company not licensed as a bank, credit union, or trust company may not store precious metals owned by an IRA. IRS Private Letter Ruling 200217059.
There has been much confusion about owning precious metals with an IRA and there is confusion over some “loophole” that allows you to store them in your home. Our advice is against home storage, for tax code reasons and for security reasons. We’ve outlined the tax reasons more fully in a prior blog article you can check out here. In general though, our advice is that if your self-directed account owns metals directly through your custodian account then those metals will be stored with the custodian or with a “bank” whom the custodian uses for customers. If the metals are bought with an IRA owned LLC, then the metals of the LLC are subject to the storage rules and this can be satisfied by the LLC opening up a safe deposit box with a bank and by physically storing the metals there.
If an IRA purchases precious metals that do not meet the specific requirements of IRC § 408(m)(3), then the precious metals are deemed collectible items. As a result, they are considered distributed from the IRA at the time of purchase. IRC § 408(m)(1). Similarly, if the storage requirement is violated, then the precious metals are also deemed distributed as of the date of the storage violation. IRS Private Letter Ruling 20021705. The consequence of distribution is that the value of the amount involved is deemed distributed and is subject to the applicable taxes and penalty.
Go for the gold, or silver, or the other approved metals with your IRA. But make sure the metals meet the code requirements and that they are properly stored.
This article is an excerpt from Chapter 12: Precious Metals of The Self Directed IRA Handbook by Mat Sorensen
by Mat Sorensen | Mar 29, 2016 | Uncategorized
A prohibited transaction case from 2015 taught an important lesson for self-directed IRA investors. That lesson is that the substance of the actual transaction matters and that you cannot avoid a prohibited transaction by creating entities or other artificial structures that create no business purpose. Summa Holdings, Inc., et al, v. Commissioner, T.C. Memo 2015-119 (2015)
In Summa, two brothers invested a minimal amount of funds from their Roth IRAs into a new corporation called JCH. JCH then established and owned 100% of another new company called JCE. This new company, JCE, then in turn contracted with and received income from a company owned and majority controlled by the Roth IRA owners’ father. Clearly, any transaction between the brother’s Roth IRAs and their father would be a prohibited transaction. The prohibited transaction rules restrict your IRA from transacting with a disqualified person and the list of disqualified persons includes the father of and IRA or Roth IRA owner. IRC 4975 (e)(2)(F).
The Tax Court, in Summa, had to determine if the transactions between companies the Roth IRAs owned and companies in which the Roth IRA owner’s father owned and controlled were a prohibited transaction. The Tax Court relied on what is known as the “Substance Over Form Doctrine” to find a prohibited transactions for the Roth IRAs receipt of income. The Substance Over Form doctrine provides that the substance and not the form of a transaction determines its tax consequences. So, despite all of the companies, three in total, that separated the brother’s Roth IRAs from their father there is still a prohibited transaction as the overall substance of the Roth IRAs transactions was to unfairly shift income and assets to the tax-free Roth IRA accounts.
In fact, the Roth IRA owners stipulated with the IRS that the sole reason for their Roth IRAs investment into the companies and for the transactions was to accumulate income and assets tax-free. They conceded that there was no other business or investment purpose for the transactions. Consequently, the Tax Court rightly found a prohibited transaction and disqualified the Roth IRAs.
While careful planning and structuring is critical in your self-directed IRA transactions, no structure can overcome the lack of a legitimate investment or business interest for an IRAs investments. When investing your IRA into a deal, make sure your IRAs isn’t receiving any favorable treatment or benefit from a disqualified person (e.g. from the Roth IRA owner’s father). If your IRA is getting some favorable treatment or allocation of income or assets from a disqualified person, as was the case in Summa, you too could have a prohibited transaction.
by Mat Sorensen | Mar 1, 2016 | Tax & Legal Updates and Policy Changes, Uncategorized
In 2012, the JOBS Act amended the rules for private placement offerings (aka “PPMs”) to allow companies to advertise and solicit their offerings to prospective investors. Under prior law, a PPM could not be marketed or solicited to people whom the offeror did not have an existing relationship with. Hence, the use of the word “private offering” in the labeling of these types of investments.
This new type of offering allows advertising and general solicitation and is known as a Rule 506 (c) Offering. Under Rule 506 (c), the company raising money could create a website soliciting the funds, or they could hold seminars or meetings with potential investors and could solicit the investment of funds from those in attendance. This is a significant change to the prior offering rules that clearly prohibit such activities.
