Self Directed IRA Real Estate Investing No-Nos Number 2 - Who Are Disqualified Persons?

->defined as Disqualified. As applied to real estate,
In 1974, following Studebaker's raid of itsIRC 4975 includes, but may not limit, Disqualified
employees' retirement plan and the company'sPersons to:
subsequent collapse, Congress enacted rules for all
retirement plans that prohibit persons with a close1. Trustee, Custodian, or Annuity Issuer --
relationship to the plan from dealing with the plan.although I must say I've never seen an annuity
Most people prefer to do business with someoneissuer involved in a real estate transaction
they are close to, that they know and trust2. Employer or employee organization
based upon prior dealings, or have family3. Fiduciary
relationships with, yet, that is exactly what the4. Person providing services to the Plan per IRC
law prohibits.4975(e)(2)(B). In the case of real estate investing,
What does this mean when you are investing withservices include rehab, property management or
your IRA or retirement plan monies? Any timedevelopment, real estate brokering, accounting,
you are dealing with anyone other than alegal, etc.
completely unrelated stranger, you must look5. Certain owners of business interests per IRC
closely at what you propose to do and who you4975(e)(2)(E) - an owner (direct or indirect) of
propose to deal with in order to determine50% or more of a a) Corporation -- Combined
whether you are dealing with a Disqualified Personvoting power of all classes or stock entitled to
and thus entering into a Prohibited Transaction.vote or the total value of all shares of all classes
Prohibited Transactions, just one part of selfof stock of a corporation, b) Partnership -- Capital
directed IRA Real Estate Investing No-Nos, areinterests or profits interest of a partnership or
defined by IRC Section 4975. While a casualc)Trust or Unincorporated Enterprise -- the
reading of the section will likely serve only tobeneficial interest of a trust or unincorporated
confuse you, a thorough reading will eventuallyenterprise. Huh? The above touch on what are
reveal that for a Prohibited Transaction to occurknown as "attribution rules", which while
there must be three elements existingmultifaceted, boil down to this: In a number of
concurrently.instances, even though you do not technically own
There must be 1) a Transaction between 2) aan entity, the law will treat you as if you do.
Plan and 3) a Disqualified Person.6. Certain businesses IRC 4975(e)(2)(G) basically
By definition a self directed IRA is a Plan, andsays that any entity owned 50% or more by a
once we refer to a transaction involving value fordisqualified person is itself a disqualified person
goods or services as a Transaction, investing a7. Persons with significant influence in employer,
self directed IRA in real estate automaticallyemployee organization or certain businesses IRC
provides the first two elements; therefore the4975(e)(2)(H) reads "An officer, director (or an
focus of any Prohibited Transaction question isindividual having powers or responsibilities similar to
always going to be whether or not there is athose of officers or directors), a 10 percent or
Disqualified Person involved.more shareholder, or a highly compensated
The term Transaction does not exist in theemployee (earning 10% or more of the yearly
statutes, but we use it because it makes sense -wages of an employer) of a person described in
it makes the whole concept simple and(C), (D), (E) or (G)". Essentially this defines a
understandable. By treating the elements as aperson who on a subjective basis can influence a
formula:"person" as being Disqualified, never mind his or
"Disqualified Person + Plan + Transaction =her ownership status, or lack of it. This is what
Prohibited Transaction"we can immediately seehappened in the Rollins case, which I mean to
that the only element left in the equation is themake the subject of another article or a
question of whether or not there is a Disqualifiedteleseminar.
Person involved.8. Family members IRC 4975((e)(2)(F) says "no
So, who are Disqualified Persons?family members", but IRC 4975 (e)(6) defines
This is really a two pronged question. First, what isfamily as spouse, ancestor, lineal descendant and
a Person, and second, what is the definition ofany spouse of a lineal descendant. Who that
Disqualified?leaves out, besides you, is your spouse, your
IRC Sec. 7701 defines Person as follows:The termchildren and their spouses, your grandchildren and
person shall be construed to mean and include antheir spouses, and your parents (and sometimes
individual, a trust, estate, partnership, association,their spouses -- for instance, in the case of
company or corporationdivorce, or the death of one parent, followed by
Long story made short, an entity is a person if ita subsequent re-marriage.) Notice that leaves in
can be taxed. An IRA or other retirement plan willsiblings (brothers and sisters, and their spouses),
always be included in the definition of a Person,aunts and/or uncles and their spouses, and
typically because they are trusts.stepfamily. However, transactions with them must
So, you see, it really all comes down to thebear up, under IRS scrutiny, as being mutually
definition of Disqualified.beneficial financially.
That definition is generally simplified, andHopefully, the preceding provides a broad
presented in many articles, to mean the IRAoverview of who is a Disqualified Person.
owner/beneficiary and certain family members.Admittedly, this is one of the most complex
While that is true to a degree, it glosses over aareas when it comes to investing self directed
significant number of other parties or personsIRAs in real estate.