A ProPublica article recently came out about the fortunes amassed by some of the wealthiest people in America. One of those, PayPal co-founder Peter Thiel, was at the top of this list. He turned less than $2,000 back in 1999 into a $5 billion Roth IRA today. The Roth IRA (individual retirement account) is one of the most coveted retirement accounts available - especially since ProPublica released information about Peter Thiel's $5 billion Roth IRA. You have $10,000 in traditional IRA contributions with a basis of $5,000. If you were to convert all your traditional IRAs to Roth IRAs and the value of your IRA account was $11,000, you would report as income $11,000 minus $5,000—your basis—which would be $6,000 in income. With a Roth IRA, contributions are not tax-deductible, but earnings can grow tax-free, and qualified withdrawals are tax- and penalty-free. Roth IRA withdrawal and penalty rules vary depending on your age and how long you've had the account and other factors.

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BY ROBERT PRESTON

EXECUTIVE SUMMARY
THE DECISION OF HOW TO INVEST IRA ASSETS is complicated because the law does not allow taxpayers to hold certain investments in an IRA. CPAs will find little formal guidance on IRA investments from the IRS or the Department of Labor. IRA INVESTMENT GUIDELINES GENERALLY ARE limited to listing what a taxpayer cannot purchase, including life insurance and collectibles, such as art works, antiques and most precious metals. Foreign investments should be limited to ADRs and domestically sponsored mutual funds. REAL ESTATE, INCLUDING LEVERAGED REAL ESTATE, generally is permitted in an IRA if the investor follows certain commonsense guidelines, such as finding a trustee that specializes in holding real estate and other unusual IRA assets. The CPA also should encourage the client to obtain a letter ruling from the IRS in advance. SELF-DEALING, OR ENGAGING IN A PROHIBITED transaction, can taint any IRA transaction. Transactions must be made at arm’s length and not involve the IRA owner or a member of his or her family. To avoid such problems, the CPA should emphasize investments for which established markets already exist. IRA OWNERS ALSO MUST BE CAREFUL NOT TO INCUR unrelated business income. IRC sections 511–514 allow the IRS to tax an exempt entity that conducts business unrelated to its original purpose.
ROBERT PRESTON, CPA, is a sole practitioner in Danbury, Connecticut. His e-mail address is rpreston@prodigy.net .

RA investors today have literally hundreds of investment options available to them ranging from the stock, bond and mutual fund offerings of Wall Street to gold coins, real estate and derivatives. The decision to purchase one or more of them is one an investor often makes with the advice of his or her CPA. Investment decisions can be more complicated when the client intends to hold the investment in an IRA. The law does not allow taxpayers to put certain investments in an IRA; despite such limitations, there remain some attractive, little-publicized and less-known investment opportunities. CPAs should be familiar with them so they can give clients the best possible advice on a confusing, and potentially risky, subject.

KEEPING WITH TRADITION

Most CPAs are aware of the traditional IRA investments—publicly traded stocks, bonds, treasury instruments, cash. But what about investments outside the United States or in private placements and real estate? Are these viable options for an IRA? How about limited partnerships or options? Can a client make these investments legally? Are commodities, personal loans or mortgages acceptable alternatives?

Unfortunately, there isn’t extensive guidance from federal regulators that answers these questions and provides a thorough overview of what investments are allowed in IRAs. CPAs, however, will find considerable guidance on IRA deduction limits and minimum distributions. The rationale for that is fairly obvious—Congress and other agencies put a priority on rules affecting revenue collection.

Growth of IRA Assets
Sources: Statistical Abstract of the United States, 1997; Employee Benefit Research Institute Notes, December 1997 and May 1999.

While the Department of Labor (DOL) is the principal authority responsible for prudent, allowable investments and overseeing prohibited transactions in qualified plans, its interest in IRAs is minimal. In most instances, the DOL does not consider an IRA a pension plan and consequently it is not covered by Title I of ERISA; for the exceptions, see DOL regulation 2510.3-2(d). However, the DOL has principal authority for prohibited transaction issues (and granting exemptions) involving IRAs under IRC section 4975(e).

ERISA initiated the concept of asset guidelines as they apply to qualified plans (principally ERISA sections 404 and 406–408), but there are no asset diversification guidelines for IRAs similar to those in ERISA section 407 for qualified pension plans. Government agencies and the courts have provided follow-up guidance. IRAs originated with ERISA in 1974, but the Economic Recovery Act of 1981 gave them a big boost by relaxing the eligibility rules, allowing more individuals to participate, including those covered by employer-sponsored pension plans. While the Tax Reform Act (TRA) of 1986 added some restrictions, the 1997 TRA continued the liberalizing trend of the early 1980s. With the proliferation of large pension distributions being rolled over into IRAs, assets have mushroomed.

IRA INVESTMENT RESTRICTIONS

While Congress put strict prohibitions on some IRA investments (for example, insurance), it did not pay similar attention to other asset classifications. Because the account owner generally manages IRA assets, Congress and the enforcement agencies probably did not foresee the same need for supervision and guidelines as with pension assets, where the potential for abuse seemed greater.

What rules does an account owner have to follow when making IRA investments? The primary laws affecting IRA investments are IRC sections 219, 408 and 4975, along with the accompanying regulations. CPAs will find that IRA owners have considerable investment leeway based on what’s not addressed by any government body or area of law. Accordingly, the scope of permissible IRA investments is somewhat vague and subject to interpretation.

What is helpful is that IRA investment restrictions are relatively straightforward. Collectibles generally are not allowed, with a few exceptions—see section 408(m). There can be no “self-dealing” with IRA funds; that is, they cannot be used to further personal financial dealings—see section 408(e). And, as mentioned above, life insurance is not allowed.

As with many of the rules there is logic behind them. For starters, a certain degree of liquidity is important in retirement assets. If too much money is tied up in illiquid investments, such as collectibles or real estate, the required cash flow may not be available to participants during retirement, or for their heirs, to make required distributions. And since the regulations, supervision and enforcement procedures surrounding collectibles and other tangibles as investments are not as clear as the overall surveillance of securities and mutual funds by the SEC and other agencies, the latter offer more leeway for IRA owners.

When specific questions arise as to allowable IRA investments, it’s possible for the client to get an IRS letter ruling beforehand; one generally takes three to six months to obtain. When the client is considering an unusual commitment with IRA funds, it’s prudent for the CPA to review existing IRS letter rulings, DOL ERISA opinion letters and prohibited transaction exemptions to spot trends that could affect the client’s decision. These rulings are available on various electronic sources (both the DOL and IRS have exhaustive references on the Internet).

WHAT WORKS; WHAT DOESN’T

Following are some of the rules that apply to specific investments a client might use in IRAs as well as some important limitations.

Life insurance. Congress’ intent in not permitting life insurance was to have IRA funds invested so they would provide inflation-protected returns. Ob

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