INHERITED IRA U.S. SUPREME COURT CASE UPDATE & 3 OTHER IMPORTANT FACTS ON INHERITED IRAS & CREDITORS

by | Jun 24, 2014 | News

The United States Supreme Court recently issued a 9-0 opinion holding that inherited IRAs are not exempt and protected from creditors in bankruptcy. As a general rule, IRAs receive special protections from creditors and cannot be reached by the creditors of the account owner. In Clark v. Rameker Trustee, Clark inherited her mother’s large IRA upon her mother’s death. Nine years later, Clark filed bankruptcy and sought to protect the inherited IRA from the reach of her own creditors. Under the bankruptcy code, “retirement funds” are protected from the reach of creditors and may generally be kept by the owner following bankruptcy. Justice Sotomayor, who wrote the opinion of the Court, wrote that inherited IRAs (not to include spousal inherited accounts) do not constitute “retirement funds” for three reasons. First, the owner cannot continue to contribute to the account. Inherited IRAs remain in the deceased owner’s name and cannot receive additional contributions from an heir. Second, the new owner is forced to take required minimum distributions from the account under a different set of rules than typical retirement accounts. And third, the account owner may withdraw the balance at any time without a 10% early withdrawal penalty. Because of these reasons the Court held that inherited IRAs are not “retirement funds” within the meaning of IRC 408 and as a result they are not protected from creditors. Consequently, the Clark’s entire inherited IRA is subject to the claims of creditors in bankruptcy.

In addition to the Court’s ruling in Clark, it is important to note three other facts regarding inherited retirement accounts and creditors.

  1. IRAs Inherited From a Spouse. When a surviving spouse inherits a retirement plan from a deceased spouse, the surviving spouse may simply roll over the deceased spouses account into an IRA owned by the surviving spouse and the retirement funds become a new account or add to an existing account of the surviving spouse. This is different from a non-spousal inherited account that was involved in the Clark case. Spousal inherited IRA funds go into the surviving spouses own IRA and are subject to the typical retirement plan rules. Because of this, inherited spousal retirement plans funds are different than that of non-spousal inherited funds and are not subject to the Court’s holding in Clark.
  2. Certain States Specifically Protect Inherited IRAs. When in bankruptcy a debtor can seek the protection of certain assets from creditors under federal exemptions and/or they can seek the protection of certain assets (such as IRAs) under the laws of their State. Under the laws of a few states, inherited IRAs are specifically protected from creditors and as a result the Court’s opinion in Clark would likely not apply. Those states include, Arizona, Texas, and Florida.
  3. Consider an IRA Trust For Large IRAs. If you have an estate comprised of significant IRA holdings, you may be able to establish a special IRA Trust, which can be used to shelter your IRA funds from your heir’s creditors. A trust should only be listed as a beneficiary of an IRA upon careful planning and consideration as the Trust needs to contain certain provisions in order to qualify as a valid trust under retirement plan rules.

Since inherited IRAs have special rules and procedures, it is recommended that person’s with large IRAs seek the guidance and assistance of an attorney in planning their estate and retirement fund’s future. Also, if you have an inherited IRA and are considering bankruptcy, stop, consult, and plan with the proper counsel lest you lose the account to creditors.

By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook

IRA ROLLOVER ROLLER-COASTER: HOW TO ROLLOVER AN IRA FOLLOWING BOBROW AND IRS ANNOUNCEMENT 2014-15

by | May 6, 2014 | News

In a recent case known as Bobrow v. Commissioner,  the U.S. Tax Court held that an IRA owner may only conduct one 60-day IRA rollover within a one year period for all of their IRAs. This holding from the Tax Court, was in opposition to the customs of many IRA custodians, financial advisors, and to IRS Publication 590. For more on Bobrow, and the rationale from the Tax Court please check out my prior blog article here.

Following Bobrow, the IRS issued Announcement 2014-15 and stated that the IRS was going to amend its guidance to taxpayers in Publication 590 and was going to adopt the Tax Court’s position of one 60-day Rollover per IRA per year

As a result of Bobrow and IRS Announcement 2014-15, taxpayers should consider the following issues when rolling over an IRA.

