Personal Guarantees for Self-Directed IRAs Are Prohibited Transactions

Published Categorized as Federal Income Tax, Retirement Accounts, Tax
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If you have a self-directed IRA, the IRA invests in LLCs, can you personally guarantee a loan for the LLC?  The court addressed this in Peek v. Commissioner, 140 T.C. 12.

Facts & Procedural History

Mr. Fleck identified a business opportunity that he intended to invest in.  Mr. Peek, Mr. Fleck’s lawyer, approached Mr. Fleck about joining the venture.

Mr. Fleck and Mr. Peek were not related to each other.

Mr. Fleck and Mr. Peek hired a CPA to structure the acquisition.  The CPA came up with a plan for Mr. Fleck and Mr. Peek to each establish a self-directed IRA, transfer funds to the IRAs from existing IRA or 401(k) plans, set up a new corporation, sell shares in the new corporation to the IRAs, and use the funds from the sale of shares to purchase the business.

The plan did not include Mr. Fleck or Mr. Peek guaranteeing loans as part of the acquisition.

Mr. Fleck and Mr. Peek executed the plan, but the deal included a $200,000 promissory note from the legal entity formed to purchase the venture to the sellers, which was secured by personal guarantees from Mr. Fleck and Mr. Peek.  The guarantees included deeds of trust being recorded for Mr. Fleck’s and Mr. Peek’s personal residences.

The venture was subsequently sold for a significant profit, which was included in Mr. Fleck’s and Mr. Peek’s IRAs.

The IRS audited Mr. Fleck’s and Mr. Peek’s individual income tax returns and made adjustments to include the profit from the sale of the venture in their gross income.

Was There A Taxable Distribution?

Was there a taxable distribution as a result of the personal guarantees?

The IRS argued that Mr. Fleck’s and Mr. Peek’s personal guaranties of the $200,000 promissory note as part of the purchase were prohibited transactions.

The taxpayers argued that the transactions were not prohibited as they were not between the plans, i.e., the IRAs, and Mr. Fleck and Mr. Peek; rather, they were between the company owned by the plans and Mr. Fleck and Mr. Peek.

The court agreed with the IRS, noting that prohibited transactions include any direct or indirect extension of credit. The court focused on the term “indirect,” to conclude that Mr. Fleck and Mr. Peek indirectly extended credit to the plans.  As a result, Mr. Fleck’s and Mr. Peek’s IRAs were deemed to have lost their tax exempt status due to the guarantees and the significant gain on the sale of the business was taxable to Mr. Fleck and Mr. Peek in the year of sale.

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