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Prohibited transaction


Guest Shelton
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  • 2 weeks later...

I have not seen any PT exemptions that allow an individucal to live in a house owned by their IRA. Many of the PT that would seem to stretch this concept were granted under very special circumstances and should be read before leaping to conclusions.

The link I saw did not convince me of anything but that a twisted interpretation can lead to an equally absurd result.

Purchasing an investment in something that the individual or a "related/disqaulifed, and so on" individual do not already currently have an interest in (directly or indirectly) wd seem, in and of itself, okay. What happens next is usually going to cause a self-dealing problem. Also, step transactions should also be avoided.

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There is a decison in the US tax court, Harris v. IRS, where the TC held that the ownership of a home by an IRA in which the owner resided is a PT under IRC 4975 because it was the use of IRA funds for direct benefit of a disqualified person. PT exemptions issued by DOL do not bar IRS from disqualfiying the IRA under IRC 4975 as discussed in previous posts. The persons who promulgate these bogus pt theories are counting on the fact the the IRS does not review IRA investments except on a random audit basis.

mjb

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Well said. Actually, many of PT are true, but the facts have been misrepresented to make them appear that they have wider applicability. Among other things, to get an exemption for a PT, the interests of plan participants generally would have to be adversly affected if the exemption were not granted. As I am sure you wd agree, this rarely happens in an IRA.

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mbozek--I thought that a PT exemption does give you cover under 4975. I thought that IRS delegated authority under 4975©(2) to grant exemptions to DOL. So if you get a PT aren't you covered under 4975 and since 408 incorproates 4975 aren't you covered under 408 as well?

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As discussed in the threads under the post cited by Shelton the IRS is not bound by a DOL PT if the transaction would violate the IRS PT rules. See Baizer v. IRS, 204 F3d 1231 for precedent that IRS is not bound by DOL agreement. I dont think the IRS would uphold a Dol PT which permits an IRA to invest in the owners house because the precedent in Harris v. IRS mandates the taxation of the IRA. Also I thought that ERISA does not preempt other federal laws such as the IRC.

mjb

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I guess it helps to read the posts on the linked thread.

A PTE does give cover under 4975 See DOL Reg. 2570.30(a)(ii)--Also see this from the preamble

Reorganization Plan No. 4 of 1978 (43 FR 47713, October 17, 1978, effective on December 31,1978), transferred the authority of the Secretary of the Treasury to issue exemptions under section 4975 of the Code, with certain enumerated exceptions, to the Secretary of Labor. As a result, the Secretary of Labor now possesses authority under section 4975©(2) of the Code, as well as under section 408(a) of ERISA, to issue individual and class exemption from the prohibited transaction rules of ERISA and the Code. The Secretary has delegated this authority, along with most of his other responsibilities under ERISA, to the Assistant Secretary for Pension and Welfare Benefits. See Secretary of Labor's Order 1-87, 52 FR 13139 (April 21, 1987).

My recollection that the decision in Arden Bowl referenced in the prior thread invovled the interaction of ERISA 404© with 4975 and did not involve a specific PTE issued by DOL.

I think there are distinctions--settling a fiduciary breach or other case with the DOL will not give you a "pass" settling an ERISA 502(i) penalty with DOL will not give you a pass, saying you are not a disqualified person because of operation of ERISA 404© will not give you a "pass" but getting a PTE will.

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I think the practical question is whether the DOL will issue an opinion letter that permits invesment in an asset that would violate the 4975 © rules-- e.g., IRA ownership in a residence occupied by the owner or using ira assets to issue mortgages to thrid party buyers for homes owned by the IRA owner. If IRC precedents for PTs are equally applicable under the DOL rules for issueing PTs then this issue will never arise.

mjb

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I am not sure I understand. The whole reason for getting a PTE is because unless you receive an individual exemption it is violative of 406 of ERISA and 4975.

However, I think that you are right that the DOL may not "buy off" on such a transaction but real property transactions between an IRA and an IRA's owner is one of the more frequent PTEs given.

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http://www.dol.gov/dol/pwba/public/program...ed/oednew20.htm

Go to this website and I think you will find more than 1/2 dozen regarding real estate transacitons where an IRA is the subject of the exemption or an IRA is listed in the "substantially similar" category.

This listing represents just a few of the IRA real estate PTEs, In the last six months I have been involved in two expedited PTE's where real property held by an IRA was sold to an IRA owner.

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KJ: The rulings you refer to are all involve the sale of RE by a plan/IRA to a participant/owner usually because of liquidity problems in disposing of RE. I dont see any ruling that would permit an IRA to purchase the residence of the IRA owner. If such a ruling was to be issued by the DOL (assuming that the IRS would not tax under the Harris case) then all homeowners could have their IRAs purchase their homes and pay tax deductible mortgage interest to themselves. Better yet, if a roth IRA was established there would never be any income taxation.

mjb

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As you can see from my prior post, I don't disagree with you that it would be a tough sell. My point was that IRS and DOL precedents in litigation are irrelevant. When you seek a PTE, you are acknowledging that the transaction is prohibited and that, without an exemption, you would be subject to litigaiton 4975 excise taxes and the like.

In essence, the fact that a transaction would be found by DOL or the IRS to be prohibited is a condition precedent to getting an exemption.

I am personally aware of analagous (I guess) situations in the qualified plan area involving sales and lease backs of employer office buildings, parking lots and the like.

Perhaps the IRA case is more compelling because the only one who gets "hurt" if the investment is not a good one is the "fiduciary" (i.e. the IRA own.er.)

I guess I could envision a scenario where DOL might buy off on this. Suppose a house was purchased legitmately as a rental property and was rented to unrelated third parties for a number of years. Then, the rental market goes south and the house sits vacant for a year with no renters. I suppose in that situation DOL might condone this if you had an independent appraisal as to the rental value; put in a rental escalator that mirrored the CPI; and had the house reappraised for rental value every three years or so. (I think this is the typical requirements in sale lease back situations).

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I am not sure of your hypo. Is your fact situation that the IRA owner moves into the rental house which the IRA had purchased as an investment? If the house is a poor investment now the best investment decision is to sell it and take a capital loss which can reduce capital gains and stop the mge payment. There is no capital loss for an IRA. There is no reason to assume that the price would rebound in the futureand the house would be worth more. Putting a house into an IRA makes no economic sense because of the tax benefits that are forfeited, e. g., depreciation, deduction of mge interest for amounts borrowed by the IRA, loss of capital gains/losses. Also who is going to pay for the cost of the PTE? Finally it would be incredible breach of tax policy to allow an IRA owner to pay deductible mortage interest to his own IRA.

mjb

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If the house is a poor investment now the best investment decision is to sell it and take a capital loss which can reduce capital gains and stop the mge payment. There is no capital loss for an IRA.

I don't understand this sentence it seems contraditory.

Looking at it from the IRA "investment" perspective. Is it better to sell it for loss or to keep making money on it by the IRA owner paying rent? Also my hypo involved paying rent where the IRA owned the house. It did not involve the IRA holding the mortgage

I agree with you about the cost of the PTE.

I know there are at least two situations where vacation rental property was purchased as an investment and then a PTE was granted to sell the property back to the IRA owner for his own personal vacation home. I guess I don't see that much difference between the sale back and the rental situation except that the rental invovles the additional complexity of an ongoing valuation.

As to tax consequences I know that some practitioners advise that if 1) a plan has a participant loan provision and 2) if the plan, instead of using the participant's account balance, uses a mortgage on the property as collateral, then you may have a situation where a participant can pay deductible interest to "himself".

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