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R. Klein, EA
R. Klein, EA, Enrolled Agent
Category: Tax
Satisfied Customers: 2879
Experience:  Over 20 Years experience
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I have a self directed Roth IRA that has bought and sold real

Resolved Question:

I have a self directed Roth IRA that has bought and sold real estate for some 15 years (20+ transactions in total) and am concerned about the possibility that one or more transactions in the distant past that may not completely pass the prohibited transaction test as you described in your post of a year ago. In that post you wrote that if so determined by the IRS "Then all the assets of the IRA would be considered distributed and you would be taxed on everything in the IRA" Does that mean that all the funds generated from other transactions that occurred in the account would be considered distributed as well? In other words, does one bad transaction jeopardize the status of the ENTIRE account and if so what can one do to ameliorate that situation? I'm still 15 years from required distributions and cringe at the thought of a complete dissolution and taxation of my entire account. Thoughts ?
Submitted: 7 months ago.
Category: Tax
Expert:  R. Klein, EA replied 7 months ago.

R. Klein, EA : Thank you for contacting me about your Tax issue. I will work hard to help you understand the issue clearly.
R. Klein, EA : Yes, if you have a prohibited transaction, your IRA would be considered closed on the date of the disqualifying transaction.
R. Klein, EA : that also means that all subsequent transactions would have been with disqualified money (the fruit of the poisoned tree theory).
R. Klein, EA : You would end up owing tax on the distribution, plus the 10% penalty! plus the taxes on all the other capital gains transactions afterward.
R. Klein, EA : So yes, this is VERY bad, and is why you must be very careful, especially with self directed IRAs.
R. Klein, EA : Now the good thing here is that your principal originally is within a ROTH, and therefore that amount is not subject to tax or penalty, but any growth is subject to tax.
R. Klein, EA : Since we are not discussing your potentially disqualifying transaction in this question, let's hope that this thing does not surface as a disqualifying transaction.
Customer:

Thank you for your prompt response. To further elaborate, the opening balance and contributions to the account were made in the early years but realistically, 90% plus of the current balance is a result of growth. Total account balance exceeds 500k, so this would be disastrous for sure. Two follow-ups if I may:

Customer:

1) I don't know of anyone who has had their IRA audited. I have been audited (business and personal) and the subject of my IRA's never came up. (I also have a large balance traditional). What circumstances triggers an audit of the IRA transactions (disqualifying or not) ?

Customer:

2) Would it be reasonable as a precaution to stop all further activity in that IRA and open a 2nd Roth account that would be insulated from the potential past errors of the 1st Roth account? Am I required to have kept ALL documents relating to every transaction that occurred in my account? No three year rule?

Customer:

Thank you for your time.

R. Klein, EA, Enrolled Agent
Category: Tax
Satisfied Customers: 2879
Experience: Over 20 Years experience
R. Klein, EA and 7 other Tax Specialists are ready to help you
Expert:  Robin D. replied 7 months ago.
Hello so sorry I missed you when you first requested me.
You asked "What circumstances triggers an audit of the IRA transactions (disqualifying or not) ?"
Just like with individuals or businesses, there are no specific triggers for audits. The “prohibited transaction” rules,which, if violated, can result in an IRA being treated as fully distributed to the IRA owner in one lump sum = terrible tax consequences. There are certain situations where the income earned by their self-directed IRA is not exempt from current tax (i.e. their IRA must file a tax return and pay a tax). The documents required by others and sent to the IRS naming the IRA would place the IRA in a position for scrutiny if the IRA did not file the return when needed.
Record keeping was your next concern, Yes you were required (for your own protection to retain the records. The 3 year rule protects but not if the return was never filed and this is for the IRA too if it needed to have ever filed a return.
You could open a second Roth but you need to have a competent tax professional go over the full information for the 1st IRA to determine if there are problems that need to be addressed as well.

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