Self-Directed IRA owners, use caution when going into a partnership directly with your IRA accounts. A recent bankruptcy case has ruled that a partnership formed by a Self-Directed IRA and the IRA owner’s spouse was actually a prohibited transaction.

In the case, Kellerman, 115 AFTR 2d 2015-1944(531 B.R. 219)(Bktcy Ct AR), the judge ruled that the real purpose of a series of transactions was to enrich the Kellermans and a real estate development company they owned called Panther Mountain.

The facts of the case were as follows:

Barry Kellerman and his spouse were going through a Chapter 11 bankruptcy hearing. Each owned 50 percent of Panther Mountain directly, as opposed to via a Self-Directed IRA. However, the Kellermans pooled their Self-Directed IRA assets together with Panther Mountain funds in a partnership where the IRA contributed property, while the IRA contributed both property and cash to a project near Maumelle, Arkansas.

The partnership purchased four acres of land in August of 2007, with the objective of complementing and assisting in the development of two nearby tracts – one of 80 acres and the other of 120 acres – already owned by Panther Mountain Land Development, LLC.

As they were going through the bankruptcy hearing, the Kellermans asserted a right to a bankruptcy exemption for their IRA assets. The IRA at the time the case kicked off was estimated as worth $180,000. The Kellermans argued that the entire IRA should be protected from creditors as an exempt asset under the Bankruptcy Act.

When the arrangement came under scrutiny under prohibited transaction rules detailed in IRC 4975(c)(1)(D), it failed to meet the test. The courts then charged the Kellermans with the burden of proving that the transaction did not violate self-dealing rules.

Any time the burden of proof shifts to you, rather than to the government lawyers trying to seize your assets, things get especially hairy. You can no longer remain silent and force the government or any other plaintiff to prove its case. They’ve already met that burden. You must make an affirmative defense – and that forces you to make statements that can be used against you. If your argument fails at any point, you stand to lose the case.

And that’s what happened here: The bankruptcy trustee rejected the Kellermans’ exemption claim, and argued that when the Kellermans violated prohibited transaction rules by combining their IRA and private assets in a project designed to enrich them in the short-term, the Kellermans forfeited the creditor-protected status normally enjoyed by IRAs.

As the court looked at the details of the transaction, they found that while the two large plots of land owned by Panther Mountain could be developed separately, that last four acre purchase substantially assisted in their development. The IRA had provided the entirety of the purchase price for the four-acre plot.

The takeaway: Self-Directed IRA owners should be very cautious about partnering directly with their IRAs in any way that could result in a prohibited transaction. The entity they owned, Panther Mountain Real Estate Development, LLC, was a disqualified person under IRC 4975.

The fact that Panther Mountain was enriched in the short-term by the IRA investment effectively put a spotlight on the conflict of interest in the transaction. It would have been much better for the Kellermans to keep the IRA out of the transaction and use other capital for that last 4-acre purchase.

So be careful about using personal assets and retirement funds in the same transaction – especially in risky endeavors such as leveraged real estate projects. Had it not been for the bankruptcy, there may well have been no problem, as IRA rules do not expressly prohibit partnering with an IRA as long as you don’t violate other prohibited transaction rules.

American IRA, LLC is a leading expert on providing third party administration for Self-Directed IRA owners, as well as those owning other kinds of retirement accounts who use self-directed strategies.

To learn more about Self-Directed IRAs, call us today at 866-7500-IRA(472). Or visit us on the Web at www.americanira.com.

We look forward to working with you.