Self-Directed IRAs Under IRS Scrutiny: Successfully Clearing the Legal and Tax Minefield

Transcription

1 Self-Directed IRAs Under IRS Scrutiny: Successfully Clearing the Legal and Tax Minefield Avoiding Valuation Errors, Prohibited Transactions, and UBTI; Protecting Tax-Deferred Status WEDNESDAY, MARCH 18, 2015, 1:00-2:50 pm Eastern IMPORTANT INFORMATION This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at x10 (or x10). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Record verification codes presented throughout the seminar. If you have not printed out the Official Record of Attendance, please print it now. (see Handouts tab in Conference Materials box on left-hand side of your computer screen). To earn Continuing Education credits, you must write down the verification codes in the corresponding spaces found on the Official Record of Attendance form. Complete and submit the Official Record of Attendance for Continuing Education Credits, which is available on the program page along with the presentation materials. Instructions on how to return it are included on the form. To earn full credit, you must remain connected for the entire program. WHOM TO CONTACT For Additional Registrations: -Call Strafford Customer Service x10 (or x10) For Assistance During the Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.

2 FOR LIVE EVENT ONLY Sound Quality When listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, please immediately so we can address the problem. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

3 FOR LIVE EVENT ONLY If you have not printed the conference materials for this program, please complete the following steps: Click on the ^ symbol next to Conference Materials in the middle of the lefthand column on your screen. Click on the tab labeled Handouts that appears, and there you will see a PDF of the slides and the Official Record of Attendance for today's program. Double-click on the PDF and a separate page will open. Print the slides by clicking on the printer icon.

4 Self-Directed IRAs Under IRS Scrutiny: Successfully Clearing the Legal and Tax Minefield Mar. 18, 2015 Warren L. Baker, JD, LLM Fairview Law Group James A. Jones Self-Directed IRA Investment Institute Kristen M. Lynch Fowler White Burnett Elizabeth Trebotich Growth Equity Group

5 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 5

6 JAMES A. JONES SELF-DIRECTED IRA INVESTMENT INSTITUTE (602)

7 What is a Self-Directed IRA? A Self-Directed IRA or SDIRA is an IRA that is designed to let the IRA holder invest in alternative assets other than stocks, bonds and mutual funds. They are like any IRA in regards to IRS Publication 590 in regard to contributions, distributions, rollovers and transfers Self-Directed IRA s are available in Traditional, Roth, SEP s, I-401K s, HSA s, and Coverdell Educational Accounts James A. Jones Self-Directed IRA Investment Institute 7

8 Investment Options in a Self-Directed IRA Investment Real Estate Private Equity and Debt Precious Metals (certain metals types) Peer-2- Peer Lending Secured Promissory Notes Tax Lien Certificates Air Water Mineral Rights James A. Jones Self-Directed IRA Investment Institute 8

9 Private Equity and Debt Real Estate Asset class has traditionally represented the largest asset class. Averaging 60-70% of SDIRA s. Private Equity & Debt Is the fastest growing asset class in the last 3-4 years. Average growth rate of 25-50% James A. Jones Self-Directed IRA Investment Institute 9

10 Private Equity Private Equity Investment Private Equity and Debt Defined Is an asset class Will generally be consisting of equity securities and debt in operating companies that are not publicly traded on a stock made by a private equity firm, a venture capital firm, an angel investor, or accredited investor exchange. Note while private equity firms and venture capital firms invest other people s money. James A. Jones Self-Directed IRA Investment Institute 10

11 Reasons for Explosive Growth of Private Equity and Debt The Global Market Meltdown Has left huge opportunities for the top private equity firms using leveraged buyouts generating $ trillions in new equity and debt. The Same Meltdown Resulted in Huge Losses for Investor Savings and Retirement Funds And investor disillusionment with Wall Street investments and the move toward diversifying in alternative asset classes. SDIRA Industry Education and Growth Efforts Along with industry mergers, acquisitions and break-ups. The Emergence of Crowdfunding and Crowd Finance James A. Jones Self-Directed IRA Investment Institute 11

12 What is Crowdfunding and Crowd Finance? Online Exchanges That Matches Investors (the crowd) With Investing Opportunities Can be Equity, Debt or Peer Lending Based Can Now Advertise and Solicit Accredited Investors but not yet Non-Accredited Investors Non Credited Investors can Invest in P2P or Marketplace Opportunities James A. Jones Self-Directed IRA Investment Institute 12

