If done incorrectly, taking an SDIRA distribution can disqualify your IRA. If the IRS disqualifies your IRA, you owe taxes on the entire IRA backdated to Jan 1 of the year of the disqualification plus interest. If your return for that year is grossly inaccurate, you can also owe an egregious return penalty of 20%. If you were under 59 1/2 in that year, you also owe a 10% premature distribution penalty. That can be a lot of money to the government for doing what you thought was a proper transaction.
This article will walk you through the steps you need. If your SDIRA is either a type one or two as listed on this page (http://frankseldenlaw.com/self-directed-ira/), then simply tell your custodian that you want a distribution. That simple. This article is for people whose IRAs are invested into an LLC or Trust which they control. The article uses “LLC” but the entity is not relevant to these issues.
You decide you want a distribution from your IRA; RMD, pre-mature, just because. The steps make a difference to the tax consequence but the reason doesn’t matter to these steps.
SDIRA Distribution – Wrong
You invested your IRA into an LLC for which you are the manager. The LLC might own real estate, a bank account, a brokerage account, other private placement investments. You want a distribution, so you write a check to yourself from the LLC. Then what?
If you want to report the distribution, you need a 1099 from the custodian. If all you did was write a check from your LLC bank account you won’t have one. So you tell your custodian you took a distribution so they can issue a 1099. They ask you how. You tell them. They tell you that was not a proper distribution but a prohibited transaction, which is how the IRS would see it. So instead of issuing a 1099, they tell you they are obligated to report the prohibited transaction.
So you decide not to tell your custodian. However, you still feel obligated to report the distribution. You add it to your 1040. The IRS contacts you that they did not receive the corresponding report from your custodian. Didn’t know that part?
So then you decide you don’t want the distribution after all. You put the money back. Problem solved? Practically, yes. Likelihood of an audit is slim. However, putting the money back does not erase the prohibited transaction. In fact, you just committed another one. Not reporting prohibited, even if they do not negatively impact the IRA, is another offense.
I am not trying to scare readers with a straw man type argument. This happens. The bottom line is follow the rules, including how to properly take a distribution from your IRA.
SDIRA Distribution – Right
- Never write yourself a check from your IRA LLC account. What if I need a reimbursement? No. What if I need a short term loan? No. What if… No. There is no legitimate scenario to ever write yourself a check or otherwise distribute property to yourself or any disqualified person from your IRA assets.
- Contact your custodian. Let them know you want to take a distribution. Follow their steps. Just like any other IRA.
- The steps will include sending funds from your IRA LLC account to the IRA via check or wire. The custodian then has the funds to send a distribution to you, create the appropriate 1099 and file their custodial paperwork with the IRS to show a proper distribution.
Yes, either way you end up with funds from an IRA asset into your own pocket. The first, simpler method results in IRS issues and more money to the government. The second, more-steps-involved scenario, lets you sleep at night.
The Bottom Line
A friend of mine has a sign on his boat which reads “One: The Captain is always right. Two: If you think the Captain is wrong, see rule #1.”
See the correlation? In our country, the rules are the captain. Well, except for people who are in position to follow the rules and get away with it (thinking of specific politicians but that is another blog post for another time). When it comes to IRAs, just follow the rules.
#1. If you want to take a distribution, talk to your custodian and follow their steps.
#2: If you think the steps are stupid, see rule #1.
Need help? Contact me first. Easier to avoid mistakes than fix them.