The physical possession rule has been confirmed by the recent court case McNulty v. Commissioner. Despite the lack of prior guidance, this case serves as a reminder that it is illegal to personally possess IRS-approved metals and coins, as stated in Internal Revenue Code Section 408(m). We have gathered all available information on this case.
McNulty Case – Summary
Under I.R.C. sec. 408, the McNulty family created a Self-Directed IRA and utilized its assets to invest in a single-member LLC, of which Ms. McNulty was the manager. She instructed the LLC to procure American Eagle coins and personally held the coins. The IRS concluded that the McNulty’s received taxable distributions equivalent to the coins’ price when they took possession of them.
The Facts of the McNulty Case
Mrs. McNulty bought a package of services from Check Book IRA, LLC via its website in August 2015. The package came with help to set up a Self-Directed IRA. Subsequently, she created an LLC and moved IRA funds into it by buying membership interests. Using this money, she procured American Eagle coins.
In 2015, Check Book’s website promoted the notion that an LLC owned by an IRA was capable of investing in coins, which could then be stored in the homes of the IRA owners without incurring taxes or penalties, provided that the coins were registered to an LLC.
There is no record of ownership certificates or any other paperwork that proves legal ownership of the coins.
Using Check Book’s services on August 19, 2015, Mrs. McNulty established a Self-Directed IRA and appointed Kingdom Trust Co. as the IRA custodian. They qualify as an autonomous and reputable custodian according to the Investment Advisers Act of 1940.
On August 24, 2015, Check Book formed Green Hill Holdings, LLC. Green Hill’s articles of organization, which were filed with the secretary of state of Rhode Island on August 25, 2015, state that Green Hill is a single-member LLC that is a disregarded entity for Federal tax purposes and its sole initial member was Mrs. McNulty’s IRA.
During 2015 and 2016, the initial managers of Green Hill were the petitioners, who also reside at the company’s main operational location. Additionally, a bank account was established by Green Hill, for which the petitioners held authority as signatories.
Between 2015 and 2016, Mr. McNulty utilized his IRA funds to procure an American Eagle coin and a condominium via an LLC model, while Mrs. McNulty was solely responsible for choosing her IRA’s investments. The latter funded her IRA by transferring money from two qualified retirement plans, namely an individual retirement annuity and a 401(k) scheme.
Kingdom Trust was directed by Mrs. McNulty to utilize her IRA funds to acquire membership interests in Green Hill. The IRA made three purchases of membership interests in Green Hill between 2015 and 2016 (Green Hill investments). On each occasion, Mrs. McNulty instructed Kingdom Trust to transfer the cost of the membership interests from the IRA to Green Hill’s bank account.
Consequently, Green Hill utilized virtually all of the money to buy American Eagle coins from Miles Franklin, Ltd, with Mrs. McNulty acting as the LLC’s manager. The receipts from Miles Franklin showed Green Hill as the buyer, but Mrs. McNulty is recognized on the shipping details as the recipient of the deliveries either privately or along with her IRA.
Petitioners’ personal residence received the coins, which were kept in a safe with the ones bought using Mr. McNulty’s IRA and those bought directly by them. The coins obtained through Green Hill, with the help of Mrs. McNulty’s IRA, were identified separately.
In August to September 2015, Mrs. McNulty utilized funds from her annuity to make her initial investment and purchase of coins in Green Hill. She directed Kingdom Trust to buy 375,000 membership units of Green Hill for $1 per unit, amounting to $375,000. The purchase money was transferred from her IRA to Green Hill’s bank account through a wire transfer.
Afterwards, Green Hill was instructed by Mrs. McNulty to acquire 320 one-ounce gold coins of American Eagle for $374,000 through Miles Franklin. The money was then transferred from Green Hill’s bank account to Miles Franklin, and the coins were subsequently delivered to the petitioner’s home and stored inside a safe, under the name “Donna McNulty Green Hill”.
In January through February of 2016, Mrs. McNulty utilized her IRA funds that were transferred from the 401(k) for the second investment and coin purchase of Green Hill. She directed Kingdom Trust to acquire 43,274.70 membership units of Green Hill for $1 per unit, totaling $43,274.70 in investment.
