GAO: Requests Rules on Prohibited IRA Transaction Exemptions
The Department of Labor (DOL) and the IRS need to establish a formal process for overseeing exemptions when IRA owners run afoul of IRA prohibited transaction rules, according to a new report by the Government Accountability Office (GAO).
Although most IRA owners invest in traditional assets like mutual funds and bonds, some choose to self-direct their retirement account so that they can invest in alternative assets like real estate or private equity. But there are strict rules for owning alternative assets in an IRA, and the IRS prohibits using retirement funds for certain investment types and transactions, such as using an IRA buy a property for personal use.
If you break these rules and engage in a prohibited transaction, your retirement account could lose its qualified tax-protected IRA status, resulting in taxes plus penalties. Often, after an IRA owner realizes they’ve committed a prohibited transaction, they apply to the DOL and ask for an exemption from these rules.
However, the GAO is concerned that the DOL and the IRS—which are both responsible for overseeing prohibited IRA transactions—have no formal process for collaborating to address prohibited transaction exemptions. The DOL can grant an exemption if an IRA owner runs afoul of prohibited IRA transaction rules, but it’s the IRS’s job to assess taxes if an IRA owner engages in a prohibited transaction.
Pushing for formal collaboration on prohibited transaction exemptions
In its report, the GAO said that of the 124 IRA prohibited transaction exemption applications it examined, the DOL contacted the IRS in only eight cases. It found the DOL does not share information with the IRS on why it denies some exemption applications, resulting in a missed opportunity to educate the IRS and IRA owners on how to avoid prohibited transactions.
To fix this, the GAO is recommending that the DOL and IRS establish a formal means—such as a memorandum of understanding—to collaborate on oversight of prohibited transaction exemptions. It is also recommending that the DOL document policies and procedures for managing the exemption process, which should help to improve transparency on how applications are handled and cut the risk of DOL employees carrying out their duties inconsistently.
According to the GAO, the DOL and the IRS have generally agreed with its recommendations.
Keeping an eye on prohibited IRA transactions
This is not the first time the GAO has weighed in on prohibited IRA transactions. In late 2016, it released a report exploring the use of "unconventional” or “alternative” assets in self-directed IRAs. In the report, it warned that not all IRA owners understand the added responsibilities that come with managing a self-directed IRA.
While the role of an IRA custodian is to ensure an asset is qualified to be held in an IRA, self-directed IRA custodians do not provide investment, tax or legal advice. That means self-directed IRA owners are taking on a fiduciary role in managing their retirement account.
The GAO said in its report that the IRS had not done enough to educate investors about prohibited transactions. Unless the IRS increased its investor outreach, the GAO warned that taxpayers might not be able to ensure compliance with rules on prohibited transactions, putting their IRA tax-favored status in jeopardy.
Steering clear of prohibited transactions
Before opening a self-directed IRA and making an investment, it’s essential to familiarize yourself with the IRS rules regarding disqualified persons and prohibited transactions. Remember: You could face severe penalties and tax consequences if you mistakenly break the rules.
It’s a good idea to hire tax or legal advisor who is familiar with the particular rules and regulations relating to self-directed IRAs. They may be able to spot red flags that you overlook. You can also use PENSCO’s Opportunity Analyzer to help determine if a deal you’re considering might be prohibited.
As a leading self-directed IRA custodian, PENSCO is fully supportive of efforts to enhance investors' understanding of IRA rules. PENSCO clients looking for more information on these issues can visit www.pensco.com or call us at 800.962.4238.
This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.
Pacific Premier Trust (formerly PENSCO Trust Company) performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Pacific Premier Trust is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.