Beware of the IRA Prohibited Transaction Scam
By Garrett Sutton, Esq.
Have you ever been told you can make incredibly beneficial investments using your self-directed IRA monies? Buyer beware.
IRAs, as most people know, can offer significant tax deferrals, thus allowing for retirement accounts to grow over time. And although there is a great deal of confusion over the issue, IRAs can also offer asset protection in bankruptcy from creditors.
But you can lose these two big IRA benefits if you engage in “prohibited transactions.”
What is a prohibited transaction? It is an investment you make with your IRA that directly benefits you. To help understand why certain transactions aren’t allowed lets look at the public policy behind IRAs. Without admitting it, Congress knows that their reckless stewardship of the Social Security system has driven it towards an inexorable bankruptcy. So they provided the tax incentives for IRAs and other retirement accounts in order for Americans to have some sort of nest egg for the golden years.
Ironically, after borrowing from the Social Security system for their own budget excesses, Congress laid down the law that individuals could not act in such a profligate manner.
Do as I say, not as I do.
So prohibited transactions are those where an individual’s retirement account benefits the individual instead of staying in safer, unrelated investments that will one day hopefully improve the individual’s future nest egg.
In a recent Florida bankruptcy case, the owner of a self-directed IRA borrowed money from the account to pay off a mortgage on a property he wanted to acquire. He then personally acquired the property and sold it. This self-dealing (using the IRA to benefit him in a separate real estate deal) was deemed a prohibited transaction. As such, his IRA asset protection was lost and the creditors were able to reach and take all of his retirement account.
Not only was his asset protection lost in bankruptcy but due to the self dealing the entire IRA account became taxable to him. The loss of tax deferral and asset protection was brought about by one simple transaction.
What do you need to know here?
That there are literally hundreds of fly by night as well as seemingly legitimate firms encouraging people to engage in prohibited transactions.
You need to be wary of the firm which paints a wonderful picture of all the financially savvy moves you can make with a self directed IRA. They will charge you thousands of dollars for their package of services and leave your IRA utterly exposed to both creditors and ungodly IRS tax levies.
So when a promoter tells you that your self directed IRA can be used to start your own business you’ll know that the answer is no. The use of IRA funds for that purpose is a prohibited transaction. When the slick operator tells you that IRA monies can be used to buy a portion of a family vacation home you’ll know to hang up the phone. It just doesn’t work that way.
And know that these promoters are persistent. They can taste the $5,000 they want you to shell out for their plan that will treble your taxes and lose your asset protection. To that end they will provide you with an IRS opinion letter justifying their position. I have read such letters – and they offer nothing of the sort. What they do offer is another way for these promoters to lure in unsuspecting clients.
The IRS is just catching up with the IRA/prohibited transaction scam. Do not allow yourself to become a part of the oncoming wreckage.