All investors who open accounts with Millennium Trust should realize that Millennium does not offer any investment management, advice or review. The success of your investment program depends on your investment selection. There are certain rules and regulations all retirement account holders must follow in order to maintain the tax-exempt status of your account.
Investing self-directed IRA funds in alternative assets is not for every investor and there are certain rules and regulations which you need to understand before considering this type of investment. Fundamentally, the IRA account owner must understand that the asset is held by the IRA for investment purposes and the account owner cannot receive any direct or indirect benefit from the investment. The individual must understand that there are transactions that are prohibited between the account owner and any disqualified persons. Prohibited transactions are described in detail in Internal Revenue Code Section 4975.
Investors are encouraged to consult with a tax and legal advisor(s) to ensure the transaction does not violate any of the prohibited transaction rules. Causing a prohibited transaction to occur could result in dissolution of the tax-advantaged status of the IRA, mandatory distribution of the self-directed IRA, and taxes and penalties on the distribution.
While IRAs offer investors great flexibility in investment choices, the regulatory bodies responsible for overseeing these types of accounts have established certain restrictions on the types of transactions an owner is allowed to conduct within an IRA. Violations of these guidelines have become known as Prohibited Transactions.
For instance, any transaction that can be construed as providing immediate personal financial gain to a self-directed account holder is not allowed, and is often referred to as ‘self-dealing’. Examples of self-dealing would include: borrowing money from your IRA, selling property to your IRA, receiving a current benefit outside the IRA from assets in the IRA, or using the IRA as security for a personal loan.
In addition, direct investments of IRA funds in any of the following categories are prohibited:
- Life insurance;
- Collectibles such as works of art, rugs, antiques, metals (other than gold, silver and palladium), gems, stamps, coins (except certain U.S. minted coins), alcoholic beverages, and other tangible property; and,
- A trust that qualifies as an IRA is not a permitted shareholder of an S corporation under IRS Letter Ruling 199929029.
Examples of prohibited transactions with an IRA include: borrowing money from it; selling property to it; using it as security for a loan; or buying property for present or future use with IRA funds.
- For IRAs, a disqualified person is:
- The IRA holder and his or her spouse;
- The IRA holder’s ancestors, lineal descendants and their spouses;
- The IRA holder’s investment advisors and managers;
- Any corporation, partnership, trust or estate in which the IRA holder has a 50 percent or greater interest; and,
- Anyone providing services to the IRA such as the trustee or custodian.
Millennium Trust encourages IRA owners to consult with a tax advisor prior to selecting any alternative investment.
Unrelated Business Income Tax
Unrelated Business Taxable Income (UBTI) is generally defined as the gross income derived from any unrelated trade or business regularly carried out by an exempt organization.(1) The tax on unrelated business taxable income is called Unrelated Business Income Tax (UBIT) and applies to Individual Retirement Arrangements (IRAs) including Traditional, Roth, SEP and SIMPLE IRAs.
If an enterprise is a pass-through entity, also known as a partnership or limited liability company, that produces and sells goods or provides services, the IRAs’ share of the enterprise’s ongoing net income will be unrelated business taxable income and the IRA is required to pay income tax (UBIT) at current trust tax rates. Additionally, if the business is a pass-through entity that acquires any assets through loans or on margin, a portion of the IRA's share of the income may also constitute UBTI subject to UBIT.
Unrelated Debt Financed Income (UDFI) is income derived from any debt-financed property held to produce income (including gain from its disposition) including rental real estate, tangible personal property and corporate stock and the amount of unrelated debt-financed income is a percentage of the total gross income derived from the property during a tax year and that income is also subject to UBIT. When an investor chooses to leverage an IRA real estate investment through the use of a non-recourse loan, the IRA will be subject to unrelated business income tax (UBIT) by the unrelated debt financed income (UDFI) produced by the property.
Investors are encouraged to review the implications of UBIT on UBTI or UDFI with their tax professional. More information can also be found by reviewing IRS Publication 598.
For More Information
Please read this Important Information Regarding Alternative Assets document for additional information on things to consider when investing in alternative assets.