A taxpayer wants to know if he can remove a limited partnership investment from his IRA account and substitute an investment of equal fair value, without generating tax consequences. My guess is that the removal of the LP from the IRA would be considered a taxable distribution and the addition of another investment would be considered an IRA contribution, potentially in excess of contribution limits. However, it's hard to know where to go to confirm this answer.

Guess we need to clarify what the individual means by "remove and substitute".

Does he mean he wants to sell the LP investment and then use the proceeds to purchase another investment? That's perfectly fine as long as it's done inside the IRA.

Does he mean move the LP from inside the IRA to outside the IRA but still in his possession? And the replacement would be something he owns outside the IRA and then would move into the IRA? Exchange of investments between an IRA and its owner is a prohibited transaction. See Q&A's 2 & 6 here: http://www.irs.gov/retirement/article/0,,id=163722,00.html

I agree with masteff....

Contributions for any IRA or ROTH are made in cash, not in stock. Just off of memory, I think there are only three ways for a stock/holding can move into an IRA or ROTH: (1) a conversion of IRA to Roth, (2) rollover of some company plan to IRA or (3) moving and IRA to IRA via direct custodial transfer.

If the LP interest is removed from the IRA the IRA owner will be taxed on FMV of LP. The LP can always be sold by the IRA and the proceeds used to purchase the new investment without any income tax. In addition, an IRA can acquire stock if the IRA owner has been granted option rights or warrants by the issuer that allows the purchase of the stock by another entity the IRA owner controls such as a trust which can include an IRA. Need to review the subscription agreement to see what is permitted.

MJB,
I just ran across this post while doing some research on another subject. It may be too old for the original poster's benefit but we run across this situation on occaision.

An IRA cannot exercise warrants it does not own. If the IRA owner owns warrants outside the IRA then he cannot contribute them to the IRA as cash contributions are required unless there is a rollover of qualified assets. The IRA owner cannot sell the warrants to his/her own IRA as that would be a PT and disqualify the IRA.

That is not true in all cases. I have reviewed several subscription agreements which under SEC rules allowed an employee who has been issued warrants or options to purchase employer stock to transfer the rights to another family member or a trust that the employee controls. The employee assigns/transfers the warrants to the IRA which can then purchase the options at the strike price from cash in the IRA. You need to check the purchase agreement to see if the employee's stock purchase rights are transferrable to the IRA.

Wouldn't that be a prohibited transaction under IRC 4975? Value is being transferred to the IRA by the Individual. It would be considered a non-cash contribution that is not a rollover in the amount of the value of the warrants at the time of the transaction. It may be allowed under the subscription agreement and the SEC but I think 4975 comes into play and at the very least a non-cash contribution.

Its not a PT if there is no a transfer of value between the IRA and the IRA owner, such as where the employer's stock purchase progam for employees allows a trust controlled by the employee to purchase stock. The employee can act as a conduit between the issuer and the IRA to facilitate a purchase of stock by the employee's IRA. In Ancira, 119 TC 6, the tax court held that an IRA owner who transmitted a check issued by the IRA custodian payable to a corporation to purchase the corporation's stock that was issued to the IRA as the owner of the shares was acting only as a conduit to facilitate the purchase because the taxpayer was exercising his right under the IRA agreement to direct investments in his IRA. Of course the IRA custodian could send the check directly to the corporation to purchase shares for the employee's IRA account.

If there is no transfer of value, what is the point of the transfer? I find it hard to believe that the individual would go to the trouble unless there was some value -- which is exactly what would make it a prohibited transaction.

That is my point exactly. Most of the time the warrant is allowing a purchase of the stock at a fixed price that is below the current market value. The difference in price is the value being transferred from the individual to the IRA.

The individual is not transferring any value to the IRA because the IRA is purchasing the stock directly from the company as is permitted under the terms of the stock purchase agreement.

If the purchase price is below market price then Value is transferred.