13 Issues Associated with Private Equity and Debt IRS Prohibited Transactions Not nearly the same potential problems as real estate other than not investing in an LLC owned by more than 50% of a disqualified person(s). SDIRA Custodian Compliance Reviews Review the subscription agreement (investment offering) but their internal policies vary greatly in the time required. SDIRA Custodian Processing Times Time-consuming 3-step manual process of (1) opening the account, funding the new SDIRA account via transfer or rollover, and (3) Directing the Investment. James A. Jones Self-Directed IRA Investment Institute 13

14 Update on federal oversight and more legal/tax problems to consider WARREN L. BAKER JD, LLM FAIRVIEW LAW GROUP, PS 1910 FAIRVIEW AVE E., SUITE 500 SEATTLE, WA P: E:

15 Form 5498 Update and GAO Report Warren L. Baker Fairview Law Group, PS 15

16 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 Warren L. Baker Fairview Law Group, PS 16

17 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 Warren L. Baker Fairview Law Group, PS 17

18 GAO recommendations 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 employersponsored plans that get preferential tax treatment. Warren L. Baker Fairview Law Group, PS 18

19 GAO recommendations Internal Revenue Services 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 590. Warren L. Baker Fairview Law Group, PS 19

20 Slide Intentionally Left Blank

21 KRISTEN M. LYNCH FOWLER WHITE BURNETT (954)

22 Why are IRAs so important? Approximately $12 Trillion Dollars in Qualified Plans right now; Approximately $6 Trillion Dollars in IRAs; Second most popular account in households behind checking account; Comprise a large percentage of personal wealth; Special income tax and estate tax considerations; Governed by federal and state law; Beneficiaries are determined by designation form provided by the trustee/custodian. Kristen M. Lynch, Esquire Fowler White Burnett PA 22

23 Laws Impacting IRAs or QRPs: Federal Law: Income Tax Estate Tax Distribution Rules Prohibited Transaction Rules ERISA/REA if QRP Bankruptcy Law State Law: Intestacy Statutes (if no beneficiary designated) Equitable Distribution/Community Property Statutes Asset Protection Statutes/Bankruptcy (if opt out) Real Property Statutes (Statute of Uses) Business Entity Statutes (LLC, C Corp, etc.) Guardianship Statutes (Minors and Incapacity) Kristen M. Lynch, Esquire Fowler White Burnett PA 23

24 What Else Governs IRAs: IRA Agreement: Beneficiary default language (estate versus surviving spouse) Per stirpes versus per capita Pay-out options during lifetime and post-mortem; Governing Law Arbitration clauses State and Federal Banking Laws Federal Securities Laws Kristen M. Lynch, Esquire Fowler White Burnett PA 24

25 What Law Governs IRAs? Federal Law: IRC 408 and 408A Requirements IRC 401 Distribution Rules IRC 4975 Prohibited Transaction Rules Other Tax Law Income Tax, Estate Tax, GST Bankruptcy Law Private Letter Rulings, Revenue Rulings, etc. Kristen M. Lynch, Esquire Fowler White Burnett PA 25

26 IRC 408 and 408A requirements: IRA custodians and trustees must be approved by the IRS; IRA agreements must be pre-approved by the IRS, and must be updated for regulatory changes much like qualified plans whenever the government requires it; IRA agreements must contain certain standard language, but may be customized for business purposes; IRAs are either trustee d or self-directed ; Non-compliant custodians and trustees may have their approval to administer IRAs revoked. Kristen M. Lynch, Esquire Fowler White Burnett PA 26

27 IRC 401 Distribution Rules: Applies to both qualified plans and IRAs; Required distributions begin upon attainment of age 70 ½ by the IRA Owner, or upon the death of the IRA Owner, depending upon what happens first; Different rules depending on whether IRA Owner died before age 70 ½ or after; Different rules depending on whether there is a designated beneficiary or not; Different rules depending on whether the IRA is a Roth or not. Kristen M. Lynch, Esquire Fowler White Burnett PA 27

28 IRC 4975 Prohibited Transaction Rules Joint jurisdiction shared between IRS and DOL; Originally written to govern qualified plans; Prohibits transactions between IRAs and Disqualified Persons ; Prohibits self-dealing; If transaction is deemed to be prohibited, IRA that holds the investment or transaction can be deemed distributed as of January 1st of the year the transaction occurred. Kristen M. Lynch, Esquire Fowler White Burnett PA 28

29 Different Ways to Invest in Real Estate through an IRA Hold the real estate investment directly currently there is a state law issue with holding direct title; Hold the real estate investment through an LLC (preferred), C Corp or partnership. Kristen M. Lynch, Esquire Fowler White Burnett PA 29

