Technical Question IRA/Real Estate?

Question

I recently answered a question about this topic. I stated that an IRA can't own rental property "DIRECTLY". Yes, I do understand the IRS allows it. And, as we all know federal tax law does not over rule state laws. 

  But, my answer was based on something told to me by a very good tax lawyer. He stated, "an IRA is not a separate legal entity; therefore, it cannot own the property directly. However,it can own the property (meaning all of the rights to any profits). The owner of the IRA can direct what he/she wants done to the property; but, this must be done through the custodian."  Simply meaning, the owner can't even change a light bulb without the risk of losing the IRA benefits. 

  I also know about something, fairly new to me, called an IRA/LLC. I am still not sure it is legal. Yes, I know about Swanson v. Commisioner 1996. That was a very specific circumstance and it was only in a single tax court, which does not apply to the other tax court regions. I am not sure that you can form a LLC without ownership, which brings into play the "self dealing" clause for the IRA. 

  I freely admit that I  might have chose the words for my answer very poorly; yet, I still think I do have a very solid basis for my answer, assuming the tax lawyer was correct. I also made a mistake of applying the question I ask him concerning three states to a general answer. My third sin was to assume that this person wanted to manage the property. With all of that being said.

My question is...was the tax lawyer correct? And, if an IRA is truly a separate entity why can it be levied...instead of a lien against the disbursements?

 I would really would like to know if I have a misunderstanding of this situation. Oh, by the way...I am also an Enrolled Agent and have been for 15 years.

Walter J · Accepted Answer

Interesting question, Russ.  I've never run across this situation before, but it's worth discussing.

First, I believe the attorney was right, in that the IRA is not a separate entity; it does not have a tax ID number, for example.  The fact that it can be levied by a court order wouldn't change anything--other types of accounts may also be levied.

As to an IRA owning rental property, I can see a few problems.  First, the custodian must be a bank or financial institution, organizations which normally do not directly manage rental properties.  Next, IRA funds or expenditures may not be mixed with non-IRA funds, so unless the IRA was so well funded that it could meet all of the expenses of maintaining the property without additional money being needed, there would be problems.

Perhaps with care, a special IRA entity could be set up that would pass muster, and own rental property, but this would not be of use to very many people, in my view.  But again, there are alwasy some special situations.

efflandt · Answer

While an IRA is protected from most creditors, it is not protected from tax penalties or excise taxes for doing things with it that are illegal. If you, family, beneficiary, or fiduciary do any prohibited transactions, it ceases being an IRA, is considered a distribution, and therefore no longer protected.

Read through the Prohibited Transactions section of Publication 590.

Chuckie O · Answer

Just an opinion to run by your tax lawyer...

The LLC law hasn't really fully "jelled" yet. This might need to be tested in court. Perhaps it is best for someone else to be the guinea pig?

And, since it is based on state law, and each state has slightly different wrinkle on their LLCs, there might have to be a lot of court cases?

? · Answer

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Anonymous · Answer

Wow, you do have interesting questions.  I wish I could give you an answer.  Good luck.

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Technical Question IRA/Real Estate?

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