In 1986, Congress allowed individual retirement accounts (IRA) to invest in precious metals bullion. Since then, many IRA owners have purchased and held precious metals bullion coins and bars in IRAs as a hedge against inflation and to diversify their retirement assets.
This white paper summarizes the legal requirements for purchasing and holding precious metals bullion in an IRA. The focus of this white paper is on the legal requirement that a bank remain in physical possession of precious metals bullion that is held in an IRA.
As a background, collectibles are prohibited from being held in an IRA.[1] A collectible is tangible personal property such as a stamp or coin, metal or gem, wine or a work of art.[2] In form and substance, collectibles are much different than traditional IRA investments like stocks, bonds, and certificates of deposit that offer no benefit of aesthetic value, personal use or consumption. The general theory behind the prohibition on investing in collectibles is that tax-deductible IRA assets should not be used, displayed, or enjoyed by an IRA owner before retirement or early distribution. If an IRA purchases or holds a collectible, then that asset is distributed from the IRA and the assets are deemed to be a collectible. A distribution typically results in taxes and penalties assessed to the IRA owner.
Congress created a very limited exception to the prohibition on holding collectibles in an IRA when it exempted certain precious metals bullion coins and bars from the definition of a collectible.[3] Section 408(m) of the Internal Revenue Code states:
(3) Exception for certain coins and bullion.–For purposes of this subsection, the term “collectible” shall not include –
(A) any coin which is –
(i) a gold coin described in paragraph (7), (8), (9), or (10) of section 5112(a) of Title 31, United States Code[4],
(ii) a silver coin described in section 5112(e) of Title 31, United States Code[5],
(iii) a platinum coin described in section 5112(k) of Title 31, United States Code[6], or
(iv) a coin issued under the laws of any State, or
(B) any gold, silver, platinum, or palladium bullion of a fineness equal to or exceeding the minimum fineness that a contract market (as described in section 7 of the Commodity Exchange Act, 7 U.S.C. 7) requires for metals which may be delivered in satisfaction of a regulated futures contract[7],
if such bullion is in the physical possession of a trustee described under subsection (a) of this section.
This white paper seeks to clarify the final paragraph of the subsection that requires a “trustee” to be in “physical possession” of precious metals bullion held in an IRA.
A “trustee” is a “bank…or such other person who demonstrates to the satisfaction of the Secretary [of the U.S. Treasury] that the manner in which such other person will administer the [IRA] will be consistent with the requirements of this section.”[8] A “bank” is defined as: (1) any bank; (2) an insured credit union; and (3) a corporation which, under the laws of the State of its incorporation, is subject to supervision and examination by the Commissioner of Banking, or other officer of such State in charge of the administration of the banking laws of such State.[9]
To be considered “a trustee,” an entity must be a bank, a credit union, a trust company or any other regulated entity supervised and examined by the banking commission of the state in which it is established. If an entity does not fit within a category above, it cannot be a “trustee” of IRA assets.[10]
Notably, the IRS has issued guidance on the issue of whether two non-bank entities could store precious metals bullion that is held in IRAs.[11] In deciding this issue, the IRS noted that the “limited exception” that allows IRAs to invest in bullion coins and bars “applies only if a certain type of bullion is in the physical possession of the IRA trustee.” The IRS then concluded that bullion stored by a non-bank, and not by a trustee, would be considered collectibles and treated as a distribution from the IRA and subject the IRA owner to taxes and penalties.
As a corollary to the “trustee” requirement, a “trustee” must be in “physical possession” of acceptable precious metals bullion. Unlike the term “trustee,” the Internal Revenue Code does not define what “physical possession” means.
To accurately interpret what “physical possession” means, a three-step approach is required. First, the term “physical possession” must be given its ordinary and common meaning. Second, since an investment in precious metals is a very limited exception to the general rule that collectibles are prohibited from being held in an IRA, the language in this exception must be narrowly construed so that the exception does not “swallow the rule.”[12] Third, interpretation of the term “physical possession” must take into account, and be in harmony with, the legislative intent of the exception that allows IRAs to invest in precious metals bullion coins and bars.
