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Non-Publicly Traded Stock in an IRA

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By Roy Lewis
October 4, 2002

If you have a self-directed Individual Retirement Account, you can put anything in that IRA that the custodian (usually a brokerage or mutual fund company) offers for sale. Stock, bonds, mutual funds, certificates of deposit, partnership interests... whatever. But what if you want to purchase some stock that isn't publicly traded? Until recently, conventional wisdom was that you couldn't do it. Since the shares in question weren't publicly traded, you broker couldn't get his hands on them.

But a recent Tax Court case -- Ancira v. Commissioner, 119 T.C. No 6 (9/24/02) -- may have provided a solution. Let's take a quick look at the case, the Tax Court ruling, and what it means for you.

Buying the shares
Robert Ancira maintained a self-directed IRA with a brokerage firm. Ancira requested that his broker purchase $40,000 of stock in SK Corp. While his broker acknowledged that there was no reason that Ancira's IRA couldn't hold the shares of SK Corp. in his IRA (i.e., this was not a prohibited transaction, nor was Ancira a "disqualified person" relative to this stock), the broker wouldn't purchase the shares since they were not publicly traded.

Not one to be denied, Ancira contacted SK Corp. and was informed that its stock was available for direct purchase. Ancira determined that the stock could be purchased directly if the broker issued a check payable to SK Corp. But the broker also told Ancira that this transaction would be deemed to be a distribution from his IRA account, subject to taxes and early distribution penalties. Nevertheless, Ancira directed the broker to issue a check from his IRA, payable to SK Corp. The broker sent the check directly to Ancira, who then purchased the shares directly from SK Corp. The company issued the shares to Ancira in the name of his IRA.

At the end of the year, the broker sent Ancira a Form 1099-R, indicating a $40,000 distribution from his IRA. But when Ancira filed his tax return for that year, he didn't report the $40,000 distribution as taxable income, since the money was used to purchase the shares in SK Corp. in his IRA. Well, the IRS examined Ancira's return and determined that the issuance of the check, even though it was made payable to SK Corp., was a taxable distribution. The IRS imposed taxes and penalties on the distribution. But Ancira took his case to Tax Court.

The Tax Court ruling
The Tax Court held that Ancira was simply a conduit for the broker by both arranging the stock purchase and ensuring that the check was delivered to SK Corp. And, the Court reasoned, since Ancira was simply a conduit, acting on behalf of his self-directed IRA, that there was no taxable distribution. The IRS took the position that any amounts paid or distributed out of the IRA would be included in gross income as noted in Internal Revenue Code Section 408. But the Court noted that neither the Internal Revenue Code nor the associated regulations provided specific guidelines as to amounts "paid or distributed" out of an IRA in these specific circumstances.

In fact, the Court stated that the "soundest view" of the case is that Ancira acted simply as a conduit for the broker. Since Ancira had a self-directed account, one of his privileges under the contract with his broker was to actually direct the investments of the IRA. It wasn't Ancira's fault that the broker's policy was not to purchase stock that wasn't publicly traded.

What this means to you
It simply means that you now have an opportunity to use money in your IRA to buy shares in companies that aren't publicly traded. However, it doesn't mean you won't have to do some homework. First review the court case to understand the reasoning that went along with the Tax Court's decision. Then review your contract with your broker in order to determine if you actually have the same type of self-directed contract as Ancira had with his broker. Also make sure that you aren't a "disqualified person" with respect to the stock in question. The IRS has a number of rules regarding "self dealing" with respect to an IRA, so ensure you're not in violation of these rules before you purchase the shares. You can read more about these rules in IRS Publication 590 at the IRS website.

Finally, ask yourself if an investment in the stock of a non-publicly traded company is something that fits your investment profile and objectives. Since non-public companies aren't subject to the rules and regulations of the SEC, these companies don't have many disclosure requirements. So it might be difficult, if not impossible, for you to obtain the information necessary to determine if this is a sound investment. Finally, remember that selling non-publicly traded shares might be even more difficult than making the initial purchase.

But if there is an investment to be had in a non-public company, it's nice to know you can put those shares in your IRA without the direct purchase by your broker. Just make sure that you understand how the process works, and walk the straight and narrow when completing the transaction. Uncle Sam might be looking over your shoulder.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though. 

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