Use of IRA Assets to Purchase Business Leads to Expensive Tax Mistake

Virginia Beach, VA (Law Firm Newswire) July 11, 2013 – A recent court decision illustrates the potential pitfalls of investing in “alternative” assets with an individual retirement account.

Lawrence Peek and Darrell Fleck of Colorado used assets held in their self-directed IRAs to purchase a fire-safety business. In a May 9, 2013 ruling, a judge for the U.S. Tax Court said that the pair’s actions were not allowed and effectively terminated their accounts when they made the transaction. The two now owe taxes amounting to nearly half a million dollars.

“IRA funds can be invested in a number of ways that many people do not realize,” said estate planning attorney Andrew Hook. “But the more creative you get with your IRA, the more careful you have to be not to run afoul of tax laws. The situation can get quite complicated.”

According to the ruling, in August, 2001, Peek and Fleck each used $309,000 held in their respective IRAs to purchase 50 percent shares of a corporation. That corporation then purchased Abbot Fire & Safety, a supplier of alarms and sprinklers, for $1.1 million. The purchase price included IRA assets, a bank loan, and a $200,000 promissory note personally guaranteed by Peek and Fleck and secured by their homes.

The promissory note proved to be the pair’s mistake. Federal law prohibits “any direct or indirect…lending of money or extension of credit between a retirement plan” and a “disqualified person.” Peek and Fleck were disqualified because they were custodians of their self-directed IRAs. The court ruled that their guarantees constituted an indirect extension of credit. As a result, their IRAs were terminated effective as of the date of the purchase.

The statute of limitations prevented the IRS from recovering taxes all the way back to 2001. But the court ruled that the pair must pay taxes on the capital gains they accrued when they sold the business in 2006. They each owe over $200,000 plus $45,000 in penalties. Their attorney said they have not yet decided whether to appeal.

“Those who want to explore how to make the most of their IRA by investing in alternative assets would be well-served to speak with an attorney experienced in tax and estate planning matters,” added Hook.

The elder law attorneys and estate planning lawyers at the Hook Law Center in Virginia Beach and Suffolk, help Virginia families with wills, trust & estate administration, guardianships, long term care planning, special needs planning, veterans benefits, and more.

Hook Law Center
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