Real Estate

[Archimage]

I am seeing the new hype with a new real esate transaction involving the IRA forming an LLC that can purchase your personal real estate. I was wondering what your thoughts were in regards to this new IRA design.

[mbozek]

Tell me more about this. I thought that there is a tax CT case (Harris) which held that using your IRA to purchase your residence was a PT which disqualified the IRA. Whats the twist in this scheme? Who is the promoter?

[KJohnson]

Do you have a link to any website that talks about how you can structure this. Even if you could set up the LLC as a REOC and get around the "look through" rules, I am not sure how you get around 4975©(1)(E) and (F) if you are setting up your LLC for the purposes of this transaction.

[Archimage]

This was an article posted on Morningstar Advisor.Com written by Donald Moine on 2/18/04. The article said they can send me a list of IRS exemptions. I will try to get this list and post it.

[Archimage]

Here is the research. Let me know what you think.

IRA_Exemption_Determinations.doc

[KJohnson]

Nothing new there. Getting an exemption under ex-pro for the transaction you described would, I think, be extremely difficult to sell to DOL. This came up before on the Boards. I indicated I could imagine a situation where it MIGHT fly with good facts but Mbozek disagreed--see the following

http://benefitslink.com/boards/index.php?s...t=0entry50653

In any event, I think that based on both costs and chances of success this is impractical unless you had very unusual facts. Also I am not sure it makes that much economic sense in most situaitons as Mbozek points out.

[mbozek]

The only difference I have with KJohnson's opinion of this issue is that he believes that the DOL might approve a PT exempton allowing an IRA to purchase the owner's residence whereas I do not think it would ever be approved. The problem is that the people who write articles about having an IRA own your home have no conception of the technical and legal issues involved.

[Guest Kevin Wiggins]

The details never fully came out, but I believe a major accounting firm got slammed for promoting a similar scheme that involved using your IRA to invest in your own business. It is highly unlikely that inserting an LLC or any other entity into the transaction would make any difference from a standpoint of the PT issues. I agree that it would be quite unusual (I'm not sure it has ever happened, but I don't claim to have knowledge of every exemption granted) for the DOL to grant an exemption for a personal residence. A second home used as an investment - doubtful too, but maybe - but not a personal residence. I've obtained several exemptions and have discussed a lot of issues with the DOL that are similar to this, and I think it would be a rare exemption. Never say never - it could happen - but it certainly won't happen every day.

[mbozek]

The program you are thinking of allowed individuals to sell accounts receivable payable to business they owned to a Corp which was wholly owned by their Roth IRA at a discount. E.g. A, a cash basis taxpayer, is a consultant who holds a promissory note or contract to recieve payment of 6k in the future from one of his customers. A sells the note to Corp B which is 100% owned by A's Roth IRA for 3k. The roth IRA collects 6k in cash and A declares income of only 3k. There is no PT if the owner of an unincorporated business acts as incorporator of the business and directs the Roth IRA custodian to purchase 100% of the stock of the company as an asset of the IRA. The dividends paid by the corp will be paid tax free to the Roth.

I dont believe that there could ever be a set of facts which would permit the use of IRA assets to puchase a personal residence for the IRA owner since the primary purpose would be to benefit the owner personally by allowing him to live in the residence rent free. If the DOL approved one ruling then the promoters would solicit the millions of home owners to apply to the DOL for identical rulings for a hefty fee.

[John G]

Correct me if I am wrong, but I think the theory behind limiting all of these type of investments is that they are subject to abuse and "shenanigans" (my mother's technical term).

If the Roth account holder has any control over the assets, then it may be possible to do an end run around the maximum allowed contributions. For example, if you could buy a house with a Roth.... you could then use taxable funds to add a deck, finish the basement, update the kitchen in one year. The house might theoretically rise 100k in value and presto chango, you have goosed up your Roth by 100k, bypassing the 3K max.

You don't need to be a rocket scientist to figure out ways to convert taxable to tax free dollars that Congress never invisioned. Allowing these kinds of transactions could damage the long term survival of the basic Roth used by most people. The bad behavior at Enron severely damaged the viability of dozens of other energy firms.