  1. Trustee to Trustee Transfers – If you want to change IRA custodians, the best way is via a trustee to trustee transfer whereby your old custodian transfers your IRA funds to your new custodian. Funds are sent directly from your old IRA to your new IRA and you as the IRA owner never touch the funds. IRA owners can still do as many trustee-to-trustee transfers as they want.
  2. New Rule to be Enforced in 2015 – The One 60-Day Rollover Per One Year Period rule won’t be enforced by the IRS until 2015. So don’t stress if you’ve already conducted multiple 60-Day rollovers over multiple accounts within a one year period. That is, unless your last name isn’t Bobrow.
  3. One 60-Day Rollover per 1-Year Period, Not Per Tax Year- The new rule has been explained as One 60-Day Rollover Per Year, however, the actual code (IRC 408(d)(3)(B) states per “1-year period” from the date of the last 60 Day Rollover. As a result, don’t think of one per tax year but rather think one can be done 1-year following the last 60 Day Rollover conducted by the IRA owner.
  4. One 60-Day Rollover Per Roth IRA and One Per Traditional IRA Per 1-Year Period – Based on my analysis of the Code, individuals would be allowed one 60-Day Rollover per Traditional IRA and one per Roth IRA.  The analysis is certainly complex but I’ve tried to summarize it below. Traditional IRAs are governed by IRC 408. IRC 408(d)(3)(B) is the section which limits 60 day rollovers to one per 1 year period and this was the section the Tax Court relied on in Bobrow. Roth IRAs are governed by IRC 408A, and IRC 408A(e) is the section that enables 60-Day rollover contributions for Roth IRAs. Under, IRC 408A(e) the code allows Roth IRA qualified rollover contributions that meet the requirements of IRC 408(d)(3) [the traditional IRA code section] but specifically states that, “For purposes of IRC 408(d)(3)(B), there shall be disregarded any qualified rollover contribution from an individual retirement plan (other than a Roth IRA) to a Roth IRA.” In other words, the section enabling Roth IRA rollovers states that you only count the number of Roth IRA rollovers when considering the one-year rollover rule for a Roth IRA Rollover. As a result, even if the taxpayer had conducted a rollover of a traditional IRA in the prior twelve-month period, this rollover would not be counted in applying the one 60-Day rollover per year rule for the Roth IRA. This application of a separate One-Rollover-Per-Year  for Roth and Traditional IRAs is also the position the IRS appears to be taking. In the IRS summary of the IRA One-Rollover-Per Year Rule, the IRS explained the One-60 Day Rollover per IRA rule for traditional IRAs and then stated that, “A similar limitation would apply to Roth IRAs.” Rather than lumping the Roth IRAs into Traditional IRAs for purposes of the rule, the IRS seems to be treating them separately. It would be nice though if they could be more clear on this issue before 2015 “rolls” around.

So, in sum, always opt for trustee-to-trustee transfers of IRA funds (where possible) and avoid taking a 60-Day Rollover from an IRA unless you are certain you have not conducted one in the prior 1-year period.

60 DAY IRA ROLLOVERS: TAX COURT SAYS DON’T FOLLOW IRS GUIDANCE

by | Mar 18, 2014 | News

A recent U.S. Tax Court case, Bobrow v. Commisioner, T.C. Memo 2014-21, held that a taxpayer may only conduct one 60-day rollover of retirement plan funds per 1-year period. The Court’s opinion was a drastic change from what most taxpayers and professionals understood and from what the IRS has explained in its own publications.

The relevant facts of Bobrow are as follows. Mr. Bobrow conducted two 60-day rollovers in a 1-year period with two separate IRA accounts. He received both sums of money personally and paid them back into his two respective IRAs each within 60 days. Mr. Bobrow, presumably, believed that since he had two different IRAs that he could do two separate 60-day rollovers with those accounts without having either account subject to withdrawal. While Mr. Bobrow relied on a commonly accepted practice that was supported clearly by IRS guidance, the Tax Court disagreed based on the language of IRC 408 (d)(3)(B).

A 60-day rollover is often used by retirement account owners who temporarily roll-over money to themselves personally from their existing retirement account and re-deposit the funds into a new custodian’s retirement account within 60 days.  A 60-day rollover, however, is not to be confused with a trustee to trustee transfer or even a direct rollover, whereby retirement account funds are sent from the prior custodian or trustee of the retirement account funds to the new custodian or trustee. These types of transactions can be done as many times as an account owner desires and do not result in a retirement account owner’s personal receipt of retirement account funds or withdrawal under the tax rules. A 60-day rollover, on the other hand, is sent to the retirement account owner in their own name and can be deposited and used by the retirement account owner during the 60-day period so long as the funds are returned to the retirement account or to a new account within 60-days. A 60-day rollover is sometimes used by retirement account owners who, for example, withdraw funds from their IRA for short-term personal use or investment and then return the withdrawn funds to their IRA within 60-days.

Under IRC 408 (d)(3)(A), an IRA owner’s withdrawal from an IRA is not taxable when returned or deposited into a new IRA within 60 days. However, the question posed in the Bobrow case was how many 60-day rollovers can an individual do in a 1-year period. The 60-day rollover exception is limited in the Code when an individual has already received one 60-day roll-over from an IRA in the past 12 months. The Code specifically states that the 60-day rollover exception cannot be used if the individual has already completed and relied on the exception for a 60-day rollover in the prior 1-year period. IRC 408(d)(3)(B). It has been unclear, however, whether the one 60-day rollover per year applied on a per IRA basis or whether it applied to the individual for all of their accounts.

