by Mat Sorensen | Nov 25, 2013 | Uncategorized
The prohibited transaction rules applicable to self directed IRAs prohibit not what your IRA can invest into but WHO your IRA may engage in a transaction with. For example, the prohibited transaction rules restrict my IRA from buying a rental property from my father. This is not because rental properties are prohibited to my IRA but because my father is prohibited by law from transaction with my IRA. My self directed IRA could buy a rental property from a third party seller whom I have no family or other business relationship with since there is nothing wrong in buying the rental property the question is just who am I buying it from. Congress decided to restrict investments with certain persons who could potentially collude with the IRA owner to unfairly avoid taxes. As a result, transactions with certain family members and business partners of an IRA owner are prohibited. The consequence for engaging in a prohibited transaction can be drastic (e.g. no longer have an IRA, penalties and taxes on distribution) so IRA owners must avoid them in all situations.
The prohibited transaction rules therefore provide the greatest restriction on using self directed IRA funds and must be understood by self directed IRA investors. These rules are found in IRC 4975 and state that a prohibited transaction occurs when an IRA engages in a transaction (e.g. buy, sell) with a disqualified person. The question immediately arises, who is a disqualified person to my IRA?
Categories of Persons Disqualified to Your SDIRA
There are essentially four categories of disqualified persons to your IRA and they are as follows.
- IRA Owner. The IRA owner is disqualified to his/her own IRA as the fiduciary making decisions for the account. IRC 4975(e)(2)(A), Harris v. Commissioner, 76 T.C.M. 748 (U.S. Tax Ct. 1994).
- Certain Family Members. Disqualified family members include the IRA owner’s spouse, children, spouses of children, grandchildren and their spouses, and the IRA owner’s parents and grandparents. Family member who are NOT disqualified persons are siblings (e.g. brothers and sisters), aunts and uncles, cousins, nieces and nephews, and parent in-laws (e.g. spouses parents). IRC 4975 (e)(2)(F), IRC 4975 (e)(6).
- Company Owned 50% or More by IRA Owner or Certain Family Members. Any Company that is owned 50% or more by the IRA Owner or Certain Family Members outlined above are disqualified to the IRA. For example, an LLC owned 30% by the IRA owner, 30% by the IRA owner’s spouse, and 40% by an un-related partner is a disqualified company to the IRA (owned 50% or more by disqualified persons) and any transaction between the IRA and the company would be a prohibited transaction. IRC 4975 (e)(2)(G).
- Key Persons in Company Owned 50% or More by IRA Owner or Certain Family Members. Any person who is a 10% or more owner of a company owned 50% or more by disqualified persons (e.g. number 3 above) or any person who is an officer, director, or manager of a disqualified company (owned 50% or more by disqualified persons) is also disqualified. For example, if my wife and I own 60% of a company and if Julie is an officer of that company then Julies is a disqualified person to my IRA. Additionally, if Julie was a 15% or more owner of the company she would also be prohibited to my IRA.
When you are dealing with unrelated persons (not related as family or as business partners) the prohibited transaction rules do not need to be analyzed but once family members or business partners are involved in any part of the transaction, the IRA owner must ensure that the prohibited transaction rules are not being violated.
by Mat Sorensen | Nov 12, 2013 | Uncategorized
An IRA may invest into a real estate investment trust. Real estate investment trusts (“REIT”) are trusts whereby the company undertakes certain real estate activities (e.g. own or lend on real estate) and returns profits to its owners. An IRA may invest and be an owner in a REIT. As many self directed IRA investors know, a form of unrelated business income tax (“UBIT” tax) known as unrelated debt financed income tax (“UDFI” tax) can arise from real estate leveraged by debt.
Many REITs engage in real estate development activities and/or use debt to leverage their cash purchasing power and as a result may cause a form of UBIT tax known as UDFI tax to IRA owners. Most REITS will not pay corporate taxes and as a result will not be considered exempt from UBIT tax as a result of having paid corporate tax. However, income from REITs is still typically exempt from UBIT and UDFI tax because the definition of a “qualified dividend” in a REIT has been defined to include dividends paid by a REIT to its owners. IRS Revenue Ruling 66-106. Qualified dividends from a REIT are exempt from UBIT and UDFI tax. REITs can be publically traded or private trusts but are not easy to establish. They require at least 100 owners and must distribute at least 90% of their taxable earnings to their owners each year. Despite the general application of exception to UBIT/UDFI tax for REITs, a REIT may be operated in a manner that will not allow for qualified dividends to be paid and therefore income from the REIT would not be exempt from UBIT/UDFI tax. If you’re investing into a REIT with an IRA, make sure you know whether the REIT intends to be exempt from UBIT/UDFI tax or not. As discussed, most will be exempt from UBIT/UDFI tax but some REITs may choose to operate in ways that will not qualify for the exception. Because UBIT/UDFI tax is about 39% at $10,000 of annual income this is something every IRA should understand before investing into a REIT.
