Tax Court Slaps Down IRAs Holding 'Alternative Assets'

I read this today and though I should post it up…

Wall street Journal


A U.S. Tax Court decision offers a cautionary tale for people who want to invest individual retirement account funds in “alternative” assets, especially operating businesses.

The case involved Lawrence Peek and Darrell Fleck, two Colorado taxpayers who used IRA assets to help them buy a fire-safety business. In a May 9 opinion, a judge ruled that Messrs. Peek and Fleck engaged in forbidden actions that terminated their accounts when they bought the business.

As a result, each owes tax of more than $225,000 plus more than $45,000 in penalties. Their lawyer, Sheldon H. Smith of Bryan Cave LLP in Denver, says they haven’t decided whether to appeal.

According to the decision, the two men each used $309,000 of assets from their respective IRAs in August 2001 to buy two 50% shares in a corporation. The corporation then paid $1.1 million to buy Abbot Fire & Safety, a provider of fire alarms, sprinkler systems and related equipment.

The purchase price consisted of $400,000 of the taxpayers’ IRA assets, a bank loan and other funds, including a $200,000 promissory note personally guaranteed by the two men. The note was secured by their homes.

The Tax Court ruled that the personal guarantees were “prohibited transactions” under federal law, which forbids “any direct or indirect…lending of money or extension of credit between a retirement plan” and insiders such as Messrs. Peek and Fleck.

Although the guarantees didn’t directly involve the IRAs, the court ruled the guarantees still constituted an indirect extension of credit that terminated the accounts upon purchase of the business.

Statute of Limitations

The statute of limitations kept the Internal Revenue Service from recovering taxes as far back as 2001. But the judge ruled the IRA termination was permanent and still in effect when Messrs. Peek and Fleck sold the business in 2006.

As a result, they owed $224,000 and $243,000, respectively, in capital-gains tax on the sale and smaller amounts for 2007, plus penalties, according to the decision.

“This decision provided a broad reading of what ‘indirect’ means for prohibited IRA transactions,” says Ami Givon, a lawyer at GCA Law Partners in San Francisco who specializes in alternative-asset IRAs. The decision can be cited as precedent in future cases.

The rules already were strict, he says. Prohibited transactions that can terminate an IRA include any improper use of the account by the owner or other “disqualified person.” That includes the owner’s fiduciary, a member of his family or an entity such as a corporation, trust, partnership or estate that is 50% or more controlled by the owner or a related party.

‘Improper Use’

What is improper use? Among other things, it includes buying, selling or leasing an asset to or from an IRA; borrowing or lending money to or from your IRA; and personal use of IRA property.

According to Mr. Givon, examples of improper use include lending IRA assets to your child to buy a house or business; selling your business to an IRA; taking a camping trip on property owned by your IRA; and taking a vacation in a beach home owned by your IRA.

Owners of rental property held in IRAs should be wary of making their own improvements—such as remodeling a basement—because the value of the labor could be an “excess contribution” to the account that is penalized.

Bill Smith, a lawyer at accounting firm CBIZ MHM in Bethesda, Md., says the decision is a reminder that alternative-asset investments in IRAs “should only be considered by taxpayers with a high risk-tolerance and large transactions that support the fees for correct advice.”

After all, he says, “do you want to have to call your tax lawyer before you replace a sink?”

Write to Laura Saunders at

A version of this article appeared May 18, 2013, on page B9 in the U.S. edition of The Wall Street Journal, with the headline: Tax Court Slaps Down IRAs Holding ‘Alternative Assets’.

What the two men did clearly crossed the line into commingling personal assets and IRA assets. I don’t feel the court’s decision was wrong or really established anything new.

Random thought: To minimize the risk of losing one’s SDIRA assets, separate them into multiple IRAs - one for each investment. That way, if any single investment is ever deemed inappropriate, it’ll just cause that IRA to be terminated, and not involve assets held in other IRAs. This idea is really just the same principle as setting up separate LLCs to purchase each mobile home park, or other asset. Separation is asset protection.

Your mileage may vary,


I agree with Jefferson that this article is more of a condemnation of poor execution than a change in policy for SDIRA’s. We always recommend that people consult with a professional SDIRA adviser before taking any step, and not just follow the advice of a post on the internet or their own interpretation of something they’ve read. I know that some people take the same steps my daughter often does with her homework – namely, look on-line and go with whatever has been posted there. The problem with this strategy is that you don’t actually know the qualifications of who posted it, and whether or not it’s correct. When my daughter does that, her worst case is that she gets a lower grade. If you do that on any tax, legal or accounting issue, the end result can be extremely damaging. So while it’s OK to gloss over your research on ways to improve snoring, it’s imperative to seek professional guidance at all times concerning SDIRAs.