Self-Directed IRAs and Other Interesting Retirement Plan Developments

Transcription

1 Self-Directed IRAs and Other Interesting Retirement Plan Developments WARREN L. BAKER JD, LLM F AIRVIEW LAW GROUP, PS 1910 FAIRVIEW AVE E., SUITE 500 S EATTLE, WA P: E: warren@fairviewlawgroup.com

2 PART 1: Introduction to Self-Directed IRAs 2

3 What makes a self-directed IRA ( SDIRA ) different? 3 Typical IRA Self- Directed IRA Publicly traded stocks, bonds, mutual funds, etc. Any type of investment except for life insurance, collectibles, S-Corps

4 Potential confusion: three types of SDIRAs 4 1. Brokerage firm SDIRA (traditional assets) 2. Direct SDIRA investment (nontraditional assets) 3. SDIRA owned LLC (nontraditional assets) **Focusing today on #2 and #3 above.

5 Example IRA custodians and other industry players IRA Custodians / Administrators IRA Services Trust Company Pensco Trust Company Equity Trust Company Millennium Trust Company Provident Trust Group Trust Company of America Horizon Trust Company RealTrust IRA Alternatives The Entrust Group 5 IRA/LLC Facilitators IRA Financial Group idirect Law Group Broad Financial Checkbook IRA LLC

6 Most common SDIRA investments Real estate Single family homes / rentals Multi-family Joint ventures via project entities (LLCs, partnerships) Undeveloped/raw land Lending (Promissory Notes and Deeds of Trust) Private equity / privately-held companies Precious metals 6

7 SDIRA Timeline / Investor Attitudes 2005: I hate Wall Street (Part 1) / tech crash hangover lingers / mostly rogue investors : I know something you don t know! / real estate dominates : I hate Wall Street (Part 2) / real estate is undervalued / promoters thrive : SDIRAs go mainstream / feds takes notice / compliance improves only slightly 7

8 PART 2: Self-Directed IRA Formation 8

9 Everything starts with the SDIRA custodian 9 Old IRA, 401(k), etc. Old custodian or plan administrator $$ rollover or transfer WARNING: Watch out for the new one IRA rollover per year rule! New Self- Directed IRA New custodian

10 SD IRA vs. SD IRA/LLC 10 Self- Directed IRA Self- Directed IRA $$ Custodian executes investment based on IRA owner s direction 100% of units New LLC IRA holds title to property LLC s Manager executes investment; LLC holds title to property

11 Joint Venture Example: Project LLC Setup: SDIRA or IRA/LLC invests into a Project LLC in exchange for a fractional ownership interest in the Project LLC. 11 IRA or IRA/ LLC $$$ Apartment Building Project LLC Project LLCs often have numerous investors, most of which are not SDIRAs.

12 PART 3: Self-Directed IRA Legal and Tax Problems 12

13 Legal/Tax Problem #1: 13 Prohibited Transactions Oops! Your IRA is invalidated!

14 Prohibited Transactions ( PT ) Two Step Analysis Type #1: Automatic PT Financial interaction between SDIRA or SDIRA/LLC and a disqualified person ( DP ) Direct or indirect benefit to a disqualified person 14 Type #2: Fiduciary PT Conflict of interest between fiduciary s loyalty to IRA and loyalty to another person A disqualified person does not need to be involved (e.g. IRA owner s brother, girlfriend, etc.) If PT occurs: IRA deemed 100% distributed to IRA owner as of the first day of the taxable year in which the PT occurred, not when it is discovered. OUCH!

