This article is the grand finale of a series with the goal of educating you, the almighty Self-Directed IRA LLC investor, on how to successfully invest & avoid triggering prohibited transactions.Because the prohibited transaction rules are so broad, the scope of their enforcement is as well. You’ll probably agree with what I’m saying if you’ve read the previous articles in this series.We’ve seen Self-Directed IRA investors lose their bankruptcy protection, gains, and even their entire IRA account, simply because they failed to properly follow the prohibited transaction rules.The case we’re about to go over below is different from our earlier cases because it doesn’t actually involve a prohibited transaction. Of course, the IRS tried to pin on on him anyway. But what it does involve could happen to any of us: a mistake in judgment.Dabney Vs The IRS: BackgroundBack in 2008, Mr. Dabney rolled over funds from an IRA at Northwest Mutual into a pre-existing Self-Directed IRA he had with Charles Schwab. After this he learned of a piece of undeveloped land in Brian Head, Utah that was for sale. Mr. Dabney believed the land was priced below its fair market value. He then conducted some Internet research and came to the conclusion that IRAs are permitted to hold real property for investment. He then set out to have his Charles Schwab IRA purchase the Brian Head property.Mr. Dabney also contacted his CPA (Certified Public Accountant). The Schwab customer service line told Mr. Dabney that he would not be able to make the real estate investment with his IRA at Charles Schwab as they did not permit such investments with IRA funds. (Of course they wouldn’t. There’s no money in it for them.)Mr. Dabney Makes a “Creative” Real Estate PurchaseAfter carefully considering his telephone conversations with the Charles Schwab customer service representative and his CPA, as well as his own internet research, Mr. Dabney arranged what he believed to be an “IRS approved” way to have his Charles Schwab IRA purchase the Brian Head property.Mr. Dabney proceeded to wire $114,000 directly to the bank account of Chicago Title and purchased the property. He told them to put the property under the name of “Guy M. Dabney Charles Schwab & Co. Inc. Customer. IRA Contributory”.He planned to then resell the property for a profit and to contribute the proceeds of the sale back into his IRA. Mr. Dabney believed that the property would not need to be managed by a trustee as long as he did not use or “enjoy” the property.Although he had hoped to sell the property sooner, Mr. Dabney was unable to find a buyer until 2011. It was then that Mr. Dabney discovered that the property was incorrectly titled in his own name.Upon discovering this error, Mr. Dabney sought and received a scrivener’s affidavit from Chicago Title, which means the company admitted the error was their fault.Mr. Dabney then sold the Brian’s Head property and received $127,226 on the sale, after taxes and fees, which was about $13,000 profit. That amount was wired back directly into his Charles Schwab IRA around January 28, 2011.Mr. Dabney’s CPA prepared his Form 1040, U.S. Individual Income Tax Return, for 2009. Charles Schwab issued Mr. Dabney a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for 2009, although Mr. Dabney said he didn’t receive it.The Form 1099-R stated that he had received a $114,000 early distribution from his Charles Schwab IRA and that no exceptions to the early distribution penalty applied. Mr. Dabney did not report the withdrawal on his Form 1040.The Court’s ConclusionThe Court confirmed that an IRA is allowed to hold real estate, but that the law does not require an IRA trustee or custodian to give the owner of a Self-Directed IRA the option to invest IRA funds in any asset that is not prohibited by statute, such as real estate.The Court further held that the withdrawal of the IRA funds from Schwab was not considered a tax free direct rollover, which means he was subject to a 10% fee. On the bright side, the court did not hold Mr. Dabney liable for the 20% understatement penalty, citing that he had acted in “good faith”.What Real Estate Investors Can Learn From The Case The traditional financial institutions and banks, such as Charles Schwab, etc, don’t make money when you invest your IRA funds in alternative investments, like real estate, and as a result, will not allow you to do so.To that point, the Tax Court was clear in stating that an IRA custodian is not required to provide its IRA clients with the ability to invest in all IRS permitted investment options if they don’t want them to.In the words of the Tax Court “The flaw is not in Mr. Dabney’s intent but in his execution.” If Mr. Dabey had ininitated a rollover or a trustee-to-trustee transfer from his IRA to a different IRA (one that is permitted to hold real property) he would have won this case hands down.The Dabney case is a great example of why you want to use a special Self-Directed IRA custodian, such as Royal Legal Solutions, when making alternative asset investments with an IRA. A small mistake can cost you thousands, which is far more than the cost of hiring a custodian. The tax code is vast and can be overwhelming for someone who lacks years of experience in dealing with them as well as the IRS. Save yourself the money and the court dates and get a Self-Directed IRA custodian if you’re not 100% sure you won’t be triggering a prohibited transaction or some other penalty.I hope you enjoyed this series of articles and learned a thing or two about directing your own investments.To learn how to take control of your future and your retirement savings with a Self-Directed IRA LLC, contact Royal Legal Solutions now.