Case — Taxability of IRA Withdrawal

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TL Case Summ

THE QUESTION

Is the purchase of real property with IRA funds a taxable event?

THE DISPUTE

Taxpayer Says: The withdrawal was not a taxable event because the property purchased with the funds was titled in the name of his Individual Retirement Account.

Internal Revenue Service Says: The withdrawal was not a transfer between IRA trustees and is taxable.

THE LAW

From Internal Revenue Code Section 408(d)(1): Generally, amounts distributed from an IRA are includible in a taxpayer’s gross income as provided in section 72.

From Internal Revenue Code Section 408(a)(3): IRAs are, as a statutory matter, permitted to hold real property.

From Internal Revenue Code Section 408(d)(3): Provides that a distribution is not includible in gross income if the entire amount of the distribution an individual receives is paid into an IRA or other eligible retirement plan within 60 days of the distribution. This recontribution is known as a “rollover contribution.” Only one rollover contribution is permitted within a one-year period.

THE CAUSE OF THE DISPUTE

Unless you have basis, distributions you take from your traditional Individual Retirement Account are taxable on your federal income tax return. When you’re under age 59-1/2, you may also be subject to a 10% penalty-tax on the amount withdrawn.

However, if you deposit the IRA distribution into another IRA or an eligible retirement plan within 60 days, the transaction is considered a “rollover” and is not taxable. You can also request your IRA custodian to transfer funds in your account directly to the custodian of another IRA with no tax consequences in what’s known as a “trustee-to-trustee” transfer.

In this case, the taxpayer, who was under age 59-1/2, withdrew $114,000 from his self-directed IRA in order to purchase a parcel of undeveloped land. His IRA custodian did not allow alternative investments, so the taxpayer had the funds wired directly to the title company and requested that title be placed in the name of his IRA.

The transaction took place in 2009. The taxpayer did not report the withdrawal on his federal income tax return.

When the taxpayer sold the property in 2011, he discovered the title company had made a mistake and placed the property in his name instead of his IRA’s name. The title company submitted an affidavit admitting the mistake, and the taxpayer had the $127,226 net proceeds from the sale wired directly to his IRA. He marked the deposit as a rollover contribution, and the custodian accepted it as such.

The IRS says the 2009 distribution was taxable because the taxpayer’s IRA did not purchase the property. The IRS argues the custodian’s policies did not permit the purchase or holding of real property in the IRA, and a trustee-to-trustee transfer did not occur since the title company was not an IRA custodian.

The taxpayer says his custodian’s refusal to allow alternative investments is a matter of policy, and not a statutory prohibition. He argues he acted as a conduit through which his IRA purchased the property, and therefore the withdrawal was not a distribution.

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!
For the IRS. The taxpayer is correct that IRAs are, as a statutory matter, permitted to hold real property.

However, we are not aware of any provision in the code that requires an IRA trustee or custodian to give the owner of a self-directed IRA the option to invest IRA funds in any asset that is not prohibited by statute. We find that the IRA trustee had the power to prohibit the purchase and holding of real property and that the taxpayer’s IRA was not capable of holding real property. Therefore, even if the property had been titled as intended, the IRA could not hold real property and would not have accepted ownership of the property. Consequently, we find that the taxpayer did not act as an agent on behalf of the IRA custodian and that the IRA did not purchase the property.

In addition, the taxpayer did not have an IRA (or other eligible retirement plan) with the title company, and there is no evidence to suggest the title company is an IRA trustee. Thus, the transfer of funds to the title company was not a transfer between IRA trustees.

We conclude, therefore, that the $114,000 withdrawal was a taxable distribution made to the taxpayer and is includible in his gross income.

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