Too pay 10% Penalty or Not

[ktupper]

I have about 500K invested in a self-directed IRA in a particular business venture.

I'm expecting about a 30 fold return on it in the next 12-18 months.

I am only 42 years old and will have enough funds to live on outside of my IRA. Most of this money is going to be put into a foundation and other non-profits.

I'd like some opinions on the best course of action.

a) Withdraw the asset from the self-directed IRA now and pay a $50K penalty (10%) and LT gains (15%) and state taxes (5%) after 12-18 months and have access to the remaining proceeds

or

b) Have an IRA with about 15 million in it that I cannot touch for 17+ more years

or

c) Have an IRA with about 15 million in it that I use rule 72(t) on and end up paying 40% tax rate on withdrawals (35% feds, 5% state)

In choices b/c, I realize I will have the proceeds from the penalty and capital gains growing tax-deferred.

I have received a professional opinion, but frankly, there are some great minds on this board that I wouldn't mind hearing thoughts from.

Any opinions?

 

[soupcxan]

d) tell me where you can get a 3000% return. I will gladly accept a PM.

 

[eridanus]

Your a) is incorrect. It'll be regular income, not capital gains.

How much do you need to live? Roll over part of the $15MM to another IRA. Do a 72(t) on the smaller IRA to get right under a marginal bracket.

But if you have enough to live, b) is obviously the best choice to maximize your foundation. Sit on it.

 

[Rich_by_the_Bay]

How certain is the staggering return you cite?

 

[FIRE'd@51]

Your a) is incorrect. It'll be regular income, not capital gains.

I think he means it will be a LT gain after it appreciates (outside the IRA) in 12-18 months. His tax liability for this year will be the 10% penalty PLUS ordinary income tax (which he doesn't explicitly mention) on the 500K.

 

[lazygood4nothinbum]

unless i misunderstood the original post, you should pay at least the 10% penalty as payback for being able to live in such an amazing country that you get to 30-fold your 500k in less than 2 years. fair is fair.

 

[cute fuzzy bunny]

How certain is the staggering return you cite?

Very safe. Almost as safe as a money market account only the returns are higher.

 

[CitricAcid]

I'm expecting about a 30 fold return on it in the next 12-18 months.

Wtf?

 

[ktupper]

The return is not guaranteed (but likely given what has transpired to date) and it isn't a return that was gained in 12-18 months. It's only that it will be realized in 12-18 months.

For those that don't understand self-directed IRA's....

Self-Directed IRA - Wikipedia, the free encyclopedia

The important point is...

Some of the additional investment options permitted under the regulations include, but are not limited to, real estate, stocks, mortgages, franchises, partnerships, private equity and tax liens.

The IRS doesn't count sweat equity as investment in the cost basis. So before things are monetized, I could pay a 50K penalty for early withdrawal at the cost basis of 500K and monetize the investment outside of the retirement account and be subject to normal long term capital gains rates. (At least that is what I've been advised.)

Alternatively, I can leave it in the SD IRA, monetize it, pay no penalty, and no capital gains, but pay ordinary income tax as I withdraw it.

The benefit of possibly withdrawing it now is the foundation will get immediate access to the money as opposed to having an annuitized access via rule 72t.

 

[ktupper]

I think he means it will be a LT gain after it appreciates (outside the IRA) in 12-18 months. His tax liability for this year will be the 10% penalty PLUS ordinary income tax (which he doesn't explicitly mention) on the 500K.

Yes, sorry for my lack of clarity on that.

 

[mn54]

Does this investment involve a guy named Guido?

 

[Bikerdude]

I would think this is a situation I would seek the help of a 'high end' tax professional. Leaving aside the non profit and foundation issues a.) would (currently) seem to give you the best tax outcome depending upon how you invest the proceeds. The problem with a) is that CG are most likely to go up, probably back to 28%.

In many states IRA's are protected from law suits and bankruptcy.

All in all its still a good problem to have .

 

[Coach]

A.

Coach

 

[Martha]

You know, with such a big amount of money at stake I would spend some of the big bucks and talk to a tax planner. Who is going your foundation? The best estate planners could help you with the tax issues and well as the charitable issues. There are a number of things you can do to minimize taxes.