15 Disqualified Person/Entity Automatic disqualified person IRA owner (fiduciary) / Spouse of IRA owner Anyone directly up or down in bloodline of fiduciary Entities 50%+ owned by a combination of the above people 10%+ owners and some employees of disqualified entities Divided loyalty / conflict of interest people Potential scrutiny in some situations Examples: siblings, nieces, nephews, friends, business acquaintances Transactions should be commercially reasonable 15

16 Recent Case Law Examples 16 Peek v. Commissioner, 140 T.C. No. 9 (May 9, 2013) Ellis v. Commissioner, T.C. Memo (October 29, 2013) Dabney v. Commissioner, T.C. Memo (June 5, 2014)

17 Peek v. Commissioner (May 2013) 17 The setup (2001): The business purchase: Peek SDIRA ($309k) Fleck SDIRA ($309k) FP Company (newly-formed C-Corp) Abbott Fire & Safety Purchase Financed by: (1) $400,ooo from FP Co (via SDIRAs); (2) Bank loan; and (3) $200,000 seller-financed Note.

18 Ellis v. Commissioner (October 2013) 18 Ellis SDIRA ($320k) The setup (2005): 98% The Investment: Used Car Business Unrelated person ($6k) 2% CST LLC Leased real property to CST $9,754 to Ellis for serving as General Manager CDJ LLC

19 Dabney v. Commissioner (June 2014) : 2009: 2011: Dabney IRA $114k Undeveloped Land $127k Dabney IRA Charles Schwab Lesson: no custodian consent = taxable distribution! Charles Schwab (1) Dabney reads online that IRAs can buy real estate (2) Dabney fills out distribution form with Schwab (3) Schwab wires funds directly to title company (4) Property s sale proceeds wired directly back to IRA ( rollover ) (5) Schwab issues Form 1099-R in for 2009

20 Legal/Tax Problem #2: 20 Current Tax to IRA (UBTI/UDFI) What?! My IRA is not growing tax free!

21 Income that is tax exempt to SDIRA 21 Rent and sales proceeds from real property Interest Dividends from C Corporations Royalties Sales proceeds from C Corporation stock Capital gain

22 Operating Business Problems / UBTI If SDIRA or SDIRA/LLC earns income from an operating business, income earned is unrelated business taxable income ( UBTI ) = currently taxable to IRA at trust rates. Examples: Real estate dealer / developer Direct equity investment into an already active business (if not C Corp) Joint investment into a new Project entity Key question: what is the ultimate investment being made? Disguised equity in promissory notes 22

23 Active Business or Passive? KEY FACTORS: Purpose of the property acquisition. 2. Number and regularity of sales. 3. Subdividing / improvements. 4. Sales effort. 5. Relation of activity to taxpayer s occupation. 6. Duration of ownership.

24 Debt-Financing Problems / UDFI 24 No disqualified person can be personally liable for debts of the SDIRA (or entities that it owns) Taxable income to the IRA based on the portion of the property that is debt-financed (UDFI) If UBTI or UDFI occurs, standalone IRA tax return required (Form 990T)

25 Legal/Tax Problem #3: 25 Estate Planning Sorry beneficiaries, my IRA is filled with weird stuff!

26 RMD Complications (before and after death) For pre-tax IRAs (e.g. Traditional, SEP), Required Minimum Distributions (RMD) begin at age 70 ½ Fundamental problem: Lack of liquidity What if the client has multiple pre-tax IRAs (e.g., one self-directed and one stock-based)? Value of LLC (or other assets) provided to the IRA custodian (hot button issue) Potential in-kind distributions / appraisals 26

27 Asset Management / Beneficiary Designations Management of nontraditional assets upon incapacity and after death. Immediate prohibited transaction risks 27 Beneficiary Designations: Division of illiquid assets Estate tax valuation problems reliance on custodian s records unwise IRA Trust a good idea?

28 The Ideal Self-Directed IRA Client Receptive to up-front education Organized Enough cash in IRA to execute without debt or partners Expertise in a particular area, but no personal involvement and/or potential current benefits Client does not need the funds for retirement purposes shoot for the moon attitude 28

29 PART 4: Other Interesting Retirement Account Developments 29

30 Rollover as Business Startup ( ROBS ) 30 Old IRA or other retirement plan Transfer or rollover All of 401k s cash New 401k plan (sponsored by new C- Corp) 401k owner / key employee of Corp / 5% shareholder 95% of C- Corp s stock Newlyformed C- Corporation $$ for 5% of Corp s stock Corp starts or acquires an operating/active business

31 Bankruptcy: Clark v. Rameker (June 2014) : 2001: 2010: Ruth s IRA ($450k) Ruth passes away IRA moves according to beneficiary designation form Heidi s inherited IRA Heidi s inherited IRA ($300k) (1) Heidi s pizza business fails (2) Heidi files for bankruptcy protection in 2010 (3) Heidi believes $300k IRA protected due to retirement funds exclusion (4) Supreme Court (9-0): Inherited IRAs are not protected under federal bankruptcy laws.