The IRS had clarified that questions and has previously explained that an individual can conduct one 60-day rollover per 1-year period per IRA and thus interpreted IRC 408(d)(3)(b) to apply on a per IRA basis. This one 60-day rollover per IRA rule is explained by way of example in the current version of IRS Publication 590, page 25, as follows.

You have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot, within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA. However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA. This is because you have not, within the last year, rolled over, tax free, any distribution from IRA-2 or made a tax-free rollover into IRA-2

Based on this explanation, it is clear that the guidance from the IRS is that an individual can make one 60-day rollover per account per 1-year period. Yet, despite this publication, the IRS sought to make Mr. Bodrow’s second 60-day rollover from a separate IRA taxable as it was his second 60-day rollover in a one-year period. The IRS did not give any consideration to the fact that the second 60-day rollover was from a separate IRA (as it clearly explained in IRS Publication 590 to be acceptable).

The U.S. Tax Court agreed with the IRS and held that the limitations of IRC 408 (d)(3)(B) means that an individual can only conduct one 60-day rollover per 1-year period. After my own analysis of IRC 408 (d)(3)(B), I have to say that I agree with the Court’s opinion as the statutory language does not make a distinction between accounts but instead refers to 60-day rollovers taken per individual. Consequently, the intent of the statute is that a taxpayer can only conduct one 60-day rollover per 1-year period for all of their IRAs. Unfortunately, the error of the IRS in providing incorrect guidance does not go in favor of the taxpayer.

Based on the Court’s opinion, retirement account owners are well advised to only conduct one 60-day rollover per 1-year period. Keep in mind that you can conduct as many trustee to trustee or direct rollovers per year as you want as those transfers or rollovers result in money being sent directly to a new retirement account custodian or trustee and are not governed under the 60-day rollover rules.

As of March 18, 2014, the Bobrow case is still somewhat in limbo as there is currently a motion to reconsider filed by the taxpayer pending with the Court. Once the Court decides the motion to reconsider, the Judge will issue a final decision and after the decision is entered the taxpayer will have 90 days to appeal the Court’s ruling to the U.S. Court of Appeals for the Third Circuit. Given the significance of the Court’s ruling, I presume that the case will likely be appealed and heard by the U.S. Court of Appeals for the Third Circuit.

By: Mat Sorensen, attorney and author of The Self Directed IRA Handbook.

Contingency Clauses in Real Estate Purchase Contracts

by | Jan 21, 2014 | Investing, News

Contingency clauses are some of the most important components of a real estate purchase contract, and can provide significant protections to buyers of real estate. A contingency clause typically states that a buyer’s offer to buy property is contingent upon certain things. For example, the contingency clause may state, “The buyer’s obligation to purchase the real property is contingent upon the property appraising for a price at or above the contract purchase price.” Under this contingency, the buyer is relieved from the obligation to buy the property if the buyer obtains an appraisal that falls below the purchase price. Because contingency cPhoto of a signpost with different directions with the text "Contingency Clauses in Real Estate Purchase Contracts."lauses provide the buyer a way to back-out of a contract they can be excellent tools for real estate investors who make numerous offers on properties.

Contingency Clause Examples

Here are some contingency clauses to consider in your real estate purchase contract.

1. Financing Contingency. A financing contingency clause states something like, “Buyer’s obligation to purchase the property is contingent upon Buyer obtaining financing to purchase the property on terms acceptable to Buyer in Buyer’s sole opinion.” Some financing contingency clauses are not well drafted and will provide clauses that say simply, “Buyer’s obligation to purchase the property is contingent upon the Buyer obtaining financing.” A clause such as this can cause problems as the Buyer may obtain financing under a high rate and thus may decide not purchase the  property. However, because the contingency only specified whether financing is obtained or not (and not whether the terms are acceptable to buyer), the clause can be unhelpful to a buyer deciding not to purchase the property. Some financing clauses are more specific and, for example, will say that the financing to be obtained must be at a rate of at most 7% on a 30 year term and that if the buyer does not obtain financing at a rate of 7% or lower then the buyer may exercise the contingency and back out of the contract.

2. Inspection Contingency. An inspection contingency clause states something like, “Buyer’s obligation to purchase is contingent upon Buyer’s inspection and approval of the condition of the property.” Another variation states that the Buyer may hire a home inspector to inspect the property and that the Seller must fix any issues found by the inspector and if the Seller does not fix the items specified by the inspector then the Buyer may cancel the contract. Inspection clauses are very important as they ensure that the Buyer is obtaining a valuable asset and not a money pit full of defects and repair issues.