Under the new Rule 506 (c) Offering there is one hitch: the person raising funds may only accept funds from accredited investors. An accredited investor is someone who has $200K in annual income ($300K if married) or $1M in net worth (excluding equity in home). The accredited investor status must be documented by the investor or certified by a third party such as an accountant or financial planner. This verification rule is a new requirement for Rule 506 (c) Offerings and is ALWAYS required if you make general solicitation and marketing efforts for investors.
Under the traditional Rule 506 offering, now known as Rule 506 (b), you may not make general solicitations for investors and that is the major downside. However, you may raise money from up to 35 unaccredited investors per offering and that is something you cannot do under the new Rule 506 (c). Keep in mind, the offering must remain private. So, moving forward, those seeking to raise money under Regulation D approved offerings have two options. First, raise money under the current rule and you can accept up to 35 unaccredited investors but are restricted from advertising. Or, second, only accept money from accredited investors but be allowed to advertise the offering. You don’t get both options in one (advertising and unaccredited investors) but at least you now have another option in being allowed to advertise and solicit under the new rules.
Here’s a quick chart the outlines the two Rule 506 Options. The key differences are highlighted below.
|
Rule 506 (b) |
Rule 506 (c) |
|
Total Amount You Can Raise
|
Unlimited |
Unlimited |
| Offering Docs Required
|
Offering Memorandum, Sec Form D Filing, State Securities Filing, Company LP or Operating Agreement, Investor Suitability Quest. |
Offering Memorandum, Sec Form D Filing, State Securities Filing, Company LP or Operating Agreement, Investor Suitability Quest.
|
| Accredited Investors |
Un-limited accredited investors and up to 35 unaccredited investors who are sophisticated enough to invest.
|
Accredited investors only. Unlimited accredited investors. Must verify they are accredited. |
| Marketing of Offering |
Must remain private. Can only market to persons with an existing relationship. |
Marketing and general solicitations are allowed. You amy market via websites, e-mail campaigns, and at events or meetings. |
by Mat Sorensen | Feb 1, 2016 | Uncategorized
Self-Directed IRA investors should be aware of the following IRA tax reporting responsibilities. Some of these items are completed by your custodian and some of them are the IRA owner’s sole responsibility. Here’s a quick summary of what should be reported to the IRS each year for your self-directed IRA.
IRA Custodian Files
Your IRA Custodian will file the following forms to the IRS annually.
| IRS FORM |
PURPOSE |
WHAT DOES IT REPORT |
|
|
|
| Form 5498 |
Filed to the IRS by your custodian. No taxes are due or paid as a result of Form 5498. |
IRA contributions, roth conversions, the accounts fair market value as of 12/31/15, and required minimum distributions taken.
|
| Form 1099-R |
Filed to the IRS by your custodian to report any distributions or Roth conversions. The amounts distributed or converted are generally subject to tax and are claimed on your personal tax return. |
IRA distributions for the year, Roth IRA conversions, and also rollovers that are not direct IRA trustee to IRA trustee. |
IRA Owner Responsibility
Depending on your self-directed IRA investments, you may be required to file the following tax return(s) with the IRS for your IRA’s investments/income.
| IRS FORM |
DOES MY IRA NEED TO FILE THIS? |
DUE DATE |
|
|
|
| 1065 Partnership Tax Return |
If your IRA is an owner in an LLC, LP, or other partnership, then the Partnership should file a 1065 Tax Return for the company to the IRS and should issue a K-1 to your IRA for its share of income or loss. Make sure the accountant preparing the company return knows to use your custodian’s tax ID for your IRA’s K-1’s and not your personal SSN (or your IRAs Tax ID if it has one for UBIT 990-T tax return purposes). If your IRA owns an LLC 100%, then it is disregarded for tax purposes (single member LLC) and the LLC does not need to file a tax return to the IRS.
|
April 15th, 6 month extension available |
| 990-T IRA Tax Return (UBIT) |
If your IRA incurs unrelated business income tax (UBIT), then it is required to file a tax return. The IRA files a tax return and any taxes due are paid from the IRA. Most self-directed IRAs don’t need to file a 990-T for their IRA, buy you may be required to file for your IRA if your IRA obtained a non-recourse loan to buy a property (UDFI tax), or if your IRA participates in non-passive real estate investments such as construction, development, or on-going short-term flips. You may also have UBIT if your IRA has received income from an active trade or business such as a being a partner in an LLC that sells goods and services (c-corp dividends exempt). Rental real estate income (no debt leverage), interest income, capital gain income, and dividend income are exempt from UBIT tax. |
April 15th, 3 month extension available |
Most Frequently Asked Questions
I’ve answered the most frequently asked questions below as they relate to your IRA’s tax reporting responsibilities.
