Do You Know About The Plan Asset Rules?

You don’t just have friends at the IRS. You also appear to have friends at the DOL too!

The Department of Labor (DOL) Plan Asset Rules were made to limit you from using retirement funds to transact with your own investment fund or assets.

The Plan Asset Rules list the circumstances which cause assets owned by an entity to be deemed to be assets of an ERISA qualified plan (401k) or an IRA. Unless an exemption applies.

Under the Plan Assets Rules, if your IRA/401 owns greater than 25% of an investment entity that is neither a “publicly-offered security” nor a mutual fund, the equity interests and assets of the “investment company” will be deemed assets of the IRA/401k.

This is sometimes referred to as the “look through rule”.

Meaning if your IRA owns 25% or more of the membership interests of a LLC engaged in passive investments (i.e. private equity fund, hedge fund, or real estate fund), the assets of the LLC are deemed to be assets of the IRA.

This is important to know because any transaction involving the “investment company” and a disqualified person will be a prohibited transaction. This is naturally something you want to avoid. Unless you like giving the IRS money.

Plan Asset Rules

The DOL’s Plan Asset Rules define when assets are considered ‘Plan” assets. IRAs are usually viewed as pension plans subjecting them to the Plan Asset Rules. Under the Plan Asset Rules, if the total plan (IRA/401k) ownership of an entity is 25% or more of all the assets of the entity, then the equity interests and assets of the “investment entity” are viewed as assets of the investing IRA/401k for purposes of the prohibited transactions rules, unless an exception applies.

Also, if a plan or group of related plans owns 100% of an “operating company”, the operating company exception will not apply and the company’s assets will still be treated as plan assets.

The Plan Asset Rules can be triggered if:

  • 100% of an “operating company” is owned by one or more IRAs/401k’s and disqualified persons, in which case all the assets of the “operating company” are deemed Plan assets (assets of the IRA/401k).
  • If 25% or more of an “investment company” is owned by IRAs/401k’s and disqualified persons, in which case all the assets of the “investment company” are deemed Plan assets (assets of the IRA/401k). In determining whether the 25% threshold is met, all plan owners are considered, even if they are owned by unrelated individuals.

Exceptions to the Plan Asset Rules.

The Plan Asset “look through rules” do not apply if the entity is an operating company or the partnership interests or membership interests are publicly offered or registered under the Investment Company Act of 1940.

They also do not apply if the entity is an “operating company,” which refers to a partnership or LLC that is primarily engaged in the real estate development , venture capital or companies making or providing goods and services, such as a gas station, unless the “operating company” is owned 100% by a Plan and/or disqualified persons.

In other words, if an IRA or 401k Plan owns less than 100% of an LLC that is engaged in an active trade or business, such as a restaurant or gas station, the Plan Asset Rules would not apply.

However, the IRA or 401k investment may still be treated as a prohibited transaction. Let’s not forget the threat of Unrelated Business Taxable Income. This may apply to the income or gains generated from the operating business.

How can the Plan Asset Rules impact my IRA/401k investments?

The Plan Asset Rules are often only triggered if your IRA/401k assets will own greater than 25% of an investment company (a passive investment fund) or will own 100% of an operating company (gas station).

Most investments involving IRA/401k funds will not cause the Plan Asset Rules to trigger a prohibited transaction. For example, any direct purchase of real estate, precious metals, or lending transaction not involving a disqualified person will likely not trigger the prohibited transaction rules or Plan Asset Rules.

Even if the Plan Asset Rules were to apply, as long as a disqualified person is not involved in a transaction with the investment entity, the prohibited transaction rules would not apply.

Consequences of a transaction falling under the Plan Asset Rules

If your Self Directed IRA LLC or 401k investment involves an investment in one of the following:

  • An “operating company” that your IRA will own 100% of.
  • An investment company in which 25% of more of the “investment company” is owned by IRAs/401k’s and disqualified persons.

Then all assets of the entity are deemed owned by the IRA/401k. Meaning all transactions between the investment entity or its assets and a disqualified person may be prohibited.

Note: A transaction not falling under the Plan Asset Rules can still be treated as a prohibited transaction.

The following are a number of examples that demonstrate the scope of the Plan Asset Rules.

Example 1.

Your Self Directed IRA LLC invests in JP Morgan, which will purchase a gas station, an “operating company”. You will take an annual salary of $50,000 to run the gas station, because that’s hard work after all.

The payment of the salary would be a prohibited transaction.

Note: Any income generated by the gas station that is allocated to the Self-Directed IRA LLC would probably be subject to UBIT Tax.

Example 2.

You, as a general partner of a hedge fund, wish to invest your Self-Directed IRA LLC in the hedge fund you manage. If the percentage of IRA ownership, including what it would be after you invests your IRA in the fund, equals or exceeds 25% of the equity interests, then the fund’s assets are considered “plan asset.”

Which means a transaction between you, as a disqualified person, and the fund, could be deemed a prohibited transaction because the assets of the fund are viewed as assets of your IRA, since a disqualified person cannot transact with the assets of his plan or IRA.

You cannot receive benefits from your IRA investment into the fund. So you would not be permitted to receive any management fees associated with the IRA’s ownership interest in the fund because you would be receiving a personal benefit from your IRA.

Example 3.

Trump’s Self Directed IRA LLC owns 100% of ABC, LLC, which operates a retail store. ABC, LLC makes a loan to Trump. The loan is subject to the Plan Asset Rules and will also be considered a prohibited transaction pursuant to Internal Revenue Code Section 4975.

Note: Any income generated by ABC, LLC that is allocated to the Self Directed IRA LLC would also likely be subject to UBIT.

Example 4.

Clinton’s Self Directed IRA LLC owns 15% of ABC LLC, an investment company. Bush’s IRA owns 20% of ABC LLC. Clinton and Bush are unrelated. Since IRAs (Plans) own greater than 25% of ABC LLC, an “investment company”, assets of ABC LLC are Plan Assets and deemed owned by each IRA.

So if ABC LLC makes a loan to Bush’s father, the loan would be a prohibited transaction.

Royal Legal Solutions would love to help you with any of your retirement account needs. Call (512) 757–3994 to schedule your free consultation today.

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