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Recent Tax Court Case Highlights Importance of IRA Financial Group’s Self-Directed IRA Compliance Service

An IRA prohibited transaction issue at the center of a tax court case could have been avoided with IRA Financial Group’s self directed IRA compliance service.

A recent U.S. Tax Court decision highlights the importance of working with tax professionals before using retirement funds to make an investment involving alternative assets. In Peek Vs. Commissioner, 140 T.C. No. 12 (May 9, 2013), two Colorado taxpayers used IRA assets to help them buy a fire-safety business. In a May 9 opinion, a judge ruled that Messrs. Peek and Fleck engaged in a prohibited transaction that terminated their accounts when they bought the business. The facts of the case are that the two men each used $309,000 of assets from their respective IRAs in August 2001 to buy two 50% shares in a corporation. The corporation then paid $1.1 million to buy Abbot Fire & Safety, a provider of fire alarms, sprinkler systems and related equipment. The purchase price consisted of $400,000 of the taxpayers’ IRA assets, a bank loan and other funds, including a $200,000 promissory note personally guaranteed by the two men. The note was secured by their homes. “Based on the facts presented, if Mr. Peck and Mr. Fleck would have worked with a tax attorney at the IRA Financial Group, they would have been told immediately that this transaction would violate the IRS self-dealing rules under IRC 4975,“ stated Adam Bergman, a tax attorney with the IRA Financial Group. As a result, each owed tax of more than $225,000 plus more than $45,000 in penalties.

According to Mr. Bergman, “the prohibited transaction rules are extremely broad and the penalties extremely harsh (immediate disqualification of entire IRA plus penalty).” As a result each client of the IRA Financial Group is automatically enrolled in an IRA compliance program that allows the client to have a proposed self-directed IRA investment reviewed by a tax attorney to make sure the transaction does not violate any of the IRS prohibited transaction rules under IRC sections 408 and 4975. Mr. Bergman further states that “the IRA owner self directing his or her investments must be especially cautious in engaging in transactions that could compromise his or her best judgment or result in a direct or indirect personal benefit.”

In general, The Internal Revenue Code does not describe what a self directed IRA LLC can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits IRA disqualified persons from engaging in certain type of transactions. The purpose of these rules is to encourage the use of IRAs for accumulation of retirement savings and to prohibit those in control of IRAs from taking advantage of the tax benefits for their personal account. “The facts in Peek vs. Commissioner are such that if the plaintiffs would have sought the advice of a tax professional before engaging in the IRA investment, they would have certainly been told that their proposed transaction violated the IRS prohibited transaction rules under IRC 4975,“ stated Mr. Bergman. “This tax court case is the reason we assign a tax attorney to all of our self-directed IRA clients so they have the opportunity to have a tax professional review their transaction to confirm that it would not violate any of the IRA prohibited transaction rules,” stated Mr. Bergman.

The penalties for engaging in an IRS prohibited transaction are very harsh, according to Mr. Bergman. “If the IRA holder or IRA beneficiary engages in a transaction that violates the prohibited transaction rules set forth under Internal Revenue Code Section 4975, the individual’s IRA would lose its tax exempt status and the entire fair market value of the IRA would be treated as taxable distribution, subject to ordinary income tax. In addition, the IRA holder or beneficiary would be subject to a 15% penalty as well as a 10% early distribution penalty if the IRA holder or beneficiary is under the age of 59 1/2.”

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Posted in IRA Financial Group, Self-Directed IRA