Yes. There is no doubt that it is legal to invest money within a self-directed IRA. For that matter, it’s also perfectly legal to invest in a self-directed 401(k), SIMPLE IRA, SEP IRA, and even in a self-directed Coverdell or Health Savings Account, provided you are otherwise qualified, and you observe the rules governing prohibited transactions.
There is simply nothing in the law, nor even in Internal Revenue Service Regulations that mandates that everything you invest in within an IRA or other retirement account be a bank product or registered investment or annuity.
The landmark tax court case that established the right of the individual investor to take more personal control of his or her IRA assets was the 1996 case Swanson v. Commissioner. The plaintiff formed two corporations within his IRAs, and named himself the director of both companies. But the stock ownership remained vested in the IRAs themselves. Swanson never took personal control of a single share.
Furthermore, Swanson arranged for dividends to be reinvested within the IRA. Dividends did not leave the IRA, but were left to compound within it, just as any mutual fund or bond dividends received in cash, as opposed to reinvested in the same fund or stock or DRIP program, would accrue within the IRA.
The IRS challenged the practice, and even went so far as to accuse Swanson of creating a number of “sham transactions” for the purpose of tax avoidance. But the Tax Court ruled with Swanson, saying that ownership of a closely held corporation within an IRA was not a prohibited transaction as defined in IRC Section 4975. This was because the sale of stock to Swanson’s IRA did not comprise a transfer between a disqualified persons, as defined in 4975(c)(1)(A).
What’s more, the IRS also lost its challenge to the reinvestment of dividends within the IRA.
Finally, the IRS argued that the fact that Swanson personally directed the two corporations was a violation of the law. And again, the IRS’s attorneys were struck down by the Tax Court, which ruled that simply acting as a director did not create a prohibited transaction.
Remarkably – and unusually in the case of Tax Court disputes, the Courts not only shot the IRS’s case full of holes, but also directed that they reimburse Swanson for any attorney’s fees.
Eventually, the IRS had to recognize that it had lost the ruling in its own internal memoranda – specifically, IRS Field Service Advice Memorandum 200128011, in which internal counsel for the IRS advised other IRS lawyers not to pursue other similar IRA setups.
Since then, the use of closely-held corporations, LLCs, partnerships and joint ventures within self-directed IRAs has become quite well established, both in practice and in case law, and the legality of owning closely-held entities within ones’ own IRA is no longer in doubt.
For more information, call American IRA, LLC today at 866-7500-IRA(472), or visit us online at www.americanira.com. We look forward to working with you.