Self-directed IRAs, which allow the IRA owner to make direct
investments in real estate or in non-publicly traded corporations,
are increasingly popular. Proponents claim self-directed IRAs allow
taxpayers to own rental properties or a business inside the IRA,
enabling the owners to benefit from the anticipated higher rate of
return from those types of investments. However, a recent court
decision, Peek v. Commissioner, 140 T.C. No. 12, (May 9,
2013), illustrates the potential problems with using self-directed
In Peek, the taxpayer, Lawrence Peek, wanted to join
Darrell Fleck in 2001 to buy Abbot Fire and Safety Inc. (AFS). To
assist them in structuring the purchase of AFS, the two hired a
local CPA, who recommended a so-called IACC strategy whereby Peek
and Fleck each rolled-over IRA or 401(k) assets into new,
self-directed IRAs. The two IRAs then formed a new corporation, FP,
by each contributing $309,000 to FP in exchange for 50% ownership
interests. FP purchased AFS for $1.1 million. Part of the purchase
price, $200,000, was in the form of a note from FP to the former
owners of AFS. Peek and Fleck personally guaranteed the $200,000
In 2003 and 2004, Peek and Fleck converted their self-directed
IRAs into self-directed Roth IRAs. In 2006, FP was sold. Each Roth
IRA received $1,573,721 in 2006 and $94,471 in 2007, a substantial
return on their initial investments.
Upon audit, the IRS determined that the 2001 loan guarantees
constituted an extension of credit to the IRAs. Section 408(e)
provides that an IRA that engages in a prohibited transaction, as
defined in Section 4975, ceases to be an IRA as of the first day of
the year in which the prohibited transaction occurs. Section
4975(c)(1)(B) prohibits any "direct or indirect . . .
extension of credit" between an IRA and a disqualified person.
(The IRA owners are "disqualified persons" for this
purpose.) So, the IRS determined Fleck and Peek did not have IRAs,
Roth or otherwise; they had investment accounts. Therefore, the
amounts paid for FP in 2006 and 2007 were taxable to Fleck and
Fleck and Peek argued that they did not extend credit to the
IRAs, but rather, they extended credit to FP, which was owned by
the IRAs. The Tax Court said that they could not escape the reach
of Section 4975 so easily. Creating an entity between them and the
IRAs did not shield Fleck and Peek from being viewed as having
indirectly providing credit to the IRAs.
The IRS assessed accuracy-related penalties. Fleck and Peek
claimed the penalties should be waived because they had relied on
the advice of a CPA. But because the CPA charged a value-based fee
for his IACC strategy, the court treated him as a
"promoter" of the structure. Consequently, Fleck and Peek
were not able to rely on the CPA's opinion. Furthermore,
the CPA's memorandum did not address the issue of personal
loan guarantees, so Fleck and Peek could not be said to have relied
on his advice for taking the position on their tax returns, the
court said, sustaining the accuracy-related penalties.
Finally, the IRS asserted that Fleck and Peek had engaged in
other acts of self-dealing with their IRAs. FP hired Fleck and Peek
to perform services. FP rented real property from the families of
Fleck and Peek. The IRS said that these were also acts of
self-dealing prohibited by Section 4975. The court declined to rule
on these questions because it had already determined the IRAs had
ceased to be IRAs because of the personal loan guarantees.
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In two similar cases decided on the same day, the Ohio Board of Tax Appeals has upheld Commercial Activity Tax assessments levied upon two out-of-state retailers under Ohio’s "bright-line presence" standards.