Investing with a "disqualified person"

[Josh Carter]

Hi everyone,

I am about to go into contract on a 5 unit property with a family member who is a "disqualified person."  Now as I understand it's ok to partner with a disqualified person but not to loan money to or from them or change anything once things are set.  

The bank I'm using as my IRA custodian has an on site lawyer who is an expert at this stuff and says there's a particular way you'd have to form the LLC to have it work and that he could get it set up for me for $1200. I'm not sure if I actually am going to need him to set it up or if he is hard selling his services. Apparently it's legal if LLC is set up at same time as partnership and nothing changes equity wise after the start of it.

Does anyone have any advice for me on how to start this myself or should I bite the bullet and have him take care of this?

Here's what it says on the IRS's website involving disqualified persons:

Prohibited transactions in a qualified plan

Prohibited transactions generally include the following transactions:

1. A disqualified person’s transfer of plan income or assets to, or use of them by or for his or her benefit
2. A fiduciary’s act by which he or she deals with plan income or assets in his or her own interest
3. A fiduciary’s receipt of consideration for his or her own account in a transaction that involves plan income or assets from any party dealing with the plan
4. Any of the following acts between the plan and a disqualified person:

Exempt transactions

The law exempts some transactions from being prohibited transactions. For example, if you are a disqualified person and receive any benefit to which you are entitled as a plan participant or beneficiary (such as a participant loan), this is not considered a prohibited transaction. However, the benefit must be on the same terms as for all other participants and beneficiaries.

Prohibited transactions in an IRA

Generally, a prohibited transaction in an IRA is any improper use of an IRA account or annuity by the IRA owner, his or her beneficiary or any disqualified person.

Disqualified persons include the IRA owner's fiduciary and members of his or her family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).

The following are examples of possible prohibited transactions with an IRA.

• Borrowing money from it
• Selling property to it
• Using it as security for a loan
• Buying property for personal use (present or future) with IRA funds

Who is a fiduciary?

An IRA fiduciary includes anyone who does any of the following:

• Exercises any discretionary authority or discretionary control in managing the IRA or exercises any authority or control in managing or disposing of its assets.
• Provides investment advice to the IRA for a fee, or has any authority or responsibility to do so.
• Has any discretionary authority or discretionary responsibility in administering the IRA.

Effect on an IRA account

Generally, if an IRA owner or his or her beneficiaries engage in a prohibited transaction in connection with an IRA account at any time during the year, the account stops being an IRA as of the first day of that year. The effect of this is the account is treated as distributing all its assets to the IRA owner at their fair market values on the first day of the year. If the total of those values is more than the basis in the IRA, the IRA owner will have a taxable gain that is includible in his or her income.

[Dmitriy Fomichenko]

@Josh Carter, you are walking on very thin ice here. As you know a transaction between qualified plan and a 'disqualified person' will disqualify your IRA (the entire IRA will be deemed distributed). Under certain circumstances it might be possible to partner, but in many examples that I looked when my clients considered doing something like that it was a prohibited transaction. I suggest you to say away from engaging in a transaction with disqualified person, find a partner who is not a disqualified. If you are not willing to do that be sure to work with the qualified expert in the field who can help you ensure that it is done properly.