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Avoid Accidentally Making a Prohibited Transaction: This Week’s Q&A

By Beverly DeVeny
Director of Retirement Education
Follow us on Twitter: @theslottreport

This week's Slott Report Mailbag examines TDAs, IRAs, and prohibited transactions.  As always, we recommend you work with a competent, educated financial advisor to keep your retirement nest egg safe and secure. You can find one in your area here.

Question:

I am a retired New York City educator who has a considerable amount accumulated in a TDA. I would like to reduce my tax burden, as I am now 65 years of age. What would you suggest I do, so I don’t have to share too much money with Uncle Sam?

Answer:

Tax deferred accounts are a great way to save for retirement. But you made a deal with the government. The deal was that you would pay no income tax on funds as they were earned, you would invest those funds, and when you turned a specified age you would begin withdrawing those funds and pay taxes on them. Whether your account is a retirement account or a non-retirement tax deferred annuity, income tax will be due on your withdrawals.

There are ways you can reduce your taxes. You should consult with a tax advisor who can look at all your income sources and expenses and make recommendations on how you could potentially reduce your taxes in your retirement years.

Question:

Dear Sir or Madam,

I have a quick question.

We purchased a rental property with our IRA. I am the trustee and my wife is one of the beneficiaries. Can she be the manager of this rental property? Thank you for clarifying this.

Andreas

Answer:

First of all, I would like to clarify some terminology. An IRA can only belong to one individual. Presumably, you are referring to your IRA of which your wife is a beneficiary. The company holding your IRA will be the custodian or trustee. You would be the IRA owner and you would have directed your IRA to purchase the rental property. These issues are important. If both you and your spouse “own” the IRA, then you do not have an IRA. But that is another issue for another day.

The IRA bought and owns the rental property. We will assume that this transaction was done properly and did not create a prohibited transaction. Either you or your spouse can act as the property manager as long as your activities are limited to renting out the property, collecting the rents, arranging for bills to be paid with IRA funds only and remitting any profits for the month to the IRA, and arranging for maintenance to be performed on the property.

Be very careful here. The rules are complicated and one wrong move could have serious consequences. To avoid problems, you may be better off hiring an unrelated third party as a property manager. Keep in mind that neither you nor your spouse can perform any maintenance on the property, use any personally owned supplies at the rental property, or personally pay any expenses of the rental property. Bottom line, there can be no comingling of personal and IRA assets. You should become very familiar with the prohibited transaction rules. Any violation of the rules would cause your IRA to be deemed fully distributed to you and income tax would be owed on the value of the IRA as of the first of the year in which the prohibited transaction occurred.

 

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