Under what provision of 4975 is the individual transferring value to the IRA if the IRA is purchasing directly from the issuer?

It is the implied value as stated above. The IRA account owner and the IRA account are separate entities. If the IRA account purchases the stock using the warrants owned by the account owner then there has been a defacto transfer of the ownership of the warrants between the account owner & the IRA account. The Account Owner has transferred (contributed) the warrants to the IRA account. A contribution (non-cash) or the IRA has purchased the warrants for zero value. Either way a transaction has taken place bewtween the entities. At the very least, there is an over contribution of the inkind contribution of the warrants.

Before I would allow this type of transaction, I would require a PLR with a positive response from the IRS to be received by the client.

Would anyone else out there just let this transaction go through without question?

There is no transfer between the employee and his IRA because the company is ALLOWING the employee's IRA the right to purchase its stock directly in the same manner permitted under Ancira, where the IRA custodian issued a check to the company to purchase stock to be issued in the name of the employee's IRA. Under these facts there is no transfer between the employee and the IRA.

Do you disagree with Ancria?

Are you saying that the company is issuing the warrants directly to the IRA, not the employee? Wouldn't that imply that the company was making a contribution directly to the IRA?

How is there a contribution by the employer to the IRA if the issuer allows the IRA to purchase the stock as allowed in Ancira? The employer can allow the warrants to be exercised by more than one entity. Why cant the IRA purchase the stock directly from the issuer if the stock purchase plan allows warrants to be exercised by the employee or a trust which is controlled by the employee? Again where is the PT violation?

Everything that I know about Ancira is what you have typed above. I am neither agreeing nor disagreeing, but rather trying to understand. I've simply never heard of a warrant being exercisable by anyone other than the person to whom it was granted and I'm struggling to understand how or why the company would grant a warrant to an IRA without it being considered to be a contribution to the IRA.

Maybe I can explain my point in a different way.

If the IRA did not receive the warrants by either an arms length purchase or a rollover from another plan then how is there not value transferred when the warrants are exercised by the IRA at a price below current market value. The IRA has gained the benefit of the discount afforded by the warrants. The IRA is a separate entity from the IRA owner. As K2 stated above how does the IRA get the benefit of the use of the warrants without value being transferred to the IRA.

GO back and Read Ancira HERE; ANCIRA

There is no mention of Warrants, The IRA owner instructed that a check be drawn payable directly to the company under a subscription agreement, not a warrant (discount). The funds were paid directly to the company and transmitted by the account holder to the company and the stock issued in the name of the IRA. The courts ruled that the account owner was the conduit on behalf of the IRA and no distribution took place. I agree with that. There was no value transferred as there was no discount involved.

Ancira states the principle that the employee can act as a conduit to transmit IRA funds to facilate the IRA's purchase the of stock from an issuer. There is no PT if the IRA, as permitted in Ancira purchases the stock with its own funds directly from the company under the terms of the stock purchase agreement since there is no value transferred from the employee to the IRA to facilitate the purchase.

Why cant the stock be offered by the company to the IRA at the same discount offerred to other participants? Please describe the PT, including the name of the disqualified person under IRC 4975(e)(2) in this transaction.

This is why the the tax adviosr must read the stock purchase agreement to determine if the IRA can make a direct purchase of stock from the company. If the employee has to transfer rights to the IRA in order to purchase the stock then there is a PT.

The employee acting as a conduit does not seem on point with the OP.

In the OP, the taxpayer is personally going to "remove" and "substitute" the asset. There is no mention or suggestion of acting as a conduit or subrogating rights or anything else.

Then whether acting directly or as a conduit, I think the issue of constructive receipt presents problems.

I think we agree.

My point was not with the OP but with the discussion of an IRA excercising warrants owned by the IRA account owner as an individual and whether the transfer of rights to the IRA account by the individual was a PT or at least an overcontribution in kind of the warrants to the IRA account.