30 A Few Basic Concepts Regarding Business Entities and IRAs An IRA is allowed to invest directly into any type of business entity except an S corporation due to S corp rules; An IRA can loan funds to anyone or any business entity other than a prohibited party; Unless leveraged investments are made through a C corporation, income will be subject to UBIT or UDFI by virtue of running a business through an IRA; Business Entities run by an IRA are subject to UBIT unless set up as a C Corporation. Kristen M. Lynch, Esquire Fowler White Burnett PA 30

31 Structural Considerations: Complexity of the transaction and nature of the investment buy and hold versus rental property versus development property; Number of transactions; Number of investors; Liability and asset protection issues. Kristen M. Lynch, Esquire Fowler White Burnett PA 31

32 Advantages of Using a Business Entity: Checkbook control by one of more of the managers of the entity; Easier and less expensive to handle changes in ownership of the investment; Easier to involve additional investors; Additional liability protection; More control. Kristen M. Lynch, Esquire Fowler White Burnett PA 32

33 Disadvantages of Using a Business Entity: Checkbook Control more chance of inadvertently commingling funds; More responsibility for the IRA owner; More expensive legal fees to establish entity, annual report filings (Fla $50); registered agent fee if necessary (typically $200-$300); filing fees for Articles of Organization; possible state taxes (ex. Delaware franchise or LLC tax). Kristen M. Lynch, Esquire Fowler White Burnett PA 33

34 How Does This Work? The IRA owner hires an attorney to form a managermanaged LLC or other business entity; The IRA owner sends the LLC Operating Agreement to the IRA custodian for approval and sign off; The IRA custodian signs the LLC Agreement as a member (for example, IRA Custodian F.B.O. John Smith IRA); Once all of the documents are executed and filed with the state, the manager of the LLC opens a checking account in the name of the LLC; The custodian wires the amount of the investment to the checking account for the LLC, and holds units of the LLC in the IRA account. Kristen M. Lynch, Esquire Fowler White Burnett PA 34

35 Who Can Invest in the Business? One IRA; Multiple IRAs for the same owner (for example, Roth & rollover); Multiple IRAs with different owners; IRA owners and their IRAs; IRA owners, their relatives, and their IRAs; Any entity or person that would not be considered a disqualified person. Kristen M. Lynch, Esquire Fowler White Burnett PA 35

36 Who is a Disqualified Person? The IRA owner; The spouse, descendant or ascendent of the IRA owner; A spouse of a descendent of the IRA owner; The trustee, custodian or other fiduciary providing services to the IRA; An entity at least 50% of which is owned (or at least 50% of the beneficial interests held) by a combination of the above; A 10% owner, officer, or director or highly compensated employee of such an entity. Kristen M. Lynch, Esquire Fowler White Burnett PA 36

37 It is a prohibited transaction to buy or sell directly between an IRA and a disqualified person, but... Co-investment is possible if it is done simultaneously because one party is not buying from the other but merely investing in the same enterprise. (DOL A); Although it is not 100% clear, it appears that if related parties own more than 50% of the enterprise, then only non-ira money may be added by additional investment; Also, it is not permissible to use IRA monies to enable a personal investment. Kristen M. Lynch, Esquire Fowler White Burnett PA 37

38 Additional Prohibited Transactions: An IRA cannot invest in a business entity in which the IRA owner or other disqualified persons already own 50% or more prior to investment by the IRA; Example: Mr. Smith would like to invest in his son s real estate development company. His son owns 60% of the business. This would be prohibited. Kristen M. Lynch, Esquire Fowler White Burnett PA 38

39 Additional Prohibited Transactions: Assets owned by the business entity cannot be used for personal use by the IRA owner or a disqualified person; Example: Mr. Smith s IRA has invested in an LLC. The IRA owns 80% of the LLC. The LLC invests in residential property in a country club community. A country club membership is given with the purchase of the real estate. Mr. Smith cannot use the country club membership personally. Kristen M. Lynch, Esquire Fowler White Burnett PA 39

40 Additional Prohibited Transactions: The IRA owner or other disqualified person cannot receive a personal benefit from the investment of the IRA in such an entity. Example: Susan Jones invests her IRA in an LLC. The LLC owns a rental apartment in Tallahassee. Mrs. Jones has a daughter that will attend FSU in the fall. Her daughter cannot rent the apartment owned by the LLC, even at fair market value. Kristen M. Lynch, Esquire Fowler White Burnett PA 40