by Mat Sorensen | Nov 5, 2013 | Uncategorized
Can my IRA own substantially all of the ownership of an LLC? Can my IRA/LLC pay a salary to me for serving as the manager of the IRA/LLC? Last week the U.S. Tax Court issued an opinion in the case of Ellis v. Commissioner, T.C. Memo 2013-245 and answered both of these questions.
In Ellis, the Tax Court resolved two questions posed by the IRS. First, did Mr. Ellis engage in a prohibited transaction when his IRA acquired 98% of the membership interest in CST, LLC? And second, did Mr. Ellis engage in a prohibited transaction when CST, LLC (owned 98% by his IRA) paid him compensation for serving as the manager?
Analyzing Ellis v. Commissioner
As to the first question, the Tax Court held that Mr. Ellis’ IRA did NOT engage in a prohibited transaction when it acquired 98% of the ownership of a newly established LLC. The other 2% was owned by an un-related person who was not part of the case and whose ownership did not have an impact on the decision. The IRS contended that a prohibited transaction occurred when the IRA bought ownership of CST, LLC. The Court disagreed, however, and held that the IRA’s purchase of the initial membership interest of the LLC was NOT a prohibited transaction. The Court stated that the IRA’s purchase of membership interest in a new LLC is analogous to prior holdings of the Court whereby the Court held that an IRA does not engage in a prohibited transaction when it acquires the initial shares of a new corporation. Similarly, the court held that a new LLC is not a disqualified person to an IRA under the prohibited transaction rules and as a result an IRA may invest and own the ownership of the LLC. IRC § 4975(e)(2)(G), Swanson V. Commissioner, 106 T.C. 76, 88 (1996). Consequently, the Court’s ruling means that it is NOT a prohibited transaction for an IRA to acquire substantially all or all of the ownership of a new LLC.
As to the second question, the Tax Court held that it was a prohibited transaction for the LLC owned substantially by Mr. Ellis’ IRA to pay compensation to Mr. Ellis personally. The court reasoned that, “In causing CST [the IRA/LLC] to pay him [IRA owner] compensation, Mr. Ellis engaged in the transfer of plan income or assets for his own benefit in violation of section 4975 (c)(1)(d).” This type of prohibited transaction is often times referred to as a self dealing prohibited transaction and occurs when the IRA owner personally benefits from his IRA’s investments. The Court looked to the operating agreement of the LLC which authorized payment to Mr. Ellis for serving as the general manager and also the actual records of the LLC which showed the payments to Mr. Ellis. When using an IRA/LLC, one of the many important clauses in the operating agreement is one which restricts compensation to the IRA owner or any other disqualified person (e.g. IRA owner’s spouse or kids). Also, the actual payment and transaction records of the IRA/LLC will be analyzed so it is important that both the LLC documents and the actual payment records do not allow for or result in payment from the IRA/LLC to disqualified person (e.g. IRA owner).
It is also important to note that the Tax Court rejected Mr. Ellis’ argument that the payments were exempt from the prohibited transaction rules under section 4975 (d)(10). Section (d)(10) provides an exemption to the prohibited transaction rules for payments from an IRA to a disqualified person [e.g. IRA owner] for services rendered to manage the IRA. The Tax Court rejected this argument stating that the payments from the IRA/LLC were not for management of the IRA but for management of the IRA/LLC and its business activities. In this case, the IRA owner was actively involved as the general manager of the IRA/LLC which LLC bought and sold cars. As a result, the Court held that the payments were not exempt and constituted a prohibited transaction.
