In a recent court case, Ball v. Commissioner, also referred to as T.C. Memo. 2020-152 (download the PDF), we learn why it is important to structure an IRA investment the right way. As Mr. Ball found out, you can’t withdraw funds from a retirement account to invest without paying taxes. This is even true if you try to re-contribute the funds and gains back into the plan. In the following, we’ll explain the court case, what Mr. Ball did wrong and how you can invest the right way with IRA funds.
Ball v. Commissioner
Back in 2012, Brett Ball withdrew over $200,000 from his SEP IRA. The first distribution of $170,000 was used to fund an LLC owned by Mr. Ball, entitled Ball LLC. He then took that money and invested it into a real estate project with Petersen Development LLC. After a year, the loan was paid back with interest. The check was made out to “The Ball SEP Account.” Upon receipt, Mr. Ball contributed those funds back to his SEP IRA. He did a similar deal with another company during that same year of almost $40,000.
Mr. Ball argued that the LLC was investing on behalf of his IRA. Thus, he failed to pay taxes on the amounts withdrawn from the SEP IRA. He filled out and filed the appropriate forms for tax purposes, but did not include those withdrawals in his taxable income.
The Court disagreed with Mr. Ball’s assessment and he was forced to pay the taxes on the entire amount he withdrew from his plan. Further, since he was not yet age 59 1/2, he was hit with an additional 10% early withdrawal penalty. Taxes and penalties amassed to tens of thousands of dollars. Obviously, Mr. Ball probably wishes he never made that investment.
Be Careful with Your IRA Investments
Let’s start with where Mr. Ball went wrong. As T.C. Memo. 2020-152 explains, Mr. Ball’s actions were not within the IRS rules. As soon as he withdraw money from the SEP IRA, he essentially had two choices. The first is to roll the funds into a new retirement plan. One has 60 days to do this so the money withdrawn is not treated as a taxable distribution. The other option was to simply do nothing, which is essentially what Mr. Ball did. The funds were withdrawn from the IRA and invested in an LLC that was owned by Mr. Ball. The LLC then invested in the real estate project.
Therefore, Ball v. Commissioner shows you that you can’t simply withdraw funds from your retirement plan, invest them, and then try to put them back in without paying taxes. As soon as that 60 day window passed, the funds were deemed to be distributed from the plan. As a result, taxes (and possible penalties) become due when you file your tax return.
Mr. Ball tried to circumvent the distribution rules by not treating those IRA funds as taxable income. Of course, this was flagged and went to court. We can see Mr. Ball used those IRA funds to make an investment and returned them back to the IRA as a rollover from his LLC. I don’t think there was any intention of Mr. Ball keeping that money personally. However, because of the way he structured the investment, there was no way he would get away with not paying taxes.
The Best Way to Invest IRA Funds
Apparently, what Mr. Ball didn’t know, was that he did not have to actually distribute those funds to first fund his LLC, then invest in the real estate project. We can assume that his SEP IRA custodian would not allow an investment into a real estate project. This is not uncommon among banks and other financial institutions. If you want to invest in alternative assets, such as real estate, you need a special custodian like IRA Financial.
IRA Financial does not limit your investment choices like banks. So long as your investment is not prohibited by the IRS, you can make it! Real estate remains the most popular investment for Self-Directed IRA holders. Ball v. Commissioner would never have happened if Mr. Ball knew about the Self-Directed IRA.
If Mr. Ball would have set up a Self-Directed IRA with checkbook control, he could have rolled the IRA funds tax-free into the Self-Directed IRA account and then fund the LLC. The LLC, which is now owned by the IRA and not Mr. Ball, could have then made the real estate investment. The loan, and any interest derived from it, would go directly back into the IRA. There would be no taxes to pay and no penalties to worry about!
What the Ball Case Confirmed
Ball v. Commissioner shows the need to work with a competent and reliable company to set up your retirement plan. Because Mr. Ball was “just another client,” he ended up “expending a significant amount of time and resources” to make this investment and ended up triggering tens of thousands of dollars in unnecessary taxes and penalties.
It’s vital you work with both an IRA custodian who allows the types of investments you want to make and a financial advisor to help you along the way. You never want to hear from the IRS that you owe a huge tax bill. Give us a call at 800.472.0646 if you have any question about how the plan works.