Houston Tax Attorney Blog
Houston Tax Attorney
Self-directed IRAs present a number of opportunities. But what if the self-directed IRA custodian chooses to limit the account holder’s options? Can the IRA account holder go around the custodian’s wishes? The recent Dabney v. Commissioner, Docket No. 14566-12, provides an example where the purchase real estate by a self-directed IRA was a taxable distribution from the IRA as the IRA custodian did not allow real estate investments.
The Facts & Procedural History
Mr. Dabney had a self-directed IRA that was held by Charles Schwab (“Schwab”) as the custodian. Schwab told Mr. Dabney that it did not permit its self-directed IRAs to invest in raw land.
Mr. Dabney contacted his CPA, who advised that this was possible. Mr. Dabney then came up with the following plan to invest in raw land:
- Have Schwab wire funds directly to the property seller,
- Take title to the property as “Guy M. Dabney Charles Schwab & Co. Inc Cust. IRA Contributory,”
- Re-sell the property for a gain, and
- Contribute the sales proceeds back to his IRA.
Mr. Dabney carried out this plan, but was not able to find a buyer for the property over the next two years.
He also did not notice that the property was originally acquired in his name, not in the name of his Schwab IRA. The title company admitted fault for mis-titling the property.
Mr. Dabney then sold the property and had the proceeds wired directly into his Schwab IRA as a rollover contribution in 2011.
Schwab issued Mr. Dabney a Form 1099-R for 2009, which indicated that Mr. Dabney had received an early distribution from his IRA. Mr. Dabney did not report this on his Form 1040 for 2009.
The IRS added the distribution to Mr. Dabney’s income and imposed an early withdrawal penalty.
Distribution from the Self-Directed IRA
Was there a distribution from Mr. Dabney’s self-directed IRA? Mr. Dabney argued that there was no distribution. He also argued that he never received or managed the funds or property purchased with the funds. These arguments are factually correct.
Mr. Dabney correctly noted that Schwab was not barred from holding real estate in its IRAs; rather, Schwab’s internal policy merely prohibited it.
The court concluded that there was a taxable distribution as the IRA plan documents did not allow investments in real estate.
Was There a Tax Free Rollover or Transfer?
Mr. Dabney also argued that this was a rollover contribution or a trustee-to-trustee transfer of funds, which are exceptions to the distribution rules.
The rollover contribution rule says that a distribution is not includible in gross income if the entire amount of the distribution an individual receives is paid into an IRA or other eligible retirement plan within 60 days of the distribution. The trustee-to-trustee transfer of funds is not considered a distribution, as the taxpayer does not have access the funds. The court concluded that neither of these exceptions applied given these facts.
It is not clear whether the court would have reached this conclusion or if Mr. Dabney’s plan would have worked had the funds been re-deposited in the IRA within 60 days of the distribution. The funds were not re-deposited within this time, so the court did not reach the issue.
Failing to Report the Early Distribution
The court did opt to not impose the accuracy-related penalty, believing that Mr. Dabney had good intent and acted in good faith. The court probably also considered the fact that Mr. Dabney could have simply used a different custodian that allowed real estate purchases and he would not have had a taxable distribution. Thus, Mr. Dabney was not penalized for doing something that he could do legally, but failed in how he went about doing it.