Other important contingency clauses are clear and marketable title clauses, approval of seller disclosure documents, and rental history due diligence information (e.g., rent rolls, lease copies, financials, etc.).

Contingency Clause Issues

When using contingency clauses buyers should pay attention to a few key terms. I’ve personally seen many disputes arise as a result of one of the following issues.

1. What Happens to the Earnest Money. One important consideration that is often vague in real estate purchase contracts is what happens to the buyer’s earnest money when the buyer exercises a contingency. Does the buyer receive a full return of the earnest money? Does the seller keep the earnest money? If the contract is silent and if you as the buyer exercise a contingency, don’t count on the seller agreeing to a release of the earnest money as they are often upset that you are not going to purchase the property. Make sure the contract clearly states something like the following, “If Buyer exercises any contingency, Buyer shall receive a full return of any earnest money deposit or payment to Seller.”

2. Contingency Deadlines. Another important contingency clause issue is the date of the contingency clause deadline.  Most contingency clauses have expiration dates that occur well before closing. Those dates should typically be somewhere from 2 weeks to 2 months from the date of the contract, depending on the purchase and seller disclosure items and the type of property being purchased. For example, single family homes will typically have a shorter window as financing and inspection can occur more quickly than would occur under a contract to purchase an apartment building. Whatever the deadline is, make sure that the deadline is set far enough out so that you can complete your contingency tasks. You need to make sure you have enough time to obtain adequate financing commitments, to properly inspect the property, and that you have enough time to review the seller’s disclosure documents. Setting a two week deadline is sometimes done but two weeks is usually not enough time to complete financing commitments, inspection, and due diligence activities that are necessary to determine whether you are going to commit to purchasing the property. If contingency deadlines are approaching and you need more time, then ask the seller for an extension before the deadline arrives. If the Seller refuses an extension, then exercise the contingency you need more time to satisfy.

3. Exercise You Contingency in Writing. If you do exercise a contingency and decide to back-out of the purchase of the property, make sure you do it in writing. Don’t rely on telephone calls or even e-mails (unless the contract permits e-mails as notice). Additionally, make sure that the reason for the contingency and that the date of the contingency are put in writing and are sent to the seller in a method where the date can be tracked in accordance to the notice provisions of the contract. For example, if the contract requires a contingency to be noticed by fax or hand delivery, don’t rely on an e-mail to the seller or the seller’s agent as such communication will not invoke the contingency.

Once the deadline to exercise a contingency has passed, the buyer is obligated to purchase the real property and may be sued for specific performance (meaning they can be forced to buy) or at the least the buyer will lose their entire earnest money deposit. Contingency clauses are the best defense mechanism to a bad deal and should always be used by real estate buyers. Keep in mind that until you close on the property, the only investment you have is a contract and if you have a bad contract, then you have a bad deal.

IRAs and the UBIT/UDFI Tax Exception for REITs

by | Nov 12, 2013 | UBIT & UDFI Tax

An IRA may invest into a real estate investment trust. Real estate investment trusts (“REIT”) are trusts whereby the company undertakes certain real estate activities (e.g. own or lend on real estate) and returns profits to its owners. An IRA may invest and be an owner in a REIT. As many self directed IRA investors know,  a form of unrelated business income tax (“UBIT” tax) known as unrelated debt financed income tax (“UDFI” tax) can arise from real estate leveraged by debt.

Many REITs engage in real estate development activities and/or use debt to leverage their cash purchasing power and as a result may cause a form of UBIT tax known as UDFI tax to IRA owners. Most REITS will not pay corporate taxes and as a result will not be considered exempt from UBIT tax as a result of having paid corporate tax. However, income from REITs is still typically exempt from UBIT and UDFI tax because the definition of a “qualified dividend” in a REIT has been defined to include dividends paid by a REIT to its owners. IRS Revenue Ruling 66-106. Qualified dividends from a REIT are exempt from UBIT and UDFI tax. REITs can be publically traded or private trusts but are not easy to establish. They require at least 100 owners and must distribute at least 90% of their taxable earnings to their owners each year. Despite the general application of exception to UBIT/UDFI tax for REITs, a REIT may be operated in a manner that will not allow for qualified dividends to be paid and therefore income from the REIT would not be exempt from UBIT/UDFI tax. If you’re investing into a REIT with an IRA, make sure you know whether the REIT intends to be exempt from UBIT/UDFI tax or not. As discussed, most will be exempt from UBIT/UDFI tax but some REITs may choose to operate in ways that will not qualify for the exception. Because UBIT/UDFI tax is about 39% at $10,000 of annual income this is something every IRA should understand before investing into a REIT.