Black’s Law Dictionary is an authoritative source of legal definitions that is useful in obtaining the meaning of physical possession, and distinguishing it from “constructive possession” of tangible personal property. Physical possession describes the actions of “a person who knowingly has direct physical control over a thing.”[13] In contrast, constructive possession describes the actions of “[a] person who, although not in actual possession, knowingly has both the power and the intention at a given time to exercise dominion or control over a thing, either directly or through another person or persons.”[14] A trustee is in physical possession of precious metals bullion if it has actual, physical control over such bullion. Constructive possession does not amount to physical possession because a trustee is merely exercising custodial control over the bullion, as opposed to being in actual, physical possession of the bullion.
As an example, if an IRA custodian were to delegate to a non-bank the responsibility of storing precious metals bullion in its custody, the “physical possession” requirement would not be met because the non-bank, and not a trustee, is in actual, physical control of bullion held in an IRA. Therefore, an IRA custodian (or any other trustee) should not delegate storage of bullion in an IRA to any party who itself does not qualify as a “trustee.”
Courts that are called upon to interpret the meaning of “physical possession” in Section 408(m) would be required to narrowly interpret that term because that term is included within an exception to the general rule that collectibles should not be held in IRAs. A narrow interpretation of the modifier “physical,” next to and in connection with the term “possession,” naturally yields a finding that a trustee must have direct physical control over bullion.
For example, if an IRA custodian leases depository space from a non-bank, and precious metals bullion stored within the leased space is exclusively handled and stored by non-bank’s employees, the IRA custodian cannot be said to be in physical possession of the bullion. This is because the non-bank’s employees maintain physical control of the bullion. Put simply, a literal and narrow interpretation of physical possession would lead to the conclusion that the IRA custodian’s metaphysical control over its leased space is not tantamount to physical possession.
Lastly, the legislative intent in requiring “physical possession” of bullion by a trustee must be examined. Section 408(m) is a very limited exception to the general prohibition on holding collectibles in an IRA. It allows an IRA to invest in certain precious metals that are unlike traditional investments because they are tangible items that are portable, durable, and liquid. These unique characteristics of bullion coins and bars underscore the need to require a regulated or Treasury-approved entity store this type of IRA asset. Without such a requirement, bullion could come into the IRA owner’s possession or be stolen – without a trace of evidence – prior to retirement or early distribution.
In conclusion, to avoid the possibility of otherwise acceptable bullion being deemed a “collectible” by the IRS (and, by extension, treated as a distribution from the IRA), the prudent course for IRA custodians, third-party administrators, and IRA owners is to deposit bullion into the custody and safekeeping of a precious metals depository that meets the Internal Revenue Code’s definition of a “bank” (i.e., a bank, credit union, or trust company). Storing in any other manner invites uncertainty to retirement planning, and it raises the distinct possibility that the retirement assets will be forfeited based on the decision to store bullion outside the physical possession of a trustee.
[1] 26 U.S.C.A. § 408(m)(1)
[2] 26 U.S.C.A. § 408(m)(2)
[3] 26 U.S.C.A. § 408(m)(3)
[4] Respectively refers to the one ounce ($50 face value), one-half ounce ($25 face value), one-fourth ounce ($10 face value), and one-tenth ounce ($5 face value) Gold American Eagle coins distributed by the United States Mint.
[5] Refers to one ounce Silver American Eagle coins distributed by the United States Mint.
[6] Refers to any platinum bullion and proof platinum coin distributed by the United States Mint.
[7] The minimum fineness requirement of each metal is as follows: Gold = 995 parts per 1,000 (99.5%); Silver = 999 parts per 1,000 (99.9%); Platinum = 999.5 parts per 1,000 (99.95%); Palladium = 999 parts per 1,000 (99.95%)
[8] 26 U.S.C.A. § 408(a)(2)
[9] 26 U.S.C.A. § 408(n)
[10] A nonbank may approved as a “nonbank trustee” if it is approved by the US Treasury upon demonstrating, among other things, that it is experienced in discharging fiduciary duties. See, 26 C.F.R. § 1.408-2(e)
[11] I.R.S. P.L.R. 200217059 (Apr. 26, 2002)
[12] See, e.g., In re Woods, 743 F.3d 689, 699 (10th Cir. 2014) (“we are guided by the interpretive principle that exceptions to a general proposition should be construed narrowly.”)
[13] Black’s Law Dictionary, 606-607 (5th Ed. 1983).
[14] Black’s Law Dictionary, 1163 (6th Ed. 1990).
About the Author:
Mat Sorensen, Esq. is a partner at KKOS Lawyers in its Phoenix, AZ office. Mat is the author The Self Directed IRA Handbook
Scott B. Schwartz, Esq., contributed to the content of this paper.