Self-Directed IRA Investor -- Beware!

Posted By: Larry Stone ICOR Blog & News ,

In the real estate profession, Self-Directed Individual Retirement Accounts (SDIRA)s have become popular tools for building your wealth – either tax-deferred or Roth. Recently, Congress considered limiting how one can invest in and how large of a retirement one can build with their SDIRA with the Build Back Better plan – this item is no longer included. Congress became concerned about mega-SDIRAs because of the recent news of Peter Thiel, founder of PayPal, who has a Roth IRA worth $5 billion https://www.forbes.com/sites/forbesfinancecouncil/2021/10/21/new-bill-could-throw-a-monkey-wrench-into-retirement-planning/?sh=7f0e450c730f. A bullet dodged by the SDIRA investor.

The Internal Revenue Service (IRS) has been working for years to limit the use of the SDIRA for real estate professionals. Now, they have succeeded with massive implications for anyone investing in SDIRAs – especially using the “Checkbook LLC.”  On November 18, 2022, the tax courts have established a ruling which will impact SDIRA investing - McNulty v. Commissioner, 157 TC 10. This is not proposed law and is the law today. Anyone investing in SDIRA’s should be familiar with these concepts.

The tax court said that a SDIRA must have “Independent oversight by a third-party fiduciary to track and monitor investment activities.”  A lack of oversight is “clearly inconsistent with the statutory scheme.”  They further stated that “Personal control over the IRA assets by the IRA owner is against the very nature of the IRA.” 

In this case, the taxpayer took physical control of the assets (gold). But it has implications that are wide-ranging for other asset classes. One wants to make sure one does not have “unfettered control” or “constructive receipt” of the IRA assets. Key language from the tax court is:

“An owner of a self-directed IRA may not take actual and unfettered possession of the IRA assets. It is a basic axiom of tax law that taxpayers have income when they exercise complete dominion over it. Constructive receipt occurs where funds are subject to the taxpayer's unfettered command, and she is free to enjoy them as she sees fit.”

The above clause describes a lot of the features of a checkbook LLC. Where the belief is that “I can do whatever I want as manager.”  For the SDIRA investor, what does yours say? If your SDIRA allows you “unfettered access” to the funds with “full control” to use them, you may be vulnerable to this ruling.

With this ruling, you should expect that the IRS will aggressively begin looking at SDIRA’s for compliance – especially the checkbook LLC. They will have the necessary tools to pursue these cases. During this year, the IRS is adding 4,000 additional auditors. In the upcoming Build Back Better plan, the IRS is expecting $80 billion in additional funding. One half of it ($40 billion) is dedicated to increasing their ability to audit and wring money from taxpayers. Their focus will be on the self-employed small business taxpayer – they are already covering everyone else.

With the detailed tax plan, you do not have to wait for the IRS examination to make sure you are dotting your “i’s” and crossing your “t’s”.  Our Discovery Session is designed to identify mistakes and missed opportunities in your tax situation, email us at info@coloradotaxcoach.com to begin one.