Prohibited transactions wipe out bankruptcy exemption for self-directed IRA.

Author:Cooley, Karen M.
Position::Individual retirement accounts
 
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The Court of Appeals for the Eleventh Circuit affirmed a district court decision (which had previously affirmed a bankruptcy court) that all funds in two of an individual's IRAs and part of a third were not exempt from his bankruptcy estate under Bankruptcy Code (USC Title 11) section 522(b)(3)(C). These IRAs were held to be not exempt because the individual had engaged in prohibited transactions under IRC [section] 4975.

In March 1993, Ernest Willis transferred funds from his existing IRA into a self-directed IRA at Merrill Lynch. Willis was informed that transactions such as borrowing from his IRA could cause it to lose its tax-deferred status. Later that year, Willis authorized a transfer of $700,000 from his Merrill Lynch IRA to his personal account. He subsequently used these funds to acquire a mortgage on real property In February 1994 Willis repaid the $700,000 he had borrowed from the Merrill Lynch IRA.

Three years later, Willis used funds from his IRA to cover negative balances in a joint brokerage account with his wife by using a series of check-swapping transactions. In each instance, he returned funds to the IRA within 60 days in an effort to avoid income tax on the IRA distributions. Willis also had two additional IRAs he had funded fully or partially with monies from the Merrill Lynch IRA.

In February 2007, Willis filed for protection under Chapter 7 of the Bankruptcy Code, claiming a bankruptcy exemption for his three IRAs, which totaled $1,499,000. On a challenge by the trustee and a creditor, the bankruptcy court determined that since Willis was managing the investments of his self-directed IRA, he was considered a "disqualified...

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