One question which comes up a lot is the extent to which assets inside an IRA can be utilized by the participant in various transactions. The problem is the so-called “prohibited transaction rules” in Section 4975 of the Internal Revenue Code.The United States Bankruptcy Court for the Eastern District of Arkansas issued its opinion on May 26, 2015 in the Barry K. Kellerman case in which the court sustained a trustee’s and creditor’s objections to Mr. Kellerman’s claimed exemption of his IRA. The court found that Mr. Kellerman engaged in prohibited transactions which resulted in the loss of the IRA’s tax-exempt status, making the IRA non-exempt and subject to seizure.
Mr. Kellerman had a self-directed IRA. In 2008, his company entered into a partnership agreement with the custodian of his IRA and through that partnership acquired a tract of land. Mr. Kellerman was the only person who could sign on the partnership checks. Its address was Mr. Kellerman’s address. Contrary to allegations that the IRA custodian sanctioned or approved the transaction as consistent with the IRA’s tax-exempt status, the evidence showed that Mr. Kellerman orchestrated everything and the custodian did as Mr. Kellerman instructed.
While the 4 acre tract could be developed independently, the purchase took place principally to complement and assist in the development of two nearby tracks of approximately 80 and 120 acres owned by Mr. Kellerman’s company. Other facts were developed to show that IRA funds were being used to benefit Mr. Kellerman and his company in ways that violated the code.
All of the parties agreed that Mr. Kellerman was a disqualified person. The real issue was whether the benefits he and his company received were “incidental.” The court pointed out that transactions which would qualify as prudent investments are not necessarily exempt from scrutiny. And, in the end, Mr. Kellerman’s direct involvement and control, the fact that the IRA funds paid at least half of the cost to acquire the land and a substantial additional injection from the IRA paid for development costs, coupled with the impact the acquisition and development had on the nearby acreage, all combined to lead the court to find that those benefits were not incidental, but were material. The court then found that the IRA ceased to be tax-exempt and thus Mr. Kellerman could not claim the IRA as exempt under section 522 of the Bankruptcy Code.