41 Additional Prohibited Transactions: Sweat equity other than ministerial work is prohibited; Example: The John Jones IRA, Tom Jones IRA and Susan Smith Jones IRA own 100% of Jones Real Estate Investment LLC. John and Tom rent a bulldozer and clear the land themselves. This is prohibited because it is artificially inflating the return in the LLC and therefore the IRAs. A third party would be entitled to compensation for such work. Likewise, they cannot pay themselves compensation for performing this service because all parties involved are disqualified persons. Kristen M. Lynch, Esquire Fowler White Burnett PA 41

42 Additional Prohibited Transactions: Funds cannot be commingled. Example: The John Jones IRA owns 100% of Teak Tree LLC. Teak Tree LLC owns an apartment building. There is a plumbing leak in the building. Mr. Jones pays the plumber on his personal credit card and then repays himself from the LLC. This is prohibited per se although there is no intended harm. Kristen M. Lynch, Esquire Fowler White Burnett PA 42

43 Who Can be the Manager? The IRA owner or another investor who would otherwise be disqualified can be the manager so long as there is no compensation paid and the duties performed are managerial in spirit, much as one would manage a stock portfolio. If the IRA owns a minority interest in the business, some professionals believe the IRA owner could be paid to manage the Non-IRA portion of the business. The safest route is to use a third party unrelated manager for the business and pay a salary or fee. Kristen M. Lynch, Esquire Fowler White Burnett PA 43

44 Other Considerations: Most standard LLC agreements are not drafted with IRA membership in mind beware of succession provisions, compensation provisions, etc. because the LLC agreement could inadvertently require actions that might be considered prohibited. Kristen M. Lynch, Esquire Fowler White Burnett PA 44

45 Other Considerations: Use of a C corporation will avoid UBTI and UDFI but will require payment of income taxes by the corporation. Income leveraged investments through a business entity other than a C corporations are subject to tax to the extent that income is generated by debt, whether business income or passive. UBTI and UDFI are taxed to the IRA itself proportionate to the investment held by the IRA. IRAs are taxed at the trust tax rate, which is the highest tax bracket. Kristen M. Lynch, Esquire Fowler White Burnett PA 45

46 Distributions and Succession Planning? The types of investments just discussed tend to be illiquid in nature and may be problematic if distributions from the IRA are desired, or when RMDs come in to play; Since IRA interests pass by way of beneficiary designation, some of the business succession planning needs to be evidenced on the beneficiary form; Without proper planning, the death of the IRA owner may inadvertently require a purchase or sale that may be prohibited. Kristen M. Lynch, Esquire Fowler White Burnett PA 46

47 Estate Planning, Retirement Planning and Business Succession Planning Must be Coordinated: Estate Planning Addresses Various Aspects of Different Life Stages: Lifetime Planning DPOA and distribution planning; Incapacity Planning DPOA and distribution planning; Death Planning Beneficiary designation and distribution planning. Kristen M. Lynch, Esquire Fowler White Burnett PA 47

48 Without Proper Planning: The state you live in may decide who gets your assets and the outcome might surprise you; In many states, if you divorce and then die without changing your beneficiary designation, your ex-spouse will still inherit certain assets; Family members may fight over assets if your intentions are not clear; Someone may end up in charge of your business that is either inappropriate or incapable of management; Uncle Sam may become a beneficiary of your estate (and your retirement account). Kristen M. Lynch, Esquire Fowler White Burnett PA 48

49 Final Thoughts: Be sure your IRA is being left to the beneficiary of your choosing; If you own a closely held business in your IRA, make sure that you have addressed management succession by way of using a trust, a buy-sell agreement with a non-disqualified person, or some other contractual arrangement; If you are using an LLC or other form of partnership, be certain that the standard provisions in the agreement are not such as would force a prohibited transaction upon the death of one of the members or partners. Kristen M. Lynch, Esquire Fowler White Burnett PA 49

50 Slide Intentionally Left Blank

51 LIZ TREBOTICH GROWTH EQUITY GROUP (866)

52 Elizabeth Trebotich Growth Equity Group 52

53 Elizabeth Trebotich Growth Equity Group 53

54 Inside an IRA Vs. Outside Condos and Townhomes Single Family Homes = Apples Multi-Family Residences And Oranges Elizabeth Trebotich Growth Equity Group 54

55 UBTI and UDFI in an IRA UBTI is NOT prohibited in an IRA and does not risk the tax-exempt status of the client s IRA if reported properly Basic definition of UBTI meets two factors: Is the income from an ongoing trade or business? Is the ongoing trade or business unrelated to the tax-exempt (or tax-deferred) purpose Elizabeth Trebotich Growth Equity Group 55