$43,274.70 was wired by Kingdom Trust to Green Hill’s bank account. A portion of the funds was used by Mrs. McNulty to buy 2,000 one-ounce American Eagle silver coins for $37,380 from Green Hill, and then wired to Miles Franklin. The coins were delivered by Miles Franklin to “Green Hill * * * FBO Donna McNulty” at the petitioners’ residence and stored in a safe.
Four one-ounce American Eagle gold coins, two one-quarter-ounce American Eagle gold coins, and one one-tenth-ounce American Eagle gold coin were purchased by Green Hill in August 2016 using the remaining funds in its bank account from the annuity and 401(k) transfers amounting to $6,731. The payment for the coins along with the insured shipping cost of $6,746 was wired from Green Hill’s bank account to Miles Franklin.
The coins were shipped by Miles Franklin to the petitioners’ address and subsequently kept in the safe under the name of “Donna McNulty”.
Kingdom Trust submitted Form 5498 to the IRS for both 2015 and 2016. The fair market values of the IRA were stated as $349,856 and $388,247 in the respective forms. However, the year-end bank account balance of Green Hill was not reported in the 2015 form, and the value of 2016 silver coins was not included in the 2016 form. Despite this, Kingdom Trust had no part in managing Green Hill, buying the coins, administering the assets of Green Hill or those of the IRA.
It seems that the aforementioned information was uncovered during an examination of the individual tax returns of the taxpayer, although the method of discovery is not apparent.
Conclusion
Although the violation of IRC 408(m) through holding coins in an IRA at home was clear, the Court decided to delve into the issue of “control” to establish if an individual holding assets in a Self-Directed IRA LLC would result in a taxable distribution, extending the McNulty case beyond what was expected to be a brief and unremarkable ruling.
The McNulty case is unlikely to affect the majority of Self-Directed IRA LLCs due to established case law indicating that possessing ownership documentation, such as stock certificates and deeds, does not result in a taxable distribution. Nevertheless, when it comes to digital assets such as cryptocurrencies that are kept in a cold wallet off an exchange under the direct ownership of the IRA holder, the verdict implies that this may constitute a taxable distribution because the IRA owner has complete control over the cryptocurrencies.
Most of the Crypto IRA customers store their cryptocurrencies under the name of the IRA on a crypto exchange that has proper licensing and insurance. However, for those who prefer greater security and hold IRA-owned cryptocurrencies on a cold wallet instead of the exchange, there are options such as dual signatures which enable them to retain control while keeping the cryptocurrencies on a cold wallet, but with certain limitations.
BONUS: Bitcoin Investing with a Self-Directed IRA
Bitcoin investment gained incredible popularity following its dramatic increase in value in late 2017 and early 2018. After an equally significant decline, it reached a value of over $12,000 during the summer of 2019. However, the outbreak of the COVID-19 pandemic in early 2020 resulted in greater favor toward cryptocurrencies, including Bitcoin. Its price reached a peak of approximately $64,000 in April of 2021, but due to certain concerns in the industry, it again fell by 50%. However, since it reached its lowest point of just under $30,000 in July, it has experienced even greater success, reaching a high of $69,000 on November 20.
From that time onwards, it has experienced more lows than highs. At present, as of January 2022, it is at approximately $42,600. Nevertheless, as evidenced by Bitcoin’s past, it will not remain at that level for long. Will it soar once more or crash down to the ground? It is uncertain. The only certainty is that cryptocurrencies are here to stay.
The options for investments in retirement accounts are vast – the IRS only specifies limitations on certain items such as life insurance, most collectibles, and transactions with disqualified individuals (further elaboration to come).
It is viewed as financially beneficial and a method of improving asset diversification to use retirement funds to invest in alternative assets. Tax-deferred growth of gains is enabled by the former, while the latter broadens the range of holdings beyond the typical selection of stocks, bonds, and mutual funds.
IRA Financial enables you to experience absolute autonomy when collaborating with a suitable administrator or custodian. You are no more constrained to invest only in your bank or any other financial establishment. Through checkbook control, you no longer require approval to initiate investments; therefore, you are free to invest in Bitcoin or any other ventures of your liking.
