Everyone these days seem to be touting the next best investment vehicle, the “self-directed IRA”.  You have more freedom to invest in what you want.  Physical gold, silver, foreign stocks, and even real estate are all options that never have been permissible to hold in traditional IRAs!  The promoters of these IRAs have been setting them up at record paces. However, many have been doing so without proper knowledge of the related tax laws that apply to such IRAs or to the limitations imposed by the ultimate custodian, which is a requirement for such account.  Guy Dabney learned this lesson the hard way.

Dabney discovered this year that the IRS may take a very different view of what you, as “the director” of such account can own.  Dabney decided he wanted to own some real estate, which if correctly arranged can be held in a self-directed IRA, so he rolled over his regular IRA into a self-directed IRA with Charles Schwab.  This is when his trouble began.

In 2008 Dabney decided he wanted to buy some raw land in Utah to add to his self-directed IRA portfolio.  He called Charles Schwab and a telephone representative told him that Charles Schwab does not allow alternative investments in IRAs.   This came as a surprise to Dabney as his research showed that the IRS allows this type of investment. Dabney thought surely the lowly representative was wrong so he decided to take the question to his CPA.

Dabney presented his research to his CPA who first told him he did not have any training or experience in retirement accounts so he could not give him an opinion one way or another.  Dabney pressed on, providing him with his research and after a long discussion he finally wore his CPA down and received the answer he was looking for, “I guess it’s okay.”  The CPA discovered that real estate was an acceptable investment per IRS guidelines so he didn’t see a problem. Yet.

In March of 2009 Dabney had his Schwab IRA wire $114,000 to the escrow company and took title of real estate in the name of “Guy M. Dabney Charles Schwab & Co. Inc. Custodian IRA”.   In 2011 Dabney received a higher offer for his Utah property so he sold the property and had the escrow agent wire the proceeds directly into his self-directed IRA marking the deposit as a “rollover”.  The trouble however, was that Schwab had issued a 1099-R for the 2009 disbursement, which Dabney does not remember receiving and it was not included in his 2009 tax return.

Of course the IRS discovered this omission and immediately sent Dabney a delinquency notice assessing tax and penalties for the withdrawal.  Dabney objected and explained that no tax was due as the investment was purchased by his Schwab IRA or at least a transfer between two IRA custodians.  The IRS did not buy this explanation of course, and asserted that it was impossible for the IRA to buy or exchange such property as Schwab’s policies strictly prohibited such investment.

Because Dabney and the IRS did not see eye to eye, the matter went to tax court.  Dabney decided to represent himself, which turns out to be his second big mistake. Remember the saying, “he who represents himself has a fool for a client!”

Dabney relied on a 2002 tax court decision where a taxpayer purchased non-publically traded stock through a direct wire from their self-directed IRA.  In this case the tax court ruled that although the IRA custodian could not have bought the stock because it was not publically traded, the taxpayer never received constructive receipt of the funds thus the ownership of the stock was assumed by the IRA.

However, Dabney’s case was different. In his case Schwab’s policies, unlike the 2002 case’s IRA custodian, strictly prohibited IRA owners from investing in alternative investments, more specifically real estate.  The court also struck down Dabney’s custodian-to-custodian argument citing that a title company is not an IRA custodian nor did he have an IRA there (which in and of itself is an impossibility).

In assessing penalties, the court was kind to Dabney. They asserted that because he acted reasonably and in good faith when he relied on his mistaken beliefs they would not assess a 20% accuracy related penalty for not reporting his IRA withdraw on his 2009 tax return.

The court did however determine that he still needed to pay the tax on the withdrawal. The 2011 wire into his IRA exceeded the maximum allowed contribution per year resulting in roughly a $7,000 penalty for each year it remained! (Considering the deposit was made in 2011 and it is 2014 that is $21,000 so far, and hopefully he will pull the excess out by the end of this year.)

This case is a clear example of why you need qualified practitioners behind you when entering into to world of finance, accounting, and tax.   And if they are in fact qualified, take their advice whether it is what you want to hear or not!

While owning real estate, gold, artwork or other non-traditional assets in your IRA can be a great investment, you need to be extremely cautious so that you do not run afoul of IRA regulations or your custodians Terms and Conditions.  Interview your custodian and ask just what investments you can or cannot own.  Ask if they maintain checkbook IRAs through an underlying LLC that is owned by your IRA.  This arrangement can give you great freedom when investing, but if your custodian does not allow such investments you could lose a substantial amount of your retirement funds to the IRS.

Contact Esquire Group for a free evaluation provided by one of our experienced asset protection professionals.  If warranted, we can implement a solid asset protection plan that we will monitor periodically to ensure it remains current as laws change.

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