ERISA-DOL Advisory Opinion Concludes That The Purchase Of A Promissory Note and Deed Of Trust By An IRA Would Be A Prohibited Transaction

In Advisory Opinion 2011-04A, the Department of Labor (the “DOL”) was asked whether the purchase of a promissory note (the “Note”) and a deed of trust by an IRA from a bank would result in a prohibited transaction under section 4975 of the Internal Revenue Code (the “Code”). In this case, the IRA owner and his spouse were the obligors on the Note. Also, title to the real property encumbered by the deed of trust was held by a family trust of which the IRA owner and his spouse were the trustees and sole beneficiaries. The IRA owner directs the investment of the IRA’s assets. Upon completion of the purchase, the IRA would become the holder of the Note, and the IRA owner and his spouse would make all payments on the Note to the IRA.

The Advisory Opinion indicates that section 4975 of the Code sets forth a series of “prohibited transactions” involving a “plan” and a “disqualified person.” Section 4975(e)(1) defines the term “plan” to include an IRA. Section 4975(e)(2) defines “disqualified person,” in pertinent part, to include:(1) a fiduciary of the IRA (“fiduciary” includes a person who directs the investment of the IRA’s assets) and (2) the fiduciary’s family members, including his spouse. Thus, the IRA owner and his spouse are disqualified persons with respect to the IRA.

Section 4975(c)(1)(B) prohibits the lending of money between a plan and a disqualified person. Here, the IRA would hold the Note and receive payments on the Note from the IRA owner and spouse, who are disqualified persons with respect to the IRA. As such, a loan, which violates Code section 4975(c)(1)(B) and is thus a prohibited transaction, will exist between the IRA and the IRA owner and spouse once the IRA acquires the Note from the bank. This prohibited transaction will continue as long as payments on the Note are made by the IRA owner, his spouse or any other disqualified person.

The DOL further notes that section 4975(c)(1)(D) prohibits any direct or indirect transfer to, or use by or for the benefit of, a disqualified person of the income or assets of the IRA. Section 4975(c)(1)(E) prohibits a fiduciary from dealing with the income or assets of an IRA in his own interest or for his own account. The acquisition and holding of the Note by the IRA would violate those Code sections, if the transaction was part of an agreement, arrangement or understanding in which the fiduciary-here the IRA owner- caused plan assets to be used in a manner designed to benefit such fiduciary, or any person(s) in which the fiduciary had an interest that would affect the exercise of his best judgment as a fiduciary. Here, the IRA would be making an investment (i.e., the purchase of the Note) where the IRA owner would have an understanding, as a fiduciary, that the assets of the IRA are being used to create a prohibited transaction (i.e., an ongoing loan between the IRA and disqualified persons) once the IRA acquires the Note. Under these circumstances, the DOL concludes that the IRA’s purchase of the Note, by itself, would be a separate prohibited transaction under Code section 4975(c)(1)(D) and (E).

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