A Series Of Landmark Prohibited Transaction Cases: The Kellermans
This article is part 3 of a series with the goal of educating you, the Self-Directed IRA LLC investor, on how to successfully invest & avoid triggering prohibited transactions.
If you’ve read parts 1 and 2, get ready for something completely different! The case we’re going to go over today is about bankruptcy, something I hope you never go through!
What’s ironic is with a Self-Directed IRA LLC’s you have a bit of an advantage as far as being protected from creditors is concerned. But as you will out by the end of this article, once you go in too deep, there’s no way out!
Kellermans Filing For Bankruptcy
The Kellermans, for whatever reason, decided to file for voluntary Chapter 11 bankruptcy. Prior to filing for bankruptcy, Barry Kellerman created an IRA, which as of October 27, 2008, had a reported value of $252,112.67.
The named administrator of the IRA is Entrust Mid South LLC. The IRA is Self-Directed by Barry Kellerman, who made all of the decisions related to the issues raised in the objections.
At the start of their case, the Kellermans valued their IRA at $180,000.00 and claimed the entire fund as exempt under the Bankruptcy Act.
The trustee in the bankruptcy case against the Kellermans objected to the Kellermans’ claimed exemption in the IRA on the basis that it was no longer exempt from taxation as of the commencement of the case and is not eligible for exemption.
The trustee alleged that the IRA lost its exempt status in 2007 because Barry Kellerman directed the IRA to engage in prohibited transactions involving disqualified persons.
The alleged prohibited transactions involved the 2007 purchase of four acres of real property located near Maumelle, Arkansas. Panther Mountain Land Development LLC helped setup the purchase.
Barry Kellerman and his wife each own a 50 percent interest in Panther Mountain. To effect the acquisition and development of the four-acre property, the IRA and Panther Mountain formed a partnership whereby the IRA contributed property and Panther Mountain contributed property and cash.
The purchase took place to assist in the development of two nearby tracts of approximately 80 and 120 acres owned by Panther Mountain. Controlling the 4 acre tract assisted in the development of the other Panther Mountain properties.
Things Get Interesting
Interestingly enough, Panther Mountain filed its own Chapter 11 bankruptcy on September 20, 2009 after the Kellermans filed for bankruptcy on June 3, 2009.
Even more interesting is that the Kellermans admitted that they are “disqualified persons”. Specifically, Barry Kellerman is the beneficiary of the IRA and a fiduciary because he exercises “discretionary authority” and “discretionary control” over the IRA as the owner.
Dana Kellerman qualifies as a “member of the family” as the wife of Barry Kellerman. Panther Mountain is a “disqualified person” according to 4975(e)(2)(G) because Barry Kellerman asserts a 50 percent membership interest. Likewise, the Entrust Partnership is also a disqualified person according to subsection 4975(e)(2)(G).
Remember: in this case it is already clear that a prohibited transaction occurred. The debtors are only seeking bankruptcy protection.
The Court Rules Against The Kellermans
Based on the Kellermans’ admittance and the court’s findings on disqualified persons, all that remained was a determination of whether a prohibited transaction occurred that terminated the tax exempt status of the IRA.
The court concluded that in 2007, Barry Kellerman engaged his IRA in transactions including the purchase of the real property with IRA funds and the cash contribution of $40,523.93 made by the IRA to the Entrust Partnership.
Both collectively and individually, both the non-cash contribution and the cash contribution are prohibited transactions with disqualified persons according to IRC Sections 4975(c)(1)(B), (D), and (E), which rendered their IRA non-exempt.
What was not stated above is that, during Panther Mountain’s own bankruptcy filings, (which were happening around the same time) they made it seem as if they were using the Kellerman IRA as a lending source for the purchase and development of property.
So then, the real purpose of these transactions was to directly benefit Panther Mountain and the Kellermans in developing both the four acres and the properties owned by Panther Mountain.
Here’s a shocker. The Kellermans each owned a 50 percent interest in Panther Mountain and stood to benefit substantially if the four acre tract and the adjoining land were developed into a residential subdivision.
Case Outcome & Summary
The Kellerman case involved a construction company’s owners, the Kellermans, who were also LLC co-owners. They were denied a claim for bankruptcy estate exemption for Mr. Kellerman’s Self-Directed IRA.
The court found that Mr. Kellerman who, along with his wife, were disqualified persons who had engaged in prohibited transactions by:
- By directing their IRA to deliver property as a non-cash contribution to an IRA and LLC.
- By making cash contribution to partnerships to develop property.
You can view the full case here.
What We Learned From The Kellermans + My Thoughts
This case is a clear example that using retirement and personal funds together in the same transaction can trigger a prohibited transaction.
The Kellermans entered into a transaction with their IRA funds, which involved a disqualified person, in this case Panther Mountain. Because they did that, they then had the burden of proving the transaction didn’t violate any of the self dealing or conflict of interest prohibited transaction rules under IRC Section 4975.
A burden that, as this case shows, can be difficult to prove.
So here’s the lesson we’ve all learned from the Kellermans: Using retirement funds and personal assets in the same transaction can potentially trigger the prohibited transaction rules.
Don’t end up like the Kellermans! If you’re interested in learning more about Self-Directed IRA LLC’s, Call Royal Legal Solutions now at (512) 757–3994 to schedule your free consultation!