What is Bitcoin?
If you’ve explored our website or gone through our previous blog posts, then you’re aware that we offer plentiful information on Bitcoin. In essence, it stands as the pioneering (and well-received) form of cryptocurrency in existence. The security of these virtual currencies is maintained due to the implementation of blockchain technology, and there is no specific government that is responsible for endorsing this form of currency.
Users are responsible for monitoring Bitcoin transactions due to its decentralized nature, and the blockchain plays a crucial role in this process. The ledger, which displays all transactions made with a specific Bitcoin, can be accessed by anyone. After verification, the transaction is added to the blockchain, ensuring full transparency, although Bitcoin does offer some level of anonymity.
Despite the increasing number of merchants that accept Bitcoin as a form of payment, it is still mostly regarded as an investment due to its early stage as an asset. The possibility of cryptos gaining broad acceptance is uncertain and can either happen soon or not at all.
Bitcoin Investing with Your Self-Directed IRA
Investing in Bitcoin, along with numerous other alternative investments, is possible through a Self-Directed IRA. Utilizing either a traditional IRA (consisting of pre-tax funds) or a Roth IRA (permitting tax-free withdrawals), is a choice that is available.
There are essentially two categories of Self-Directed IRAs: those with Checkbook Control and those that are Custodian Controlled.
Custodian Controlled Self-Directed IRA
Several financial institutions have embraced the self-directed approach, providing Self-Directed IRAs for diversified investment options. Nevertheless, there are restrictions. Your investment must undergo approval by the custodian before implementing. Although a custodian-managed Self-Directed IRA is superior to a typical IRA, it fails to afford you absolute autonomy.
Although this structure may be appropriate for various investors, it may not matter much to wait for approval if you do not make numerous investments each year. Nevertheless, investing in Bitcoin is a distinct matter. The cryptocurrency markets operate continuously, and any delay in approval could have an impact on your profits.
Checkbook Control Self-Directed IRA
Previously, we stated that customers of IRA Financial can enjoy checkbook control. This allows you to connect your bank account to your Self-Directed IRA, granting you complete control over decision making. IRA Financial is considered a passive custodian, which suggests that they acknowledge and permit what occurs or what others do without actively responding or resisting.
In essence, an LLC is established that is owned by the IRA. As the IRA manager, you have the authority to make investment choices. Passive custodians such as IRA Financial will not impose restrictions on your investment decisions; their role is limited to establishing and maintaining the account while ensuring it complies with IRS regulations.
Prohibited Transaction Rules
The sole condition that may prohibit a Bitcoin transaction is if it involves a disqualified individual, as long as we exclude investments in collectibles or life insurance. A disqualified person can include yourself, your ancestors and lineal descendants, and any entity in which you have a minimum of 50% ownership.
Investments made must solely benefit the IRA and not benefit the investor or any disqualified persons through Bitcoin investment. Tax advantages are already in place for the IRA, and the IRS has prohibited any additional personal benefits for the investor.
The IRS Stance on Bitcoin Investing
When it comes to Federal taxes, Bitcoin is taxed differently than traditional fiat currencies such as dollars and euros. According to Notice 2014-21 issued by the IRS, virtual currency is considered property for tax purposes, and therefore the same tax principles that apply to property transactions also apply to virtual currency transactions.
The profits obtained from selling Bitcoin are regarded as a type of capital asset by the IRS and are therefore subject to either short-term or long-term capital gains tax rates. As Bitcoin is classified as property, the IRS requires adherence to strict record-keeping protocols and taxes for its utilization.
Conclusion on Bitcoin Investing
Investing in Bitcoin is relatively new and unstable. If you buy at the right time, you can earn a considerable amount of money, but the opposite is also true. The principle of buying low and selling high applies here. At IRA Financial, we are yet to fully embrace the cryptocurrency trend and its underlying technology.
It is crucial to collaborate with an expert prior to entering the realm of Bitcoin investments. Crypto investing operates around the clock, without any end-of-day closure. Therefore, you need to assess the potential profits against the risks before delving into the world of cryptocurrency.
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