by Mat Sorensen | Jul 29, 2014 | Uncategorized
In a recent U.S. Tax Court case, the Court ruled against an IRA owner and deemed his IRA distributed and taxable as the IRA owner failed to properly execute his intended self-directed IRA real estate investment. Dabney v. Commissioner, T.C. Memo 2014-108.
The IRA owner had an IRA at Charles Schwab and intended to use the IRA to acquire real estate in Brian Head, UT. Upon conducting research Mr. Dabney learned that an IRA could own real estate. However, instead of rolling or transferring his IRA funds to a self directed IRA custodian who would allow his IRA to own real estate, Mr. Dabney took a distribution of the IRA and directed Schwab to wire the funds to closing for the purchase of the property. Additionally, he instructed title and eventually received a deed in the name of his Schwab IRA.
The problem was that rather than invest his IRA into real estate he instead distributed his IRA and use the distributed fund to buy real estate outside of his IRA. Charles Schwab issued Mr. Dabney a 1099-R for that distribution and Mr. Dabney contested the 1099-R and the taxes owed as a result arguing that the funds were used to buy a property owned by his Schwab IRA. Mr. Dabney argued that Charles Schwab made a mistake. However, the Court ruled against him because his funds were distributed out of his Charles Schwab IRA and because his IRA funds and the real estate were not held by a self-directed IRA custodian that allowed for IRAs to own real estate. The Court stated that an IRA can certainly hold real estate but that Charles Schwab’s policies did not allow for Mr. Dabney’s IRA to own real estate and since his custodian would not hold the real estate as an asset of his IRA that it was deemed distributed.
The lesson to be learned from the Dabney case is that in order to properly execute a self-directed IRA investment into an asset such as real estate, the IRA owner needs to roll over or transfer their IRA funds first to a self-directed IRA custodian who allows the IRA to own real estate and then that self-directed IRA will actually take title and ownership to the IRA asset directly. While these rules seem simple, I’d estimate that I speak to at least one or two IRA owners a year who took a distribution from an IRA and used those funds to buy real estate (or some other alternative asset) thinking that the real estate would still be owned by their IRA and that the funds would not be distributed and subject to tax. The confusion usually arises with the non-self directed custodian who misunderstands what the the account owner is trying to do (invest the IRA, not distribute it). Keep in mind, that in order to own real estate with a self-directed IRA, you must have a self-directed IRA custodian.
by Mat Sorensen | Jul 22, 2014 | Uncategorized
Many savvy investors have come to find Roth retirement accounts as a great tool to building long-term tax-free wealth. Roth IRAs were first introduced in 1997. Roth 401(k)s came around in 2006 but had many restrictions and were not widely offered. Under current 401(k) rules, you can contribute $17,500 a year to your Roth 401(k) account as an employee contribution. You can contribute up to an additional $34,500 to your 401(k) for the year, depending on your income, up to a total amount of $52,000 but the $34,500 would be employer contributions and must be Traditional dollars. So, if you’re self-employed and have a solo 401(k) and want to max-out your 401(k) contributions you could contribute $17,500 as Roth 401(k) dollars and $34,500 of Traditional 401(k) dollars. But what if you want all of the funds to be Roth 401(k) dollars? Well, have no fear; all you have to do is convert the Traditional 401(k) dollars to Roth. Also, what if you want to roll-over existing retirement accounts to your Roth 401(k)? This is also possible, you just have to roll the funds over and convert. This article outlines the brief history and details on how you can maximize your Roth 401(k) account.
The American Tax Payer Relief Act of 2012 (“ATRA”) totally changed the game for Roth 401(k)s. Following ATRA, Roth 401(k)s became significantly more beneficial to investors for one simple reason: you could more easily put your existing retirement plan dollars into it. Since 2012, any 401(k) account owner, whose plan offers a Roth 401(k) account (and most now do), is eligible to convert any and all of their existing Traditional 401(k) dollars to Roth 401(k) dollars. This includes Traditional IRA rollovers to the 401(k), 401(k) employee contributions, and vested 401(k) employer contributions. Keep in mind that when you convert any Traditional retirement plan dollars to Roth 401(k) dollars that you will be taxed on the amount converted. That’s what Roth retirement account dollars are. They are post-tax retirement plan funds (you’ve paid taxes on them already) that grow tax-free and are withdrawn at retirement tax-free (age 59 ½).