32 Planning Points Post-Rameker Very few states have specific bankruptcy exceptions for inherited IRAs (AZ, AK, FL, ID, MO, NC, TX, OH) 32 Standalone IRA Trust (aka: IRA Legacy Trust, IRA Preservation Trust, IRA Asset Protection Trust ) potential benefits: Protection against creditor s post-death Preserve tax-deferred benefits of IRA ( stretch going away?) Trustee oversight of nontraditional assets within IRA Even greater benefits for Roth IRA

33 IRA Rollovers: Bobrow v. Commissioner (Jan 2014) 33 IRA #1 IRA #2 IRA #3 IRA #4 (1) (2) IRA Owner Pre-Bobrow (Prop. Reg & IRS Publication 590): Once-per-year IRA rollover rule applies on an IRA-by-IRA basis. Post-Jan 1, 2015 (Bobrow & Revised Pblication 590): Once-per-year IRA rollover rule applies on an aggregate basis.

34 401(k) In-Plan Roth Conversions Roth conversion planning likely open to active participants in 401(k) plans 34 Just like IRAs, high income earners can convert as much or as little to Roth as they choose Employer plan must have a Roth 401(k) component not required to offer, but many do.

35 Form 5498 Reporting Changes Form 5498: once-per-year disclosure form from IRA custodian to IRS (similar to Form 1099 from custodian to IRA owner) IRA contributions Rollover contributions Roth IRA conversions Required Minimum Distributions (if required) Fair Market Value of IRA Effective 2015: two new boxes on Form a: Fair market value of certain specified assets 15b: Code corresponding to the type of asset listed in 15a 35

36 36

37 Form 5498 Certain Specified Assets Codes A - Stock or other ownership interest in a corporation (not publicly traded) B - Short or long-term debt obligation C - Ownership interest in a limited liability company or similar entity D - Real estate E - Ownership interest in a partnership, trust, or similar entity F - Option contract or similar product G - Other asset that does not have a readily available FMV H - More than two types of assets (listed in A through G) are held in this IRA 37

38 Government Accountability Office (GAO) Report GAO commissioned by U.S. Senate Finance Committee to look at Large Balance IRAs Preliminary report: 9000 IRAs worth more than $5 million (as of 2011) 314 IRAs worth more than $25 million (too low?) Final report: GAO (publicly released: 11/19/14), entitled IRS Could Bolster Enforcement on Multimillion Dollar Accounts, but More Direction from Congress Is Needed 38

39 GAO recommendations (part 1) Congress should consider revisiting the use of IRAs. Options: 1) The types of assets permitted in IRAs. 2) The minimum valuation for an asset purchased by an IRA. 3) The amount of assets that can be accumulated in IRAs and employer-sponsored plans that get preferential tax treatment. 39

40 GAO recommendations (part 2) IRS should consider enhancing enforcement and awareness. Options: 1) Improve IRS ability to detect prohibited transactions (e.g., fully compile and digitalize the new Form 5498 information). 2) More examination of asset valuation problems in private equity and hedge funds investments. 3) Expand statute of limitations. 4) Help taxpayers understand compliance risks by public outreach. 5) Add caution in IRS Publication

41 QUESTIONS? THANK YOU EPCSKC!! W ARREN L. BAKER JD, LLM F AIRVIEW LAW GROUP, PS P: E: warren@fairviewlawgroup.com W: FAIRVIEW AVENUE E., SUITE 500 S EATTLE, WA 98102