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Self-Directed IRA's Purchase of Real Estate Was a Taxable Distribution.
(Parker Tax Publishing June 27, 2014)

The fact that the custodian of the taxpayer's self-directed IRA did not allow IRAs to hold real property (even though applicable tax rules permit such holdings) meant that a distribution from that IRA that was used to purchase property titled in the IRA's name, was a taxable distribution. Dabney v. Comm'r, T.C. Memo. 2014-108 (6/5/14).

In 2008, Guy Dabney rolled over funds from an individual retirement account (IRA) to a preexisting self-directed IRA he had with Charles Schwab & Co., Inc. He found some real estate (the "Briand Head" property) he wanted to purchase and hold in the IRA. He conducted some Internet research and came to the conclusion that IRAs are permitted to hold real property for investment. He proceeded to have his Charles Schwab IRA purchase the Brian Head property. Before initiating the purchase, Guy called Charles Schwab's customer service line where a customer service representative informed him that Charles Schwab did not allow alternative investments, which would include the purchase and holding of real property.

On the basis of his telephone conversations with the Charles Schwab customer service representative and talks with his CPA, as well as his own research, Guy arranged what he believed to be a viable way to have his Charles Schwab IRA purchase the Brian Head property, even though Charles Schwab did not allow alternative investments. His plan was to have funds wired directly from the IRA to the seller of the Brian Head property and to have title to the property placed in the name of "Guy M. Dabney Charles Schwab & Co. Inc. Cust. IRA Contributory." He planned to then resell the property for a small gain and to contribute the proceeds from the sale back into the IRA.

In 2009, Guy, who was under 59 and 1/2 years old, bought the property with $114,000 he took from his IRA. In seeking the funds from his IRA, Guy completed a distribution request form from Charles Schwab selecting an early distribution with no known exceptions. However, Guy continued to presume that his transaction would not be classified as an early distribution. Charles Schwab wired $114,000 directly to the bank account of the company handling the property sale. Guy directed the company to name "Guy M. Dabney Charles Schwab & Co. Inc Cust. IRA Contributory" as the owner of the property. However, because of a bookkeeping error by the company, title to the property was placed in Guy's name. In 2011, Guy subsequently found a buyer for the property. It was not until the sale that he discovered that the property was incorrectly titled in his own name. Guy promptly sought and received a scrivener's affidavit from the company in which it admitted fault for the error. Guy sold the property and received $127,226 after taxes and fees.

Charles Schwab issued Guy a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for 2009. The Form 1099-R stated that he had received an early distribution of $114,000 from his Charles Schwab IRA and that no exceptions to the early distribution penalty applied.

Guy did not report the withdrawal on his Form 1040. He argued that the $114,000 withdrawal was not a taxable distribution because the withdrawal was either: (1) a purchase by the IRA, or (2) a transfer between IRA trustees. According to Guy, he acted as a conduit through which his Charles Schwab IRA purchased the property. Guy cited the holding in Ancira v. Comm'r, 119 T.C. 135 (2002), as support for his argument.

In Ancira, a taxpayer maintained a self-directed IRA. In order to direct funds from the IRA to be invested in specific assets, the taxpayer made requests by telephone to the IRA's investment adviser. When the taxpayer requested that his IRA purchase a particular company's stock, the investment adviser informed the taxpayer that, while the issuing company's stock could be held as an asset of the IRA, the custodian would not purchase the stock because the stock was not publicly traded. Subsequently, the investment adviser determined that the IRA could invest in the issuing company's stock if the custodian issued a check payable to the issuing company and the taxpayer delivered the check to the issuing company. The taxpayer used a "Distribution Request Form" to request a check made payable to the issuing company, and the custodian sent the taxpayer the requested check. The taxpayer forwarded the check to the issuing company, and the issuing company issued a stock certificate which stated that the IRA was the owner of several hundred shares of the issuing company's stock. The custodian held the stock certificates. In Ancira, the Tax Court held that there was no IRA distribution to the taxpayer.

The IRS argued that Guy's Charles Schwab IRA did not purchase the property because Charles Schwab's policies do not permit the purchase or holding of real property and that a trustee-to-trustee transfer did not occur.

The Tax Court agreed with the IRS and held that the $114,000 distribution was taxable to Guy in 2009. While IRAs are, as a statutory matter, permitted to hold real property, the Tax Court was not aware of any provision in the Code that requires an IRA trustee or custodian to give the owner of a self-directed IRA the option to invest IRA funds in any asset that is not prohibited by statute. IRA trustees and custodians generally have broad latitude to direct or limit the investment of funds in an IRA, the court noted. The court found that, in its role as an IRA trustee, Charles Schwab had the power to prohibit the purchase and holding of real property and that Guy's Charles Schwab IRA was not capable of holding real property. Thus, the court found, unlike in Ancira where the investment company authorized the IRA funds for purchase of other assets and the taxpayer directed the action, Guy did not act as an agent on behalf of Charles Schwab and that the Charles Schwab IRA did not purchase the Brian Head's property.

The court further held that because the title company to which the $114,000 was transferred was not an IRA trustee, there could be no trustee-to-trustee transfer.

Practice Tip: Had he gone about it in a different way, Guy could have achieved his goal of increasing the value of his IRA by investing in real property using funds from the IRA. The flaw was not in his intent but in his execution. Had he initiated a rollover or a trustee-to-trustee transfer of funds from his Charles Schwab IRA to a different IRA - one that permitted the purchasing and holding of real property - he would have achieved his goal without any unintended tax consequences.

OBSERVATION: The Tax Court did not enforce accuracy-related penalties because Guy had acted with reasonable cause and in good faith given his honest belief that the transaction was workable since the law permits IRAs to invest in real property, but his investment firm's policies require otherwise.

For a discussion of the use of self-directed IRA, see Parker Tax ¶134,505 (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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