Transfer and Rollover Rules
Additionally, funds in prior employer Roth 401(k)’s may be rolled into your existing Roth 401(k). Unfortunately, one source of funds that cannot be rolled, transferred, or converted into a Roth 401(k) are Roth IRAs. Here’s a quick chart breaking down the rules.
| Existing Retirement Plan Dollars |
Can These Retirement Plan Dollars Go Into My Roth 401(k)? |
| Transfer/Rollover from a Traditional IRA or Prior Employer Traditional 401(k). |
Yes, but tax will be due at the time of conversion on the amount converted to Roth. |
| Traditional Employee Contribution Made to Your Traditional 401(k) Account. |
Yes, but tax will be due at the time of conversion on the amount converted to Roth. |
| Employer Contribution Made to Your 401(k). These Are Always Contributed as Traditional Dollars. |
Yes, but tax will be due at the time of conversion on the amount converted. |
| Prior Employer Roth 401(k). |
Yes, these are rolled from the old Roth 401(k) plan to the existing Roth 401(k). |
| Roth IRA |
No, right now you cannot roll Roth IRA dollars into a Roth 401(k). We expect this law to change over time but not anytime soon. |
In addition to the chart above, here’s a link to IRS Notice 2013-74 which discusses Roth 401(k) conversions and rollovers.
Keep in mind that conversions to Roth dollars are only permitted if your 401(k) plan allows it. Most Solo or Owner Only 401(k) plans allow for Roth contributions and conversions. Also, only vested amounts are available for conversion, which in a Solo 401(k) plan, all amounts contributed are usually immediately vested. Finally, keep in mind that any amounts converted are still subject to tax based on your personal tax rate liability. However, once converted, all subsequent distributions will be tax-free, so long as any converted funds remain in the Roth account for five years prior to distribution.
In summary, Roth 401(k) sums can be accumulated from many different sources. They can be accumulated from conversions of traditional IRAs, old employer Traditional 401(k)s, and from existing Traditional 401(k) contributions (employee or employer). You aren’t just limited to putting in your annual $17,500 of Roth 401(k) dollars each year. So, if you want to maximize your Roth 401(k) account, all you need to do is rollover and/or convert your existing dollars to Roth.
by Mat Sorensen | Jul 15, 2014 | Uncategorized
In a recent Private Letter Ruling (PLR 201423043), the IRS stated that a deceased person’s Roth IRA may be inherited by the Roth IRA owner’s surviving spouse through their Trust when the surviving spouse was the sole beneficiary and had sole control of the Trust upon the passing of her husband.
As many retirement account owners already know, listing your Revocable Living Trust as the beneficiary of your retirement account can be tricky as the Trust needs to meet certain requirements in order to receive rolled-over funds from the surviving spouse.
For example, Under Reg. § 1.408-8, Q&A 5, a surviving spouse of an IRA owner may elect to treat the spouse’s entire interest as a beneficiary in an individual’s IRA as the spouse’s own IRA, but only if the spouse is the sole beneficiary of the IRA and has an unlimited right to withdraw amounts from the IRA.
The IRS has stated that, “If a trust is named as beneficiary of the IRA, this requirement is not satisfied even if the spouse is the sole beneficiary of the trust.” Under the PLR though, the IRS stated that when the surviving spouse is the sole trustee of a trust and has the sole authority and discretion under the trust to pay the IRA proceeds to herself/himself, then the spouse may rollover the deceased spouses Roth IRA to the surviving spouses Roth IRA as long as the rollover occurs within 60 days of the distribution from the deceased person’s IRA.
The rules regarding spousal rollovers can be tricky and you should consult with your attorney before listing your trust as the beneficiary of your IRA. As a result, I have the following three tips to follow when listing beneficiaries on your retirement accounts.
- When In Doubt, List Your Spouse Directly, Don’t List Your Trust – If you aren’t sure about whether your Trust qualifies as a beneficiary for your retirement account, then list your spouse directly as the beneficiary.