I was happy to read this case and find the Court’s conclusions because it matches the same opinion and advice we have been giving clients regarding IRA/LLCs for nearly ten years: that a newly established LLC owned by an IRA does not constitute a prohibited transaction but the IRA/LLC cannot pay the IRA owner (or any other disqualified person) compensation for managing the IRA/LLC.
by Mat Sorensen | Oct 29, 2013 | Tax & Legal Updates and Policy Changes, Uncategorized
The SEC finally issued their proposed regulations for Crowdfunding last week in a 538 page proposed set of regulations. These regulations are open for comment for 90 days and will then go into effect in their present or modified form shortly thereafter.
Crowdfunding is the newest form of raising capital for small business or investments and it will eventually dominate as a primary method of raising capital in amounts under $1,000,000. Crowdfunding relaxes the current securities law restrictions, which make it nearly impossible for a small business or budding entrepreneur to raise capital from others. The basic premise of the Crowdfunding exemption to the securities laws is that the laws are loosened so long as the total amounts being raised are capped ($1M) and so long as each investor is only allowed to invest only a small portion of their income or net worth.
Here’s a summary of what we already knew.
- Total amount that may be raised in a Crowdfunding offering is $1,000,000.
- The company raising funds under the Crowdfunding rules must prepare disclosure and legal documents which comply with the rules.
- An investor may invest an amount between $2,000 and $100,000 depending on their annual income or net worth. This is a total for all Crowdfunding projects from that person annually.
- Crowdfunding deals must be processed through a Corwdfunding portal that acts like the title or escrow company in the transaction. Crowdfunding portals will be on-line companies registered with the SEC.
Here’s what is new in the regulations.
- Crowdfunding offerings up to $500,000 do not need to have audited financial records. Offerings over $500,000 must complete audited financials.
- Crowdfunding portals must be registered with the SEC and must also register with FINRA.
- Annual reports need to be filed with the SEC by any company that conducted a Crowdfunding offering.
- The income or net worth of an investor, which determines how much they can invest, does not have to be verified by the portal.
If you’re looking to raise capital from others in amounts under $1,000,000 you should consider a Crowdfunding offering. While the implementation process has taken nearly 2 years the end of the tunnel is in sight and Crowdfunding will be available soon.
by Mat Sorensen | Oct 15, 2013 | Uncategorized
I’ve recently received numerous e-mails from clients regarding an article written on Sovereignman.com. In the article the author states that the IRS is no longer issuing Tax IDs to IRA/LLCs. The article references word of mouth information from an attorney although the attorney’s name is not listed nor does the article reference the law, case, IRS pronouncement, or instance where this Tax ID denial has occured.
Since this article was published in August and since I’ve been asked so many times as to the authenticity of it I figured that I would respond to the rumors and let everyone know that there has been no change in the IRA/LLC structure in the Courts, in law, or in practice with the IRS. In fact, since the Sovereignman article was published in August and as early as yesterday we have been obtaining Tax ID’s for IRA/LLCs and our Tax ID application makes it very clear that an IRA is the owner of the LLC. It almost goes without saying, but don’t believe everything you read on the web and only seek tax and legal advice from those who are licensed to offer it.
If you are curious as to some of the recent cases and law on the IRA/LLC structure, please refer to my 2012 IRA/LLC legal update which can be found here.
By: Mathew Sorensen
by Mat Sorensen | Oct 1, 2013 | Uncategorized
The SEC’s final regulations implementing the JOBS Act and allowing advertising in the raising of capital went into effect last week on September 23, 2013. This is a significant change in the laws relating to the raising of capital and is one that has been discussed and written about extensively. Prior to last week all raising of capital by real estate investors or small business owners needed to consist of private methods whereby the person raising capital could only talk to persons whom they knew or had a prior relationship with. They could not make a “solicitation” for investment from anyone else without having to go and do an extensive and costly public SEC Offering.
Under the new rules in effect last week, those raising capital may now make public solicitations to anyone and may make presentations at meetings or seminars, on websites, or through social media and they don’t have to work with people they know or have a prior existing relationship with.
In order to comply with the new rule, known as Rule 506 (c), those raising capital must create offering memorandum and legal documents in accordance with the new rules and must make a notice filing to the SEC to claim compliance with the new law. Additionally, the new advertising rules will only allow those raising capital to accept funds from accredited investors. Accredited investors are those who have $1M net worth (excluding equity in residence) or $200K annual income single or $300K income married. The person raising capital must take steps to verify an accredited investors status and can’t just rely on the investor stating that they are accredited. While some offerings do allow for up to 35 unaccredited investors, the rule allowing for unaccredited investors cannot be applied when advertising has been used in the offering and as a result is not available under the new rule.
