Tax expert Vern Hoven, CPA, MT discusses the challenges of self-directed IRAs using real-life scenarios, and how to legally establish Rollovers as Business Startups (ROBS).
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Vern Hoven: If we have any area that is causing a little bit of consternation for preparers, it is in the area of self-directed IRAs. Your material and the slides cover self-directed IRAs. I guess the problem that I have with self-directed IRAs are all IRAs are self-directed. I can go to Merrill Lynch or UBS, who’s ever using it, I can get on to the internet and I can change every day, what it is my mix on alternative assets. It is also known as self-directed IRA. I’m not saying that you’re going to be able to go onto the internet and self-correct what it is. Self-directed IRAs is when I go outside the custodian’s workplace and decide to do it by myself.
Because in a self-directed IRA that is truly being directed by the custodian, by the trustee, you really have to be careful about two things. Not violating prohibited transactions, I’m going to cover that in a moment. If I do self-directed, I have to annually say, what the assets are worth? That is really going to end up being difficult. If it’s for example, real estate. In a self-directed IRA, please remember the form 5498 tells us about what is the value, what’s the prohibited transaction et cetera. The specified assets that have to be valued new is quite a list as you can see on the screen.
Let me give you an example. In the Vanderbosch case, he had a SEP IRA. Took $125,000 out, put it into his personal account and then moved it to a start-up. Wait a minute. He touched the money. If he had asked the custodian to invest in a startup business and the custodian would be willing to do that, no violation. Now, we end up having $125,000 as a distribution, and therefore is going to be taxes on it. More than likely is basis is zero.
If you look at the McGaugh case, this is a taxpayer who did another self-directed IRA, ended up purchasing it through the company. Taking the money directly as a transfer but not touching it, and he did it all right and they said that there was no distribution, that he did it right. If you want to know how to do a self-directed IRA and know what the step-by-step procedures are to avoid instant taxation. Take a look at the McGaugh case, IRAs was stunned that they lost the case and they are appealing it, so you might want to watch that.
The Terry Ellis case is one that the IRS won–tax payer lost. He directed the IRA to purchase and then he took a management fee of $9,754. Prohibited transaction. The entire $319,000 from his 401(k) plan ended up being considered a taxable distribution. He owed tax plus penalties of the $319,000. He needed to pay the IRS 194,000, bad mistake.
Is there any way that you could actually do a variation off of a self-directed IRA and be able to call it a proper avoidance of prohibited transactions, it’s called ROBS. Really. Shouldn’t I just alert you to the acronym alone? Should cause just the hair on the back of your neck go up a little bit. ROBS means Rollovers as Business Startups.
You will find ROBS being encouraged by franchisors who are trying to say, “Hey, why don’t you take your retirement plan from your employor, quit and invest in my franchise and take the money from the 401(k) will tell you how to buy our franchise through a ROB.” And the material gives again a step-by-step basis of showing you how to use the ROBS to fund a franchise and not violate the prohibited transaction rules.
Here’s a taxpayer who used a ROB and didn’t follow the rules. No plan, no trustee, put the money into their own name. No, no, no and therefore that’s going to end up being a taxable event.