- If You List Your Trust Instead of Your Spouse, Make Sure Your Trust Qualifies- Have an attorney review your Trust to make sure that it meets the requirements above (that your spouse will have sole control and authority under the trust to distribute the IRA to himself/herself) so that your spouse can rollover the retirement account in the most tax advantageous manner possible. For example, a spouse can rollover their deceased spouse’s account into their own account as was shown in the PLR above. That’s a great tax benefit as you can keep the funds in a retirement account and outside of taxation longer. However, if the Trust doesn’t meet the proper requirements then the trust receives the retirement account and it cannot be directly rolled into the retirement account of the surviving spouse and must instead be distributed.
- Consider a Separate IRA Trust for IRA’s Over $1M- If you have an IRA over $1M, you may benefit by having a special IRA trust as the beneficiary of your IRA. It depends on your goals and tax planning, but is worth considering.
Bottom line, the rules here are very tricky so consult with your estate planning attorney on the best way to list your heirs as beneficiaries on your retirement accounts.
By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook
by Mat Sorensen | Jul 8, 2014 | Uncategorized
Limited Liability Companies (LLCs) owned by a 401(k) or other qualified retirement plans (e.g. profit sharing plans, defined benefit plans) can be exempt from the California Franchise Tax, when the LLC is used exclusively for the purpose of acquiring and holding real estate. In other words, if you have a 401(k) owned LLC that is used to buy and hold real estate investments then that LLC is likely exempt from the California Franchise Tax.
The exemption from the California Franchise Tax is found in R&TC Section 23701x, and requires, among other things that the LLC.
1. Be Owned by a Qualified Pension Plan. This exemption only applies to qualified pensions, profits sharing plans, and stock bonus plans. This would include self-directed 401(k) and profit sharing plans, which are commonly used by many self directed retirement plan investors. It is important to note, however, that a self directed IRA (even if a SEP IRA) would not qualify as a qualified pension plan under the exemption.
2. The LLC Must Used to Buy and/or Hold Real Estate. The LLC owned by the 401(k) (or other employed based plan) must be used to buy and/or hold real estate.
3. Requires CAFTB Determination Approval. In order to rely on the exemption, the LLC must file receive an exemption approval letter from the California Franchise Tax Board (CAFTB). This is obtained by filing CAFTB Form 3500.
It is important to note that the exemption will not apply to IRA/LLCs, as IRAs do not specifically meet the exemption’s definition of a qualified retirement plan. I have had clients seek the exemption fro the tax with SEP IRAs, arguing that these retirement accounts were similar to a 401(k) or profit sharing plan, but their exemption request was denied.
Additionally, if the 401(k)/LLC is used to own assets other than real estate then the LLC will not meet the exemption requirements. Despite the narrow application of the exemption, it does cover many investors in California who use self directed 401(k)s and Profit Sharing Plans to invest and own real estate, and who do so using an LLC. Because the CAFTB tax rules can be tricky, please consult with your attorney or tax advisor prior to relying on the exemption. Also, please note that you must actively file for the exemption with the CAFTB as the exemption is only applicable when received by application.
By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook
By: Kevin Kennedy, Attorney, KKOS Lawyers
by Mat Sorensen | Jul 1, 2014 | Uncategorized
Penny Stocks are company stock offered on the Over-The-Conter Bulletin Board (OTCBB). OTCBB is an electronic system for selling certain SEC compliant securities that are not listed on NASDAQ or another national securities exchange. These Penny Stocks on OTCBB include smaller companies, foreign companies, and other unique financial products. The stocks are typically less stable than stocks listed on NASDAQ or the NYSE and have less stringent trading and reporting requirements.
An IRA may invest in penny stocks and in doing so you’ll generally work with a broker-dealer who allows their clients’ IRAs to invest into OTCBB securities (aka “Penny Stocks”). Many brokerage firms, such as TD Ameritrade, E-Trade, and Scottrade have IRA brokerage accounts that can invest into Penny Stocks. You may also use a IRA with a self directed custodian but generally a brokerage IRA works best as you’ll need a broker to execute the trades. It is important to note that just because you can invest in Penny Stocks with your IRA doesn’t mean that you should. My mantra on investing, if I can say that I have one, is to invest in what you know. This mantra shared by many of our clients who self directed their retirement accounts into real estate or into start-up companies with promising futures where the IRA owner has specific knowledge of the quality of the owners/management or in their products. In other words, they invest into assets they have knowledge in. So, if you see opportunity to invest into penny stocks with your IRA, keep in mind that it is a possibility but proceed with caution.