 

[NW-Bound]

I understand the OP's point about this IRA being invested in a private equity, which is going to experience a great appreciation in the near future.

Somebody, correct me if I am wrong, but I thought moving assets in/out of an IRA has to be done with cash. That forces an evaluation of the asset, and causes it to be "marked to market". Assets can only be moved between 401k and IRAs without this limitation.

If the above is true, how is this private equity going to be fairly valued? Most often, if this venture has been raising capital all along, they may look at the price that the last investor paid to get in. The IRS would look at any "material" news, inventions, business deals, etc..., that would raise the valuation of the assets. Tricky stuff!

By the way, I often listen to Ray Lucia's show to learn about tax laws, which he and his cohorts are very knowledgeable about.

 

[ktupper]

I understand the OP's point about this IRA being invested in a private equity, which is going to experience a great appreciation in the near future.

Somebody, correct me if I am wrong, but I thought moving assets in/out of an IRA has to be done with cash. That forces an evaluation of the asset, and causes it to be "marked to market". Assets can only be moved between 401k and IRAs without this limitation.

If the above is true, how is this private equity going to be fairly valued? Most often, if this venture has been raising capital all along, they may look at the price that the last investor paid to get in. The IRS would look at any "material" news, inventions, business deals, etc..., that would raise the valuation of the assets. Tricky stuff!

By the way, I often listen to Ray Lucia's show to learn about tax laws, which he and his cohorts are very knowledgeable about.

Agreed. I am certainly going to get a second and third opinion before making a move. Also I want legal sign-off on it so I don't get snake bitten.

If I do this, I have to move the asset now before significant appreciation is realized. The risk, of course, is that the appreciation does not occur or perhaps not to the extent we believe. In that case, I exchanged my way to a hefty tax bill.

 

[clifp]

If you are eligible I would certainly investigate, converting your conventional IRA to a ROTH IRA. (If you can hang on until 2010 anybody can do a Roth conversion regardless of income). Having made a conversion I know you can transfer assets other than cash into a Roth

It is true you would owe tax on the 500K now, but withdrawals would be tax free in the future. (Not sure what the rules are for Roth and 72(T)

The really cool thing is if the big appreciation DOESN'T occur you have you until Oct of the next tax year to reverse your decision and recharacterize/reverse the conversion from a conventional to ROTH IRA. Thus eliminating the tax bill.

I have a number of speculative private equity investments in IRA and I am planning on doing a Roth conversion if it looks promising. Like your situation some of these investments are potential 10-20x return but who knows when or if they will occur.

 

[NW-Bound]

I just remember now to mention a tax break similar to the OP's situation, but only for 401k.

Suppose you have been working at Intel or Microsoft since the 80's, and have been using your 401 contributions of $10K/year to buy your employer's stock. These shares that you bought, plus whatever company was matching, are now worth several millions, though you and the company paid much less for them.

If you now leave the company, you can roll these shares out to an IRA. Or you can do better by taking a distribution of the shares into a taxable brokerage account. You will pay an income tax, but only on the cost basis of these shares, not on the current values. If you are under 55, you will also pay 10% penalty, again only on the cost basis.

Then, if you hold these shares for more than 1 year before selling them, you will pay only the long-term cap gain tax. This special tax treatment of Net Unrealized Appreciation (NUA) is way better than the common IRA rollover, which will be taxed as regular income upon distribution.

This one-time treatment only applies to distribution of the employer stock off the original 401k. Once you roll the shares out to an IRA, you have lost this special treatment. If you trade these shares of your employer stock inside the 401k -- by buying a more diversified mutual fund, for example -- you also lose this treatment.

This tax treatment has been used to enrich many employees of tech companies who ER'ed. My ex-employer stock did not appreciate enough for me to employ this tactic. My ex-neighbor however was such a lucky guy. Shortly after ER'ing 10 years ago, he moved away to a much better neighborhood with houses costing 4 times his old house, and paid cash for it too!

I am not aware of this NUA tax treatment been extended to IRAs. One would think 401k and IRA should be treated similarly, but that is not so. Another example is bankruptcy protection.

 

[Westernskies]

You left out option D- which is that someone is going to end up in prison for participating in an investment scheme with the returns you mentioned. Hope it isn't you.