The basic program works just fine for most people, especially if they start early. Note that one of the few adjustments made by Congress was to allow older couples to increase their contributions as part of a catch-up provision.

[KJohnson]

I do agree with Mbozek that there would never be a situation where DOL would agree to a PTE to let you live rent free. I am aware, however, of certain sale lease back PTEs: Accounting firm sells its building to its profit sharing plan and leases the building back from the plan at fair market value.

http://www.dol.gov/ebsa/regs/fedreg/notices/97_14559.htm

The hypo I proposed in the other thread was

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).

I am not sure that this hypo would be any more "extreme" than a sale lease back situation. Again I completely agree that the DOL would be skeptical about the "smell". I went back and looked at this one sale lease back PTE (I believe that there are one or two others) and I have posted the DOL's 12 conditions below. Not only would the "smell test" be difficult to overcome, but the conditions that would be imposed by DOL--which I am sure would be similar to those below-- would make it impractical. All that said, I am not sure given the right facts and meeting conditions similar to that below it would be "impossible" to obtain DOL's agreement.

(A) The terms and conditions of the transactions are at least as favorable to the Plan as those obtainable from unrelated parties;

(B) The Plan is represented at all times and for all purposes with respect to the Sale and the Lease by a qualified, independent fiduciary;

© The Sale is a one-time transaction for a lump sum cash payment;

(D) The purchase price is the fair market value of the Property as determined on the date of the Sale by a qualified, independent appraiser;

(E) The monthly rents paid to the Plan will be adjusted every year after the first 12 months of the Lease by an amount to reflect the greater of either a 3 percent per year increase or the most recent percentage increase in the U. S. Department of Labor Consumer Price Index;

(F) In addition, the rents initially paid under the Lease are no less than the fair market rental value of the Property as determined by a qualified, independent appraiser, and thereafter are adjusted every third year to be no less than the fair market rental value as then determined by the independent appraiser;

(G) The Lease is a triple-net lease under which the Employer as the

lessee is obligated for all expenses incurred by the Property, including all taxes and assessments, maintenance, insurance, utilities, and any other expense;

(H) The qualified, independent fiduciary of the Plan monitors and enforces compliance with the terms and conditions of the Lease and the exemption herein proposed;

(I) At all times the qualified, independent fiduciary for the Plan determines that the Lease is in the best interests of the Plan and its participants and beneficiaries, and at all times determines that there are adequate protections of the rights of the participants and beneficiaries of the Plan, and takes all the necessary steps to protect those rights;

(J) In the event the Plan sells the Property and the proceeds received from the sale plus the net rentals received for the Property are less than the Plan's cost of acquiring, holding, and maintaining the Property plus a 5 per cent per annum compounded rate of return on the cost to the Plan in acquiring, holding, and maintaining the Property, the Employer, or its successors, shall pay in cash the

difference to the Plan within 45 days of the sale;

(K) No commissions, expenses, or costs shall be incurred by thePlan from the Sale or the Lease; and

(L) At all times during the Sale and Lease, the fair market value of the Property represents less than 25 percent of the total assets of the Plan.

[mbozek]

I agree that under unusual facts in the above hypo the DOL could approve a pte for the purchase of the owners residence by the IRA. But the economic downside, e.g., payment of escaling rent, taxes, maintence fees, etc by the IRA owner, payments to independent fid during the term of the lease, payment of legal fees for PTE and cost of appraisal will deter almost all IRA owners from requesting the PTE. Finally no more than 25% of the IRA assets could be invested in the residence.

[david rigby]

"shenanigans"

To us non-lawyers, the law would be better if this were a recognized legal term.

[Guest Kevin Wiggins]

God forbid! Non-lawyers are always saying us lawyers engage in frivolous litigation. Can you imagine the litigation that would ensue over the meaning of that word if "shenanigans" became a cause of action?

[Lame Duck]

We have to earn a living somehow.