Self-Directed IRAs and Disqualified Parties

David Moore: Hi, David Moore and Tina Colson here today from Equity Advantage, and Tina’s got some questions for me today on some different topics. Retirement topics, it sounds like.

Tina Colson: Yes. Today, we are going to be talking IRAs and disqualified parties. So…

David Moore: Fun, fun, fun stuff.

Tina Colson: Right? So we get a lot of questions regarding properties purchased with a self directed IRA, and who is the qualified party to either work on the property, or to rent the property. Disqualified parties, as we talk frequently, would be an immediate family member, such as a grandparent, a child, a spouse. However, aunts, uncles, cousins, and even a sibling is okay. Okay. To me, why? That’s my first question.

David Moore: Some senator. We all see the way it works.

Tina Colson: But secondly, thinking this through, so hypothetically speaking, what if the investor is not married, but lives with a significant other who has a contractor’s license, and even though they live in the same household, would the contractor be allowed to work on the property with their significant other paying the bill as the owner of the property? And is that going to be an issue?

David Moore: So we look at retirement accounts, we always look at two different things. So somebody comes into us and says, hey, I want to do this with my retirement money. Can I do this? We’re going to say, okay, what kind of investment do they want to make? And who are they transacting between or for the benefit of?

So rarely is the investment itself going to be a problem. An IRA, the only restrictions are collectibles, life insurance contracts, or stock and sub S-corp, and in 401k plans, it’s only collectibles. So rarely ever is the investment a problem. It’s the transaction between or for the benefit of the disqualified party that’s a problem. What been interesting over the time that we’ve been doing this now for quite a while, and I’ve had people try to do a variety of things or talk and ask about doing a variety of things.

David Moore: We’ve had people quit jobs, get access to money. We’ve talked about that. We had a new one recently that you’ve been involved with, literally getting divorced to get access to money. I’ve had people quit their job. Owners step away from their job to get access to money.

These are all situations where we’re dealing with the creation of the account, not necessarily the prohibited transaction between disqualified parties, but we look at that prohibited transaction that occurs when a disqualified party gets a benefit. The common question is, hey, Johnny went to school at ABC college, and can I use my retirement now to go buy that? Well, you can buy the building, but you can’t have Johnny in it.

Tina Colson: Correct.

David Moore: So that’s the problem. So when we look into those disqualified parties… A few years ago, we had a state take a domestic partnership, converted marriage, and you had a situation where at one level you could do things, and then the state thought they were doing these people a favor, and all it did was create a prohibitive transaction for them, because they could, before that changed, loan each other money.

So you’ve got to be very careful. I had somebody a few years back, want to buy this gal, her retirement account, her boyfriend was a hairstylist, and so they were looking at… Everybody always talks about these new properties where you’ve got the retail on the bottom and the living quarters above. Anybody watched a western lately? Okay. That concept has been around for awhile, right?

David Moore: So in that situation, she wanted to use the retirement account to buy this property, and he was going to live in it and run the business down below. First thing, she wanted to live above it. I said, well, how are you going to get to it? Well, if I put money in… No, don’t do that. So then she was going to just buy the thing and let him be in it.

And then in the middle of the transaction, what happened? They got engaged. So you went from a situation where, okay, that engagement means that at some point, you’re going to get married at some point, there’s going to be a problem.

So you’ve got to look at what you’re doing with that property. So anytime somebody walks through the door, picks up the phone, or hits those little keyboard strokes to ask us a question, we want to know what the relationship is, what’s going on, and what they want to do with this money.

David Moore: Back to your question. Could your boyfriend do work on an investment property owned by your retirement account? The answer is yes. You get married. Now you got a problem. So you got to look at that stuff, and understand where to push those lines.

In a Wall Street investment, it’s hard to commit a prohibited transaction. Virtually impossible. Now you can make horrible investment, but it’s really hard to do something that’d be considered a prohibited transaction. A truly self-directed retirement account, you have those opportunities. So you’ve got to be diligent to make sure you’re doing the right thing all the time.

David Moore: If you’ve got to check book IRA, anytime you pull that checkbook out to write a check, you’ve got to think, okay, who am I writing this to, and what’s it for? And you cannot do things that create a prohibited transaction.

Prohibited transaction, for those of you out there that don’t know, with an IRA, prohibited transaction means the entire account is taken as a distribution as of the first day in the year in which the indiscretion occurred. You don’t want to do that. 401k plans, totally different thing, only the money involved with the indiscretion.

Tina Colson: Great. So I’m going to hire my boyfriend, my son, they can work on the properties. My son, though…

David Moore: Son’s a problem.

Tina Colson: That’s another questions.

David Moore: Yep. Son can’t do it.

Tina Colson: So, he can’t do it even though he’s a separate party.

David Moore: And the thing that comes up all the time, Tina, is people, they’ll ask, they say, well, can I do this? Can I do that? And then they’ll ask, oh, we say, okay, no, your son can’t go paint the property. And your next question is, well, how’s anyone going to know? Well, if I were an auditor, first thing I’d do is take a look at the ledger for those things and say, okay, gee, you’ve got a thousand dollar paint invoice. Where’s the labor?

Tina Colson: Well, he’s a contractor. I’m going to make… you know, I’m paying my bill.

David Moore: So your next question is I’m not hiring him, I’m hiring his corporation.

Tina Colson: Correct.

David Moore: But it’s still him. So disqualified party, if you look at what Tina said earlier, disqualified parties to your retirement account would be you, your spouse, parents, grandparents, kids, grandkids, their spouses, or any legal entity owned in a controlled interest by one of those. So you’ve got to be very, very careful in what you’re doing with that stuff.

And my advice is, and some of our clients, you haven’t seen it yet, but some of our clients they’ve lived their whole life working on their properties. And when I tell them they can’t, in this context, working on their properties is in the 1031 world. But when we do the retirement account for them, and I’d say, you can’t work on it, it’s pretty funny. Sometimes they just, oh, thank you for saying that. Thanks for telling Harry I can’t work on it. That’s the bottom line. It’s nice for them, and you just got to factor that stuff into the return.

Tina Colson: Right. Absolutely. And so we have covered everything, all of my questions. And I think it’s the fine print we need to watch for as we move forward. And again, as David is saying, what is the relationship with the people that we are asking to do the work, and thank you for clarifying.

David Moore: So to wrap it up, once again, can’t transact between or for the benefit of the disqualified party, you can transact along with one. So if you want to go out and add additional funds to an investment, you might not have enough in the retirement account, you want to add personal money into that transaction, we can do that. You might have a situation where you’ve got a 1031, even.

You want to go buy bigger. You can go out and buy along with, you’d have to buy tenancy common, since the exchange requires that. You cannot exchange into or out of a partnership interest, but you can be a co-owner of a property, either jointly tenancy in common or jointly as common members of an LLC. Either way is great. The thing I always say is, the only dumb question is the one you don’t ask.

David Moore: So we offer free consultation, and my advice is call up, ask the questions. Don’t hide behind the keyboard. And it is to take us forever to get to the bottom, but if you pick up the phone, give us a call, we can typically get through something pretty quickly, and tell you whether or not what you want to do is something that’s viable.

And we’re here for you. So we like to say, we’re the guys with the answers, you work hard for your money, we work very hard to keep it yours. And I’d just like to thank you for the time today. Once again, David Moore, Tina Colson, Equity Advantage, IRA Advantage, and look forward to dealing with you, working with you in the future. Thank you.

Tina Colson: Thank you.