Volume 35 • Issue 7 • July 2010
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Note:
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So you want to have an airplane in your IRA?
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The joy and pain of having unusual assets in your Individual Retirement Account
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By:
David Carroll
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People are often shocked and surprised when I tell them about IRAs I have managed with such diverse assets as airplanes, tractors, real estate and limited partnership interests. In fact, I’ve occasionally faced having to discourage some clients from including a fine wine collection or Krugerrands in their IRA.
Some professionals have questioned me about the legality of holding such assets. But Section 408 of the Internal Revenue Code, controlling IRAs, only lists two classes of investments that you cannot hold in your IRA: insurance policies and collectibles. (There is even an exception in the definition of collectibles allowing gold, silver or platinum coins minted by the U.S. government or any state, and gold, silver, platinum or palladium bouillon.) One of the largest problems with these types of assets is finding an IRA custodian willing to deal with them for a price you want to pay.
Finding a Custodian
Well over 90 percent of all IRAs are "Custodial IRAs,” IRAs where the owner directs the investments. A vast percentage of those IRAs are held at Vanguard, Fidelity or other large financial services firms. These firms generally will not allow clients to invest IRA funds in out-of-the-ordinary assets, preferring such simpler investments in stocks, bonds, cash, mutual funds and the like.
The IRA owner with more unusual assets must then find a custodian willing to handle these assets. There aren’t a lot of custodians in this specialized category and they typically charge more than the larger financial firm custodians.
It is important for an investor to research these providers before making a selection to ensure whoever an investor chooses is equipped to handle and understands the complexities of handling such unique assets.
Two other major issues often play a role in these more tangible unique assets – real property like airplanes and tractors. First, the IRA must cover all the costs related to the asset. For example in the case of real estate, the IRA must have sufficient funds to cover the taxes, insurance, utilities and other costs related to the property.
Secondly, people who decide to have unique assets in their IRAs must also be careful not to be caught by the "prohibited transaction” rules. The main trap here is personal use of an asset.
Neither the IRA owner, his/her immediate family nor lineal descendant may benefit from the fact that the IRA owns the asset. Therefore, real estate can not be lived in, a plane can not be flown or a tractor cannot be used by the IRA owner or other "disqualified persons.” If the IRS finds there is a "prohibited transaction” in an IRA, the agency has the ability to disqualify the entire IRA and make it immediately taxable.
Valuing Assets
Also, keep in mind that prior to the asset holder reaching Required Minimum Distribution (RMD) age, the management of unique assets can present additional challenges. Notably IRA assets must be able to be valued annually to allow for preparation of the annual IRS Form 5498. Assets that are hard to value present an obvious issue.
It is the legal responsibility of the IRA owner to provide the IRA custodian a value for all assets, which in the case of unique assets, may call for an appraisal or other acceptable manner of establishing value. All costs related to an appraisal of value must be paid for with IRA funds, not outside funds.
Another problem with unique assets comes when Required Minimum Distributions have commenced. In this case the valuation issue is the main concern. RMDs for a year are determined based on the Dec. 31 value of the preceding year. If an item cannot be valued, the custodian must make hard and sometimes unpopular decisions about how to calculate and pay out the distribution.
A former client of mine held a Limited Partnership interest for which a value could not be ascertained. We ended up distributing the actual interests at our carrying value and informed him if he did not agree with our valuation, he would have to take it up with the IRS.
At the end of the day, IRA owners must decide the risk versus reward of holding unusual assets. Clearly there are some pitfalls to be aware of before placing unique assets into an IRA account.
David Carroll is a retirement specialist in Wealth Advisory Services for Key Private Bank in Bellingham. This piece is not intended to provide specific tax or legal advice. Readers should consult with their own advisers about their particular situation. Reach Carroll at david_l_carroll@keybank.com or 360.527.4455.
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