Page 498 - TaxAdviser_2022

TAX CLINIC

tax provisions may affect potential offered security or a mutual fund, the
investors planning to indirectly invest underlying assets of the investment
in collectibles. When individuals want entity are deemed plan assets owned
to use pretax dollars by the plan (29 C.F.R. §2510.3-101(a)
Self-directed IRA to invest in assets (2)). Similarly, if the self-directed IRA
Most traditional IRAs set up through owns 100% of an operating company,
large financial services companies have that are not offered in the lookthrough rules apply. An operat-
a standard menu of investment options a traditional IRA plan, ing company is defined as “an entity that
including stocks, mutual funds, and is primarily engaged, directly … in the
bonds. Should individuals want to invest they must establish a production or sale of a product or service
self-directed IRA.
outside those prescribed options, they other than the investment of capital” (29
must take matters into their own hands. C.F.R. §2510.3-101(c)(1)).
When individuals want to use pretax If either scenario is present and the
dollars to invest in assets that are not self-directed IRA is considered a plan
offered in a traditional IRA plan, they deemed to have received a distribution benefit investor, the lookthrough rule
must establish a self-directed IRA. equal to the cost of the collectible (Sec. will apply, and the underlying assets of
Companies that specialize in such of- 408(m)(1)). Additional penalties may the investment entity or operating com-
ferings will act as a custodian of a self- apply for early withdrawal, depending on pany would be deemed as owned directly
directed IRA. Once the self-directed the age of the account holder. Overall, by the self-directed IRA. There are cer-
IRA is established, the owner funds it these transactions can result in signifi- tain exceptions to these rules, but they
and selects the investments. cant penalties and require careful vetting are beyond the scope of this analysis.
by tax professionals. These rules are consistent with IRS
Collectibles guidance regarding exchange-traded
Sec. 408(m)(2) prohibits individuals Plan asset rules funds (ETFs) backed by precious metal.
from directly investing in items defined The Department of Labor (DOL) has In Legal Advice Issued to Program
as “collectibles.” Pursuant to Sec. 408(m) promulgated rules that expand the po- Managers Memorandum 2008-01809,
(2), collectibles include: tential application of penalties for direct the IRS Chief Counsel’s Office states:
■ Any work of art; investments in prohibited collectibles by
■ Any rug or antique; treating certain assets of an investment [I]nvestors in a “physically backed
■ Any metal or gem; entity in which the self-directed IRA in- metal ETF” are considered to own
■ Any stamp or coin; vests as assets owned by the self-directed undivided beneficial interests in the
■ Any alcoholic beverage; or IRA. The plan asset rules, also known underlying physical metal. If a trustee
■ Any other tangible personal property as lookthrough rules, determine when of a “physically backed metal ETF”
specified by the IRS for purposes of an underlying asset of the investment treated as a trust sells some of the
this subsection. entity would be treated as an asset that is metal held by the trust, the investors
It is important to note that the directly owned by the self-directed IRA. are treated as having sold the metal.
broad category of tangible personal These lookthrough rules apply to a plan
property is not defined by the Code or benefit investor such as a self-directed Taken together, these rules demon-
the regulations. IRA (see 29 C.F.R. §2510.3-101(f) strate that the IRS and DOL are willing
While the Code prohibits IRA (2)(ii); see also Sec. 4975(e)(1)(B)). As to impute the ownership of underlying
investments in these collectibles, Sec. a result, the self-directed IRA’s owner assets to the entities that indirectly
408(m)(3) carves out an exception for should consider the underlying assets invest in those assets. This practice can
certain coins and bullion that may be of the investment entity when mak- have grave consequences for investors
held in a self-directed IRA. Secs. 408(m) ing investments. using self-directed IRAs to make alter-
(3)(A) and (B) require that these items native investments.
must meet certain metallurgical speci- Lookthrough rules
fications and must be held in trust for Generally, the self-directed IRA will Collectibles held in alternative
the account. be considered a plan benefit investor in investment partnerships
The penalties for investing in prohib- two scenarios. First, if the self-directed This section explores examples of in-
ited collectibles are severe. Upon acquisi- IRA owns greater than 25% of an vestments where an underlying asset is
tion of the collectible, the IRA owner is investment entity that is not a publicly a prohibited collectible and illustrates

12 October 2022 The Tax Adviser