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Advanced SDIRA Topics, Law & Cases
IRC § 408(a). The Exclusive Benefit Rule requires that all investments from a retirement account must be made for the benefit of the retirement account.
Internal Revenue Manual, Section 184.108.40.206.2, Prohibited Transactions (www.irs.gov, 2013). The IRS has explained that the prohibited transaction rules and the exclusive benefit rule are related rules and that in many instances a violation of the prohibited transaction rules will also result in a violation of the Exclusive Benefit Rule.
Id. at 220.127.116.11.2. If the Exclusive Benefit Rule has been violated by an IRA, then the entire IRA is disqualified and it loses its tax exempt status.
Internal Revenue Manual, Section 18.104.22.168.3, Prohibited Transactions (www.irs.gov, 2013). There are a couple of key factors to consider in determining whether the Exclusive Benefit Rule has been violated in an IRA.
The cost of an investment must not exceed its fair market value at the time of the investment.
A fair return commensurate with the prevailing rate must be provided.
29 C.F.R. 2509.75-2. …if a transaction between a party in interest [disqualified person] and a plan [IRA] would be a prohibited transaction, then such a transaction between a party in interest and such corporation or partnership will ordinarily be a prohibited transaction if the plan may, by itself, require the corporation or partnership to engage in such transaction.
Code of Federal Regulations § 2510.3-101. Provides that assets of a company can be deemed assets of a retirement plan, and thus, the laws effecting retirement plan investments apply to the company where the plan is invested. it simply means that the Company is subject to the following restrictions, among others.
The Company must ensure that all activities, expenses, payments, and investments of the Company do not result in a prohibited transaction for any retirement plan member of the Company. In order to comply with this, the Company must know every disqualified person of a retirement plan owner and must avoid transaction between the company and any of these disqualified persons.
The Company is subject to fiduciary standards for its conduct, investments and payment of expenses. This is an extremely high standard and creates significant liability to the company and its management.
29 C.F.R. § 2510.3-101(f). The Plan Asset Rule applies to a plan when it invests into a company and when that company is owned 25% or more by retirement plans. If the Plan Asset Rule applies, the company that received the funds is subject to the same rules in its transactions as apply to an IRA (e.g. prohibited transaction rules and fiduciary responsibility/liability rules). There are numerous exceptions to the Plan Asset Rule.
Cases and Opinions
Gregory v. Helvering, 293 U.S. 465 (1935). The Step Transaction Doctrine is a legal principle applicable to structuring IRA investments and prevents an IRA owner from unfairly adding additional steps into a transaction in an effort to avoid a prohibited transaction. With regard to self directed IRA investments, the Step Transaction Doctrine typically arises when an IRA owner is trying to benefit from his or her IRA’s investments and is using a “straw person” to be part of the transaction in place of the IRA owner or other disqualified owner.
Opinion 2006-01A. Under this opinion, a self directed IRA owned 49% of an LLC (the rest was owned by a non-disqualified person) which in turn leased property to a company that was majority owned by the IRA owner. The DOL found that this would be a prohibited transaction if the IRA invested into the LLC with the intent that the company would lease to a company majority owned by a disqualified person.