Q: My IRA is a member in an LLC with other investors. What should I tell the accountant preparing the tax return about reporting profit/loss for my IRA?
A: Let your accountant know that the IRA should receive the K-1 (e.g. ABC Trust Company FBO John Doe IRA) and that they should use the Tax-ID of your custodian and not your personal SSN. Contact your custodian to obtain their Tax ID. Most custodians are familiar with this process so it should be readily available.
Q: Why do I need to provide an annual valuation to my custodian for the LLC (or other company) my IRA owns?
A: Your IRA custodian must report your IRA’s fair market value as of the end of the year (as of 12/31/15) to the IRS on Form 5498 and in order to do this they must have an accurate record of the value of your IRA’s investments. If your IRA owns an LLC, they need to know the value of that LLC. For example, let’s say you have an IRA that owns an LLC 100% and that this LLC owns a rental property and that it also has a bank account with some cash. If the value of the rental property at the end of the year was $150,000 and if the cash in the LLC bank account is $15,000, then the value of the LLC at the end of the year is $165,000.
Q: I have a property owned by my IRA and I obtained a non-recourse loan to purchase the property. Does my IRA need to file a 990-T tax return?
A: Probably. A 990-T tax return is required if your IRA has income subject to UBIT tax. There is a tax called UDFI tax (unrelated debt financed income) that is triggered when your IRA uses debt to acquire an asset. Essentially, what the IRS does in this situation is they make you apportion the percent of your investment that is the IRAs cash (tax favorable treatment) and the portion that is debt (subject to UDFI/UBIT tax) and your IRA ends up paying taxes on the profits that are generated from the debt as this is non-retirement plan money. If you have rental income for the year, then you can use expenses to offset this income. However, if you have $1,000 or more of gross income subject to UBIT then you should file a 990-T tax return. In addition, if you have losses for the year you may want to file 990-T to claim those losses as they can carry-forward to be used to offset future gains (e.g. sale of the property).
Q: How do I file a 990-T tax return for my IRA?
A: This is filed by your IRA and is not part of your personal tax return. If tax is due, you will need to send the completed tax form to your IRA custodian along with an instruction to pay the tax due and your custodian will pay the taxes owed from the IRA to the IRS. Your IRA must obtain its own Tax ID to file Form 990-T. Your IRA custodian does not file this form or report UBIT tax to the IRS for your IRA. This is the IRA owner’s responsibility. Our law firm prepares and files 990-T tax returns for our self-directed IRA and 401(k) clients. Contact us at the law firm if you need assistance.
Sadly, not many professionals are familiar with the rules and tax procedures for self-directed IRAs so it is important to seek out those attorneys, accountants, and CPAs who can help you understand your self-directed IRA tax reporting obligations. Our law firm routinely advises clients and their accountants on the rules and procedures that I have summarized in this article and we can also prepare and file your 990-T tax return.
by Mat Sorensen | Jan 26, 2016 | Uncategorized
The recent case of Niemann v. Commissioner involves a successful real estate investor who unknowingly used his self-directed IRA owned LLC (aka, checkbook control IRA) in a way that caused a prohibited transaction under IRC § 4975. While the Tax Court’s holding and decision focused on other tax matters, the Court did outline the history of the case and the prohibited transactions that occurred and that disqualified Niemann’s IRA. Here are the pertinent facts regarding Niemann’s self directed IRA investments.
CASE FACTS
- Neimann formed Real Estate Rabbit, LLC with his IRA as the sole member and himself as manager.
- Neimann used Real Estate Rabbit, LLC for numerous real estate investments including buying homes at auction and slipping them for a profit. Real Estate Rabbit, LLC also bought mineral rights investments and held notes.
- Neimann personally engaged in real estate investments in his own name and in the name of an LLC he personally owned called Magic, LLC. Neimann intended for Magic, LLC to be a multi-member LLC to be owned by himself, his personal LLC, and his IRA/LLC. This LLC was not properly established nor was it properly operated. He learned about it from a seminar and engaged a non-lawyer (“vendor”) to set up the LLC.
- Neimann transferred properties from his Real Estate Rabbit, LLC (his IRA/LLC) to himself personally and to his personally owned LLC. These transfers caused a prohibited transaction and resulted in the entire distribution of Neimann’s self directed IRA.