56 How Can an IRA generate UBTI? UBTI applies to some specific types of income received within an IRA Full ownership of a pass-through business Use of IRA funds/assets to loan money to a business where the loan terms contain a profit percentage Use of IRA funds to flip properties such that the sales volume rises to the level where the properties are considered inventory IRA Publication 598 contains a complete list of income types subject to UBTI when realized within an IRA Elizabeth Trebotich Growth Equity Group 56

57 Debt-financed income can also generate UDFI (Unrelated Debt- Financed Income) UDFI arises where the IRA purchases property partially financed by debt While rental income received by the the IRA is exempt from tax reporting, the proportional part of the income is considered UDFI and is subject to current tax The pro-rata portion of expenses related to the debtfinanced income would be netted against the payments in determining taxable UDFI Elizabeth Trebotich Growth Equity Group 57

58 Elizabeth Trebotich Growth Equity Group 58

59 Elizabeth Trebotich Growth Equity Group 59

60 UDFI Tax Isn t Scary. It isn t even complicated. Using leverage in your retirement accounts allows you to use all the standard real estate write-offs such as depreciation etc. Standard Straightline Depreciation: Take the value of the asset and deduct the land cost (5% is standard for a townhome) $97,900 5% = $93,005 $93,005 / 27.5 yr standard depreciation = $3,382 1 st yr. Total Rent / income received for 1st year: $11,640 $11,640 $3, Depreciation deduction $1, Standard deduction $2, Interest expense $1, HOA (which includes insurance) $1, Tax $ Maintenance estimate for repainting etc. b/w tenants $ Management/yr 1 at 8% The IRS cannot tax a negative. Let s pretend that a few years have gone by, rents have been raised, and that negative number has become a positive $1,000. UDFI Tax is only on the leveraged portion of your income. If you are 60% financed, $600 of that thousand is subject to UDFI Tax at 15%. 15% of $600 = a whopping $90 = Elizabeth Trebotich Growth Equity Group 60

61 Passivity, Prohibited Transactions, and IRS Red Flags How to Protect Your Real Estate Investors The IRS looks at LOCAL FIRST! IRS Red Flags in Real Estate within a SDIRA: Excessive Flipping Backyard Rentals ANY personal affiliation outside of the IRA Elizabeth Trebotich Growth Equity Group 61

62 Slide Intentionally Left Blank

63 Self-Directed IRA Legal and Tax Problems Warren L. Baker Fairview Law Group, PS 13

64 Legal/Tax Problem #1: Prohibited Transactions Oops! Your IRA is invalidated! Warren L. Baker Fairview Law Group, PS 64

65 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 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! Warren L. Baker Fairview Law Group, PS 65

66 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 Warren L. Baker Fairview Law Group, PS 66

67 Recent Case Law Examples 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) Warren L. Baker Fairview Law Group, PS 67

68 Peek v. Commissioner (May 2013) The setup (2001): The business purchase: Peek SDIRA ($309k) Fleck SDIRA ($309k) FP Company (newly-formed C- Corp) Purchase Financed by: (1) $400,000 from FP Co (via SDIRAs); (2) Bank loan; and (3) $200,000 seller-financed Note. Abbott Fire & Safety Warren L. Baker Fairview Law Group, PS 68

69 Ellis v. Commissioner (October 2013) The setup (2005): The Investment: Ellis SDIRA ($320k) 98% 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 Warren L. Baker Fairview Law Group, PS 69

70 Dabney v. Commissioner (June 2014) 2008: 2009: 2011: Dabney SDIRA $114k Undeveloped Land $127k Dabney SDIRA 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 Warren L. Baker Fairview Law Group, PS 70

71 Legal/Tax Problem #2: Current Tax to IRA (UBTI/UDFI) What?! My IRA is not growing tax free! Warren L. Baker Fairview Law Group, PS

72 Income that is tax exempt to SDIRA [Assumes that the types of income listed below did not resulting from debtfinancing (i.e., the IRA or IRA/LLC did not borrow money in order to increase returns] Rent and sales proceeds from real property Interest Dividends from C Corporations Sales proceeds from C Corporation stock Royalties Income from the sale of property not held in the ordinary course of business / inventory (i.e., most capital gains are exempt). Warren L. Baker Fairview Law Group, PS 72

73 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 Warren L. Baker Fairview Law Group, PS 73

74 Active Business or Passive? KEY FACTORS: 1. 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. Warren L. Baker Fairview Law Group, PS 74