IRA -- Leveraged Property Transferred to a 401K

[Guest John P.]

Would like to get others' feedback on an issue. There is discrepancy amongst professionals.

Person has an IRA that has purchased a property with a loan....presumably non-recourse (as required). Obviously, there is debt on the property as it has a mortgage/lien on the property.

Person wants to transfer the asset "in-kind" to a 401k. Normally, this would be no issue as an asset in kind can be rolled over to the 401K as a rollover. However, Section 4975(f)(3) seems to suggest that any property with a lien or mortgage on it cannot be brought into a qualified plan. This seems to be further buttressed by a 1993 Supreme Court 8-1 decision in the Keystone Consolidated Industries case....where they said, in short, that an encumbered property cannot be transferred into a qualified plan and there does not appear to be anything that there would be exceptions....for the situation I am referring to.

Thoughts? Thanks.

[jpod]

There is only a problem if the transferor is a disqualified person or party in interest, and I could be mistaken but I don't think an IRA is either a dp or a pii.

[Guest John P.]

Interesting, but in case I didn't make it clear, the IRA account owner (through a self-directed IRA) is a disqualified person to the IRA and the asset is being transferred to an individual plan where the only participant in the plan is the trustee of the plan. So, it is an IRA for the benefit of the person who is transferring the property to a qualified plan where the trustee and participant are the same person. I am concerned that the Keystone case I don't think it (but I could be wrong) that a differentiation is made about a DI? Your thoughts?

[Guest John P.]

Yes, just to clarify.....I believe the DI was part of the decision.

[jpod]

John P., no offense but it seems to me that this is something that is readily answerable by working through the definitions of di and pii. While I think after doing that you will conclude that neither the IRA nor the Plan is a di or pii just because the sole beneficiary of each is the same individual, I can't be 100% sure without doing that legwork (which I am not going to do).

[masteff]

I think a key difference between the John's scenario and the Supreme Court case is that in the case, the contribution was to satisfy the employer's funding obligation. http://caselaw.lp.findlaw.com/scripts/getcase.pl?court=us&vol=508&invol=152

Since the proposed rollover is not "in satisfaction of a monetary obligation", then I'd argue it doesn't count as a "sale or exchange". And thus that particular PT is side stepped.

http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics---Prohibited-Transactions

http://www.irs.gov/irm/part4/irm_04-072-011.html

Edit - sorry, was re-reading the case and 4975(f)(3) says it's treated as a "sale or exchange" if it's a transfer by a disqualified person. So then you're back to whether the individual is a disqualified person. I have a hard time accepting that the rollover is between the IRA and the QP and that the individual is not a part of the transfer. So I would say by virtue of 4975(f)(3) that it is a PT. But I'd defer to someone who can better define why the individual is not a DP in the scenario of a rollover from an IRA to a QP.

[Guest John P.]

How funny...I had typed a response to your previous comment and I must have done something wrong as it did not post. Hmm.

Anyway, it sounds as if you and I are in agreement....agree? Like you, initially, I don't believe most would believe it is a problem. However, based on the wording, I don't see how an IRA with an encumbered property can transfer the asset to a QP without it being a PT. And, for those that say the transfer is coming from the custodian and not the individual I don't believe that matters as, in my humble opinion, obviously the IRA account owner is a DI and I believe the custodian is a DI as it is providing services to the plan. Even if it wasn't, they are acting on behalf and at the request and behest of the IRA account owner.

So, I think we agree unless someone has something in writing that says otherwise, it is a PT.

[jpod]

In thinking through this again I have changed my mind. A rollover from an IRA to a Plan is, at least for 4975 purposes if not for ERISA Title I purposes, a distribution of the asset in kind from the IRA to the individual, subject to the mortgage/lien, followed by a contribution of the asset subject to the mortgage/lien to the Plan. So, moving the asset subject to the mortgage/lien into the Plan is a contribution by the individual to the Plan. However, I don't see how it is a PT because a rollover isn't satisfying any obligation which the individual has to the Plan and, therefore, is not a sale or exchange between the individual and the Plan (even if the individual is a di or pii with respect to the Plan).

[Guest John P.]

Interesting point....however, I still think it is a PT as the court case (to my knowledge) did not stipulate that it had to be meeting an obligation for it to be considered a PT. I believe the wording of the code is that any transfer of property from a DI to a qualified plan would be a PT if the property was encumbered. While the case was in reference to funding an obligation or making a contribution, the actual wording of the Court, I think, seems to suggest that it doesn't matter.....it was just that the issue was involved in the Keystone case.

I get what you are saying, but I think the wording doesn't differentiate whether it is only a problem IF it is a funding obligation?

[masteff]

However, I don't see how it is a PT because a rollover isn't satisfying any obligation which the individual has to the Plan and, therefore, is not a sale or exchange between the individual and the Plan (even if the individual is a di or pii with respect to the Plan).

By virtue of 4975(f)(3) which says

"(3) Sale or exchange; encumbered property

A transfer or {sic - I think it should be "of"} real or personal property by a disqualified person to a plan shall be treated as a sale or exchange if the property is subject to a mortgage or similar lien which the plan assumes or if it is subject to a mortgage or similar lien which a disqualified person placed on the property within the 10-year period ending on the date of the transfer."

So if we concede that person is a DP then by this special rule, it's a sale or exchange and is therefore a PT

[BG5150]

Pardon my ignorance:

What happens if the mortgage goes into default and the property reverts tot he mortgage holder? Is this an exemption to the anti-assignment rules?

[Guest John P.]

Masteff this was my comment from before...I apparently didn't post it. It may or may not be germane to the conversation.

Masteff, I agree with your point that in this case, the Court was looking at a more narrow, however, from what I read they did address the question in general as well....and, if I am reading it correctly, from the caselaw article you posted, the following (which I think says that regardless of obligation requirements)...

"The legislative history demonstrates that Congress intended 4975(f)(3) to expand, not limit, 4975©(1)(A)'s scope by extending the reach of "sale or exchange" to include contributions of encumbered property that do not satisfy funding obligations. The Commissioner's construction of 4975 is a sensible one. A transfer of encumbered property, like the transfer of unencumbered property to satisfy an obligation, has the potential to burden a plan, while a transfer of property that is neither encumbered nor satisfies a debt presents far less potential for causing loss to the plan. Pp. 161-162."

And, when going to the code, it does not differentiate (from what I saw) between as asset being transferred for contribution purposes or meeting an obligation, it just says that an encumbered property cannot be transferred into a QP.

[Guest John P.]

Here is also a thought, while may not be on point, could be a consideration to this issue...a friend of mine who is QPA mentioned this:

What if the IRA had a property with a lien/mortgage on it and the IRA is unable to make the necessary payments on the property. By rolling over the property into the 401(k) (with the attached lien), it would now make it possible for the 401(k) plan to use ITS funds to make payments....something that could be considered an arrangement to meet an obligation. On the surface, if this was permitted, it could open the doors to unlimited possible transactions, actions and results which would not meet the primary purpose of the plan...and, if the 401(k) was formed merely for this purpose, could be scrutinized accordingly. Bottom line, I am not sure that an IRA rollover exempts the account owner or the custodian from disqualified person-hood....at least I don't see that in the context of the written word.

[masteff]

John - I agree. The participant is a disqualified person with respect to at least one of the two accounts, if not both, so by 4975(f)(3), the rollover would result in a PT.