IRA Exemption Lost Due to Prohibited Transaction

Posted by NCBRC - June 30, 2015

The debtors’ use of funds in the husband’s self-directed IRA to fund the purchase and development of property was a prohibited transaction that disqualified the IRA from exemption in bankruptcy. In re Kellerman, No. 09-13935 (Bankr. E.D. Ark. May 26, 2015).

In their bankruptcy petition, the debtors sought to exempt Barry Kellerman’s IRA under section 522(d)(12). The chapter 7 trustee and a creditor objected to the exemption arguing that Mr. Kellerman was a “disqualified person” who undertook “prohibited transactions” causing the IRA to lose its tax exempt status and, consequently, its entitlement to bankruptcy exemption.

Mr. Kellerman created a partnership between the IRA and Panther Mountain, a business he co-owned with his wife, in order to purchase and develop a four-acre property. The bankruptcy court explained:

“Barry Kellerman is the only person specifically designated to sign partnership checks. The Partnership Agreement does not disclose Panther Mountain’s ownership. The partnership operated under the name Entrust Mid South LLC FBO Barry Kellerman IRA #0605002–01 and Panther Mountain Land Development, LLC (“Entrust Partnership”). Although the IRA and Panther Mountain each possessed a 50 percent interest, the Partnership Agreement called for the IRA to deliver the real property as a “Noncash Contribution” valued at $122,830.56. The IRA was also called upon to make a “Cash Contribution” of $40,523.93 by November 30, 2007. Panther Mountain’s sole obligation was a cash contribution of $163,354.49—an amount equal to the IRA’s cash and non-cash contribution values—at an unspecified “construction completion” date. Neither party introduced testimony or evidence that Panther Mountain ever partially or fully made its cash contribution. Exactly one day after the formation of the Entrust Partnership, Barry Kellerman directed the IRA to liquidate assets in the amount of $123,000. His August 9, 2007 Sell Direction Letter (“Sell Letter”) illuminates the relationship between Barry Kellerman, the beneficiary of the IRA, and Entrust, the plan administrator, and contradicts the debtor’s assertion that the administrator sanctioned or approved of the transaction as consistent with the IRA’s tax exempt status” [citations to the record omitted].

After the debtors filed for bankruptcy, Panther Mountain filed its own chapter 11 bankruptcy, listing the IRA and the Kellermans as unsecured creditors. The Kellerman court explained that the “two debts [in Panther Mountain’s bankruptcy] are reflected as owed to the IRA: (1) $163,000.00 with the claim described as ‘50% Interest in new entity,’ and (2) $7,891.96 with the claim described as ‘Loans from B Kellerman IRA to PMLD, LLC.’”

Section 522(d)(12) permits a debtor to exempt an IRA that would be tax exempt under IRC section 408. Paragraph 408(e)(1) exempts an individual IRA, but paragraph 408(e)(2) provides that an IRA loses its tax exempt status:  “If, during any taxable year of the individual for whose benefit any individual retirement account is established, that individual or his beneficiary engages in any transaction prohibited by section 4975 with respect to such account, such account ceases to be an individual retirement account as of the first day of such taxable year.” Section 4975 describes a prohibited transaction as one involving a disqualified person, including IRA fiduciaries, owners, directors, family members. “Prohibited transaction” as described in paragraph 4975(c)(1), includes lending of money between the plan and the disqualified person and use by the disqualified person of plan assets for his own interest.

While all parties agreed that the transactions at issue in this case involved disqualified people, the debtors argued that the transactions were not prohibited under section 4975(c) because they were for an investment in real estate through Entrust Partnership for the benefit of the plan rather than the disqualified person.

The court disagreed. It found that the transactions and Panther Mountain’s treatment of them in its own bankruptcy suggested that Panther Mountain was using the IRA as a lending source for the purchase and development of property. Essentially, Barry Kellerman, as the owner and fiduciary of the IRA “(1) orchestrated the IRA’s membership in the Entrust Partnership with Panther Mountain, (2) signed the Buy Direction Letter and the Sale Letter that facilitated the purchase of the four acres solely by the IRA but held with Panther Mountain as tenants in common, and (3) directed the payment of “Business Expense[s]” by the IRA to develop the four-acre tract. The real purpose for these transactions was to directly benefit Panther Mountain and the Kellermans in developing both the four acres and the contiguous properties owned by Panther Mountain.”

In sum, the court concluded that “Thus, the Kellermans utilized the income and assets of the IRA for their benefit, as disqualified persons, in violation of subsection 4975(c)(1)(D). Alternatively, Barry Kellerman dealt with the income or assets of the IRA as a fiduciary for his own interest in violation of subsection 4975(c)(1)(E).”

The court sustained the objections.

The debtor has filed an appeal to the district court, No. 15-347 (E.D. Ark.)

Kellerman Bankr. ED Ark opinion


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  1. By Bankruptcy News Briefs 6/30 | NACBA Now on June 30, 2015 at 3:39 pm

    […] IRA Exemption Lost Due to Prohibited Transaction […]

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