It is quite clear from the case and from the Court’s analysis that Neimann was not intending to unfairly avoid tax nor was he attempting to improperly engage in a prohibited transactions. In fact, his real estate transactions were very successful. And if you were a successful real estate investor looking to illegally avoid taxes, you wouldn’t transfer properties from your IRA owned LLC (that pays no taxes on gains) to yourself personally (where you do pay taxes on the gains). If you were a tax cheat, you’d do the opposite and would transfer properties with gains from yourself personally to your IRA. It is quite clear instead, that Neimann was unaware of the rules and as a result he moved his real estate investments around between his LLCs and his personal name as he would with any property he owned. These transfers were made without regard to IRA rules which require IRA investments to be held separately from personal assets and which restrict transactions between the IRA (and IRA/LLC) and the IRA owner personally.
Neimann conceded with the Court and the IRS that he engaged in a prohibited transaction when his IRA owned LLC (Real Estate Rabbit, LLC) transferred property to himself personally and to his personally owned LLC.
LEARN THE RULES AND SEEK OUT QUALIFIED LICENSED PROFESSIONALS
This case illustrates a critical point that self-directed IRA investors must first become acquainted with the self-directed IRA rules before they enter into real estate, LLC, or other transactions with their IRA. Neimann was a successful investor and a former engineer but he either received poor advice or he sought no professional legal or tax advice in the process.
Learning how to self-direct your IRA is like learning a new board game. At first, it takes some time to learn what you can and cannot do but once you understand the rules for the investments you intend to make it becomes second nature and you can proceed without having to consult the “rulebook” or a lawyer, or CPA, or other licensed advisor. So, if you’re new to self directing your IRA, make sure you’ve received competent advice from licensed professionals. Don’t rely on something you’ve heard at a seminar or by someone trying to sell you an investment. Instead, seek a specific consult with a licensed attorney or CPA who is competent in the rules effecting your self-directed IRA.
by Mat Sorensen | Jan 12, 2016 | Real Estate & Alternative Asset Investing , Tax Planning, Uncategorized
The most common asset class for self-directed IRA accounts is real estate. Real estate investments for self-directed IRAs come in various forms from simple single-family rentals owned 100% by the IRA to LLC or LP investment partnerships with multiple investors in larger commercial or multi-family properties.
Given the changes in federal securities laws that now allow investment sponsors and real estate syndicators to raise capital more easily, many self directed IRA investors have considered investing their IRAs into these offerings. Crowdfunding sites such as Realcrowd are already offering Crowdfunding type investment opportunities for investors under SEC Rule 506(c). This rule and those investments are currently only available to accredited investors and have no restriction on the investment amount that may come from the accredited investor. These offerings have traditionally been known as private placements or “PPMs” but can now be marketed and there is no requirement that they be “private” so long as the offering company only accepts accredited investors.
For those who are not accredited investors, “true” Crowdfunding under Title III of the JOBS Act goes into effect in May of 2016. Under these Crowdfunding offerings everyone will be able to invest into Crowdfunding opportunities and the investment amount will be based on the investor’s income and assets. These new Crowdfunding rules were enacted in Title III of the JOBS Act and were put into final regulations by the SEC in late 2015.
Before investing your self-directed IRA into a real estate Crowdfunding offering, you must first learn and understand one very important tax called UBIT tax that may apply to your self-directed IRA’s income.
Will My IRA Be Subject to UBIT Tax?
Unrelated Business Income Tax (“UBIT”) applies to an IRA that receives non-passive income. UBIT is a hefty tax and has a maximum rate of 39.6%. IRC § 511. The tax table is copied below.
2016 UBIT Tax Rates
| If taxable income is: |
The tax is: |
| Not over $2550 |
15% of the taxable income |
| Over $2550 but not over $5950 |
$375 plus 25% of the excess over $2550 |
| Over $5950 but not over $9050 |
$1225 plus 28% of the excess over $5950 |
| Over $9050 but not over $12300 |
$2107 plus 33% of the excess over $9050 |
| Over $12400 |
$3179 plus 39.6% of the excess over $12400 |
Although not shown on the table, the first $1,000 in UBIT gross income is exempt and you receive an automatic $1,000 deduction.
UBIT will apply to your self-directed IRAs real estate investment in two scenarios. First, it will apply if the income to the IRA is ordinary. And second, it will apply if the offering company uses debt to acquire its properties.
Step One: Is the income passive?
First, UBIT will apply if the investment is an ordinary income producing business. An ordinary income business in real estate investing would include investing into an LLC or LP that conducts new construction, real estate developments held for sale, or other activities that are deemed business activities. Passive income investments, on the other hand, are specifically exempt from UBIT and include real estate rental income, capital gain income, interest income, and dividend income from a c-corp. IRC § 512(b). The vast majority of real estate Crowdfunding offerings are structured to obtain passive income such as rental income while the property is held and capital gain income when the property is sold. Typical real estate offerings where UBIT can be due include offerings to fix and flip properties or offerings for new construction or real estate development where the investment strategy is to buy properties to then immediately sale.
