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IRA Investments Are Subject to Special Investment Limitations


3/24/17

Synopsis
 
Individual retirement accounts (IRAs) are subject to special investment limitations under IRC Sections 408(a)(3) and (m), as well as the “prohibited transaction” provisions of IRC Section 4975. Failure to comply with these requirements can result in adverse tax treatment for the IRA, which in the case of a self-directed prohibited transaction causes the entire IRA to lose its tax-exempt status. 
 
Details
 
IRC Section 408(a)(3) prohibits an IRA from investing in life insurance contracts (investments in certain annuity contracts are permissible). Under IRC Section 408(m), an investment by an IRA in a “collectible” is treated as a taxable distribution from the IRA in an amount equal to the cost to the IRA for the purchase of the collectible. If an IRA experiences such a deemed distribution, if the IRA owner is then younger than age 59-1/2, he or she will also be subject to the additional 10% premature distribution tax on such amount under IRC Section 72(t). 
 
The “prohibited transaction” rules of IRC Section 4975 apply to IRAs, and where the owner or beneficiary of an IRA causes the IRA to engage in a prohibited transaction (a “self-directed” prohibited transaction), under IRC Section 408(e)(2), the entire IRA loses its tax-exempt status as of the first day of the year in which the prohibited transaction occurs, and is treated as having distributed all of its assets to the IRA owner on such day at their then fair market value.
 
If an IRA experiences such a deemed distribution, if the IRA owner is then younger than age 59-1/2, he or she will also be subject to the additional 10% premature distribution tax on such amount under IRC Section 72(t). 
 
Collectibles:
  • Works of art
  • Rugs
  • Antiques
  • Metals (exceptions apply for certain bullion, see below)
  • Gems
  • Stamps
  • Coins (exceptions apply for certain coins, see below)
  • Alcoholic beverages 
 
Exceptions for certain coins - (1) certain $50, $25, $10 or $5 fine gold coins, (2) certain “American Eagle” fine silver coins, (3) certain platinum coins, and (4) coins issued under the law of any State.
 
Exceptions for certain bullions - gold, silver, platinum or palladium bullion of a fineness equal to or exceeding the minimum fineness that a contract market requires for metals which may be delivered in satisfaction of a regulated futures contract.
 
IRA prohibited transactions:
  • Sale, exchange or leasing of any property between an IRA and a “disqualified person” (see definition below)
  • Lending of funds or other extension of credit between an IRA and a disqualified person (including the use of IRA assets as collateral for a loan to a disqualified person)
  • Furnishing of goods or services between an IRA and a disqualified person
  • Transfer to or use by or for the benefit of a disqualified person of IRA income or assets
  • An act of self-dealing by an IRA owner of IRA assets (ie, where the IRA owner deals with the income or assets of the IRA in his own interest or for his own account)
 
Disqualified persons to an IRA:
  • Owner
  • Designated beneficiary
  • Owner’s spouse
  • Owner’s or spouse’s child, son-in-law or daughter-in-law, grandchild, great grandchild, parent, grandparent, or great grandparent
  • Investment manager, trustee or custodian
  • Any entity in which any of the above own more than a 50% interest
 
What Does CohnReznick Think?
IRA owners often enter into (or come close but obtain professional tax advice to the contrary) transactions with or involving their IRAs that as a technical matter constitute (or would constitute) a prohibited transaction under IRC Section 4975. Whereas a prohibited transaction under a non-IRA plan results in a 15% excise tax, the result for a self-directed IRA (ie, where the IRA owner or beneficiary triggers the transaction) is far worse - namely, the entire IRA is deemed to have been distributed on a fully taxable basis. 
 
We often see the following self-directed prohibited transactions involving IRAs:
  • The sale of the IRA owner’s vacation home to his/her IRA
  • An IRA owner using his/her IRA as collateral for a personal loan
  • The IRA owner’s meeting a minimum investment requirement for a personal investment by also having his/her IRA make the same investment
 
Due to the extremely draconian consequences of a self-directed IRA prohibited transaction, it is critical that clients obtain advice on the permissibility of such contemplated transactions before the consummation of same.
 
Contact
For more information, or for assistance with other employee benefits or executive compensation inquiries, please contact Dana Fried, a CohnReznick National Tax Managing Director, at dana.fried@cohnreznick.com or 516-417-5064.
 
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. 
 
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