When investing in Penny Stocks with your IRA, you should pay careful attention to the following concerns.
1. Commissions – The commissions paid on the selling of “penny stocks” can be significant. Check to see what commissions are being paid on the penny stocks you are interested in acquiring.
2. Substantial Risk – Be prepared to sign lots of disclosures indicating that you understand the risk in acquiring these types of securities as all brokerage firms make you sign documents indicating that you know what you are doing.
3. Penny Stocks May Be Easy to Buy But Can be Hard to Sell – Because the trading volume is lower on OTCBB securities than securities on the NASDAQ or NYSE, it may be difficult to sale your Penny Stocks. If you hold a significant number of shares you may need to sell the shares over time to avoid having a drop in price on the shares you are selling.
In summary, Penny Stocks may be acquired by an IRA but an investor should take significant caution and should only invest after conducting adequate due diligence on the company stock being purchased. Because the reporting information required on Penny Stock companies is limited, this takes additional effort from the investor.
By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook
by Mat Sorensen | May 20, 2014 | Uncategorized
Roth IRAs can be established and owned by anyone who has earned income and that includes children. As many savvy investors have come to understand, Roth IRAs offer the best tax-free treatment for investment income and returns in the tax code. But these accounts aren’t just for adults. Minors who have earned income can also establish Roth IRAs.
I have many clients who establish Roth IRAs for their children who have earned income. Some use them to co-invest those funds with their own Roth IRAs into certain real estate deals or start-up companies. Some open up brokerage accounts and teach their kids how to buy and sell stocks. Whatever your investment strategy, don’t leave your kids out. Consider a Roth IRA as a valuable tool that can be used to teach your kids or grand-kids how to invest and how to save for their own college education. But before you open up a Roth IRA for your child, here’s what you need to know.
- Earned Income – The only qualification to establishing a Roth IRA is that the account-owner has earned income. If your child works in your business, on your rental properties or real estate investments, or even if they have a part-time or summer job, give them some income so they can establish a Roth IRA. Their earned income can be contributed to the annual Roth IRA contribution limit of $6,000. My own 13 and 15 year-olds actually have their own small business and we will be establishing Roth IRAs this year for both of them. If a child has made a Roth IRA contribution, it is generally recommended that they either have a W-2 for the income for that year or that they file a 1040-EZ for their 1099 income or self-employment income even if they are under the standard deduction. While earned income to a child is taxable, if the child is under the standard deduction amount of $6,200 the child will pay no income tax (though there may be employment taxes).
- Custodial IRA – If you open a Roth IRA for your child it is often times referred to as a custodial IRA because the account owner is not old enough to establish the IRA for themselves and therefore their parent or legal guardian must open and oversee the account for the child. When the child reaches age 18, the child will take over as the responsible party for the account.
- Tax & Penalty Free With-Drawls – In all instances, the amounts contributed to a Roth IRA can be withdrawn penalty free and tax free. Earnings withdrawn may be subject to a penalty and tax. Earnings may be distributed penalty free for the qualified higher education expenses of the child though the earnings withdrawn can be subject to tax. Check out the IRS explanation here. http://www.irs.gov/publications/p970/ch09.html. In other words, the Roth IRA can be accessed without penalty or tax when you simply pull out the amounts comprising contributions to the Roth IRA. Keep in mind, the withdrawn earnings used for qualifying higher education expenses (e.g. the investment returns or growth in the account above the contributions) will not be subject to the 10% early withdrawal penalty but they may be subject to taxes on the child’s tax return. As a result, I wouldn’t recommend withdrawing the earnings. While using a child’s Roth IRA for education expenses is common, it is not just education expenses to consider as contributions to a Roth IRA can be withdrawal without penalty and tax for anything. That could be a new car purchase, a non-traditional education expense, church service expenses, a new business, job training, or any other worthy cause or purchase worth saving for.
If you want to teach your child how to invest or if you want to help them save for college, the first account option to consider is a Roth IRA. Why choose an account that is taxable when you can choose one that grows tax-free?
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