If you have an investment offering that is ordinary income (e.g. a fix and flip fund), then the income to the IRA from the fund will be subject to UBIT tax and the IRA will be required to file and pay the tax each year by using IRS Form 990-T. This responsibility to file the return each year is on the IRA account owner and not the investment sponsor or the IRA custodian so IRA owners need to know for themselves whether the IRA is subject to UBIT or not. So for example, let’s say that a self-directed IRA invested into a Crowdfunding offering that was a real estate development with properties held immediately for sale and that the income was ordinary income. Let’s further assume that the self-directed IRA received a K-1 for profits to the IRA for the year of $10,000. Based on the UBIT tax table, the IRA would owe UBIT tax in the amount of $2,420. This amount is due from the IRA to the IRS and is reported and payable using form 990-T.
If you’ve determined that the Crowdfunding offering income is passive (e.g. rental, capital gain), then you may still be subject to UBIT if the LLC or LP offering company is using debt to leverage and acquire its properties.
Step Two: Will the investment be leveraged with debt?
Second, UBIT will apply to profits returned to your IRA from a Crowdfunding real estate offering (and really any real estate owned by your IRA) if the offering company uses debt to leverage its acquisition of properties. For example, let’s say the offering company raises $1M in cash to buy a $4M multi-family property. There will be $1M of cash invested into the property and $3M of debt. The property will therefore be leveraged 75% with debt.
Whenever an IRA’s investment is leveraged with debt, the tax code requires the IRA owner to determine what profits are attributable to the IRAs cash and what profits are attributable to the debt. The profits attributable to the cash invested is still treated as tax deferred (traditional IRA) or tax free (roth IRA) and is not subject to UBIT. The profits and income attributable to the debt, however, is called unrelated debt financed income (“UDFI”) and is subject to UBIT. IRC § 514. So, in the multi-family property example above where the property is leveraged 75% with debt, the self-directed IRA will be subject to UBIT tax on 75% of the income.
In order to calculate UBIT tax based on debt, you must first determine the leverage ratio. Once we know the leverage ratio, we can then begin to calculate how UBIT will apply. The good news is that the IRA is also allowed to take expenses against the property using the same leverage ratio and is able to take depreciation expenses which help to offset UBIT. In many situations, even where a property is cash-flowing the IRA will not be subject to UBIT because the property expenses and depreciation will offset UBIT income.
Let’s continue through this example to illustrate how this works.
Example
Property Purchase Price = $4M
Debt/Leverage = $3M
Leverage Ration = 75%
Income = $1.3M
Income at Leverage Ratio (75%) = $975,000
Operating Expenses= $1,000,000
Operating Expenses at Leverage Ratio (75%) = $750,000
Net Leveraged Income = $225,000
Depreciation Expense ($4M / 27.5) = $145,500
Depreciation Expense at Leverage Ratio = $109,125
Net UDFI/UBIT Income = $115,875
SDIRA Investor Invested $20K and received 1.5% of Company Profit/Loss
SDIRA Investor 1.5% of Net UDFI/UBIT = $1,738.
Automatic IRS $1,000 deduction = $738 subject to UBIT/UDFI
UBIT Table Rate of 15% of $738 = $110 in UBIT is Due
As the example demonstrates, given the low-level of investment from the IRA it isn’t subject to much UBIT as the net UBIT income (after expenses and depreciation) keeps the tax rate on the low end of the tax table. That being said, 990-T tax returns must be filed by the IRA investor for the IRA and the IRA will be responsible for the tax due. Factors that will cause more UBIT are higher returns and income, larger investment amounts and ownership, and more leverage.
While self-directed IRA’s are subject to UDFI and UBIT on leveraged real estate investments, it is worth noting that self-directed 401(k) and other employer based plans are exempt from UDFI on leveraged real estate investments. IRC § 514(9). Unfortunately, self-directed IRAs do not receive this exemption.
So, in short, the quick list to determine whether UBIT will be due a self-directed IRA Crowdfunding real estate investment requires analysis of two issues. First, is the offering company’s income passive or is it ordinary. If it is ordinary then it is subject to UBIT. If it is passive, then it is only subject to UBIT if the company uses debt to leverage its investments. Once you can answer these questions you know whether UBIT will apply to your investment and whether your IRA will need to report and pay tax on its income.
