If you have a self-directed individual retirement account, you can put anything in that IRA that its 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 held that you couldn't do it. Since the shares in question weren't publicly traded, your broker couldn't get his hands on them. But a recent Tax Court case -- Ancira v. Commissioner, 119 T.C. (available in PDF format) -- 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. His broker acknowledged that there was no reason that Ancira's IRA couldn't hold shares of SK Corp. -- it wasn't a prohibited transaction, nor was Ancira a "disqualified person" relative to this stock. However, the broker wouldn't purchase those shares, since they were not publicly traded.
Not one to be denied, Ancira contacted SK Corp. and learned that its stock was available for direct purchase if his broker issued a check payable to the company. But the broker also told Ancira that this transaction would be considered 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 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 SK Corp. shares in his IRA. 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, so Ancira took his case to tax court.
The Tax Court ruling
The 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. Since Ancira acted entirely on behalf of his self-directed IRA, the court reasoned that there was no taxable distribution. The IRS argued that any amounts paid or distributed from 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 guidelines regarding such distributions or payments in these specific circumstances.
Since Ancira had a self-directed account, the court stated, it was his privilege under the contract with his broker to control his IRA's investments. It wasn't Ancira's fault that the broker wouldn't purchase stock that wasn't publicly traded.
What this means to you
The Tax Court's ruling now gives you 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 court's decision. Then review your contract with your broker to see whether you have the same type of self-directed contract as Ancira. Next, make sure that you aren't a "disqualified person" with regard to the stock in question before you buy it. (You can read more about the IRS' rules regarding "self-dealing" in IRS Publication 590, also in PDF format, at the IRS website.)
Finally, ask yourself whether an investment in the stock of a non-publicly traded company fits your investment objectives. Non-public companies aren't subject to SEC rules and regulations, so they have few disclosure requirements. It might be tricky, if not impossible, for you to obtain the information necessary to determine whether this is a sound investment. Remember also 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 a 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.
When he's not dealing with tax issues, Fool contributor Roy Lewis is a motivational speaker who lives in a trailer down by the river. 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.