Every person who saves for retirement with a Self-Directed IRA should use this recent court ruling as a sober warning on prohibited transactions. In June of 2019, Florida’s 11th Circuit Court ruled that a man could not shield his IRA in a Chapter 7 bankruptcy because he had purchased cars and real estate in violation of the retirement plan’s rules.
The court determined that the Self-Directed IRA was no longer an IRA because of the prohibited transactions and was therefore not exempt from creditors. Under normal circumstances, IRAs–both Traditional and Roth–have an exemption of $1,000,000 from an individual’s bankruptcy estate. These exemptions apply, however, only if the plan keeps its qualified status, which this particular plan failed to do, thanks to its owner’s prohibited transactions.
What are prohibited transactions?
According to the IRS, a Self-Directed IRA that engages in a prohibited transaction ceases to be an IRA as of January 1st of the year in which the transaction takes place. The IRA loses its tax-deferred status and all of the benefits that come from it.
Prohibited transactions are those that are considered to be self-dealing or benefiting the IRA owner or a disqualified person with assets that are in the IRA.
Some examples of prohibited transactions include:
- Borrowing money from the IRA.
- Selling property to the IRA.
- Putting up the IRA as security for a loan.
- Buying property for personal use with IRA funds.
- Using the property while it’s under the retirement plan.
- Performing services for the investments in an IRA.
Who are disqualified persons?
To remain compliant when investing with your Self-Directed IRA retirement funds, you must avoid taking part in transactions with disqualified persons. The following people are considered disqualified persons:
- You and your spouse.
- Your employer.
- Your lineal ascendants and descendants and their spouses (parents, grandparents, children, grandchildren).
- Any person providing services for your plan (custodians, advisors, fiduciaries, administrators).
- Any entity (business, corporation, partnership) of which you are at least 50 percent owner, whether directly or indirectly.
Employee benefit plans have an unlimited exemption
Employer-sponsored plans, including 401(k) plans, Simplified Employee Pension plans (SEP), and Savings Incentive Match Plans (SIMPLE IRAs), have an unlimited exemption from creditors under a bankruptcy filing because they are employee benefit plans. That exemption, however, applies only to plans that maintain their qualified status.
Don’t take chances with your retirement accounts
Let the court case mentioned earlier serve as a cautionary tale. Several prohibited transactions were exposed during the bankruptcy proceedings, which resulted in the Florida man losing the status of his IRA. The rules on prohibited transactions are meant to prevent IRA account owners from conducting business for personal gain, rather than saving for retirement.
The Florida man may not have realized that the transactions in which he engaged were not allowed, but that did not stop the circuit court from ruling against him and declaring his retirement account to be non-IRA.
The potential ramifications of not following the rules on prohibited transactions and disqualified persons can be devastating. In this instance, the man’s IRA lost its tax-deferred status, and his retirement savings were left vulnerable to creditors in the bankruptcy.
Do not underestimate the importance of being aware of and following the rules on prohibited transactions. You risk losing the tax-deferred status of your IRA, which could result in hefty taxes and penalties. You could also miss out on being able to shelter your IRA if you file for bankruptcy.
Don’t take chances with your Self-Directed IRA
At American IRA, we work with Self-Directed IRAs every day, and our team is familiar with all aspects of real estate investing. Our Self-Directed IRA for Real Estate will give you the chance to invest in alternative assets such as single-family and multi-unit homes, apartment buildings, condominiums, land, commercial property, and more. These investments are an opportunity to own real estate in your retirement account, which can be an excellent tool to help you reach your retirement goals—as long as you follow the IRS guidelines!