Federal Judge Rules in Favor of Real Estate IRA Investor
A recent decision from a bankruptcy court in Georgia delivered some good news to Real Estate IRA owners. In the recent ruling in In Re: Cherwenka, the court upheld the right of Real Estate IRA owners to conduct due diligence, consulting and other activities in the effort to add value to their investment properties without forfeiting the tremendous asset protection benefits of the Real Estate IRAs, nor endangering the tax advantages of Real Estate IRA investing.
In 2014, Michael Cherwenka, a 50 year old Georgia resident declared personal bankruptcy under Chapter 7. He had a self-directed IRA that he used for real estate investing – particularly house flipping – as well as an annuity. Normally, both the annuity and the Real Estate IRA assets enjoyed substantial protection from the claims of creditors, under Georgia bankruptcy exemption statutes. The Real Estate IRA value was estimated to be $212,961, while the annuity with AXA Equitable was valued at $440,743.
His creditors, however, objected to the creditor exemption for the Real Estate IRA assets. Their attorneys argued that because Cherwenka was a hands-on real estate investor, who took an active role in the investment decisions of the IRA assets that a third party firm held for his benefit, the usual creditor exemption rules that apply to passive investors in conventional IRA assets like mutual funds shouldn’t apply here. They sought to have the court force the transfer of the assets to the creditor.
The court noted that Cherwenka owned at least one property in a 55-45 percent partnership with his IRA.
The creditor’s argument amounted to an assertion that Cherwenka had violated the prohibited transaction provisions under 26 U.S.C. § 4975, which should in turn disqualify the IRA and make it fair game for attachment or further collection actions. Specifically, they argued that Cherwenka personally performed work by researching and identifying the properties, appointing and approving work on the properties, and overseeing payments from his IRA custodian for the contracting work. The creditors argued that this work constituted direct or indirect services between the IRA custodian and Cherwenka, under U.S.C/ Section 4976(c)(1)(C).
The court didn’t buy it. According to the judge in the case, Mary Grace Deihl, the creditors’ legal argument required her to read the word “transaction” right out of the statute. Judge Deihl ruled that none of the services that Cherwenka performed in connection with his Real Estate IRA amounted to engaging in a transaction. He received no fees or commissions for his involvement, nor did any other party. “A transaction includes the exchange of goods or services,” ruled Deihl. ‘There is no evidence that Debtor engaged in any transaction.”
Judge Deihl went on to uphold the right of self-directed IRA owners and Real Estate IRA owners to make investment decisions concerning their IRAs. “By its very nature, Debtor, as IRA owner, is required to make decisions,” she ruled.
Creditors also argued that since Cherwenka had taken some early withdrawals from the Real Estate IRA – for which he paid the 10 percent penalty – the IRA should be disqualified on that basis as well. The Judge rejected this argument as well, since funds withdrawn from the plan no longer constitute ‘income or assets of the Plan,’ under the law.
We have many, many clients who engage in real estate investing within their IRAs, and we are gratified by this obviously correct ruling. The claims of the creditors in this case seem to us to be clearly unjustified, stretching the definition of “transaction” beyond all usefulness.
Nevertheless, the details matter – and had Cherwenka been more careless, or had not worked with an experienced custodian or third party administrator that knew the rules and how to keep Cherwenka’s personal and IRA assets strictly separated, the case could have had a very different outcome.
American IRA specializes in self-directed IRAs, especially Real Estate IRAs. If you are currently investing in real estate, precious metals, or other nonconventional assets within a retirement account, or you are interested in learning more, call us today at 866-7500-IRA(472), or visit us on the Web at www.americanira.com.
We look forward to hearing from you.