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Physical Possession of Coins Owned by Self-Directed IRA Was a Taxable Distribution

(Parker Tax Publishing December 2021)

The Tax Court held that a taxpayer who self-directed her individual retirement account (IRA) to invest in American Eagle coins through a limited liability company owned by the IRA and managed by the taxpayer, and who then took physical custody of the coins, received a taxable distribution equal to the cost of the coins. The court also found that a statement on the website the taxpayer used to set up her IRA, which indicated that taxpayers could purchase coins with IRA funds and obtain physical possession of the coins without tax consequences, did not constitute a reasonable cause defense to the substantial understatement of tax penalty. McNulty v. Comm'r, 157 T.C. No. 10 (2021).


Donna McNulty is a registered nurse. Her husband, Andrew, is a plant manager for a sailcloth manufacturer. In August of 2015, Donna purchased services from Check Book IRA, LLC (Check Book), through its website, that included assistance in establishing a self-directed individual retirement account (IRA). Check Book's website advertised that a limited liability company (LLC) owned by an IRA could invest in American Eagle (AE) coins, and that IRA owners could hold the coins at their homes without tax consequences or penalties if the coins were "titled" to an LLC. Donna established a self-directed IRA using Check Book's services and named Kingdom Trust Co. (Kingdom Trust) the IRA custodian. Check Book formed Green Hill Holdings, LLC (Green Hill), a single-member LLC that is a disregarded entity for federal tax purposes. Its sole member was Donna's IRA. Donna and Andrew were appointed Green Hill's managers. Their personal residence is Green Hill's principal place of business.

Donna funded her self-directed IRA through direct transfers from two qualified retirement accounts, an individual retirement annuity and an employer-sponsored Code Sec. 401(k) plan. Upon Donna's instruction $378,487 was transferred from the annuity to her IRA during 2015 and $48,375 from the 401(k) during 2016. The McNultys did not report any part of these transfers as gross income. Donna instructed Kingdom Trust to use her IRA funds to purchase membership interests in Green Hill. In turn, Donna, as the LLC's manager, had Green Hill use almost all of the funds to purchase AE coins. The coins were shipped to the McNultys' personal residence and were stored in a safe. Kingdom Trust filed Form 5498, IRA Contribution Information, with the IRS for 2015 and 2016, reporting the IRA's fair market values as $349,856 and $388,247, respectively.

The McNultys' 2015 and 2016 tax returns were prepared by a CPA. The McNultys did not seek advice from the CPA about the tax reporting with respect to their self-directed IRAs or their physical possession of AE coins purchased using funds from their IRAs, nor did they disclose to their CPA that they had physical possession of the AE coins at their residence. In a notice of deficiency, the IRS determined that Donna received taxable distributions on receipt of the AE coins that she failed to report. The IRS also applied penalties under Code Sec. 6662 for both years for underpayments due to substantial understatements of income tax and, alternatively, negligence or disregard of rules or regulations, attributed to her failure to report the distributions. The McNultys took their case to the Tax Court.

Under Code Sec. 408(a), an IRA is a trust created or organized for the exclusive benefit of an individual or his or her beneficiaries, but only if the written governing instrument creating the trust meets certain enumerated requirements. One requirement is that the IRA be a trust that is administered by a trustee that acts as a fiduciary. The trustee must keep separate and distinct records with full information on each IRA. If assets require safekeeping, the trustee must deposit them into an "adequate vault" and keep a permanent record of deposits and withdrawals from the vault. An owner of a self-directed IRA is entitled to direct how his or her IRA assets are invested without forfeiting the tax benefits of an IRA. However, IRA owners cannot have unfettered control over the IRA assets without tax consequences. Under Reg. Sec. 1.408-2(e), a qualified custodian or trustee must be responsible for the management and disposition of property held in a self-directed IRA. A custodian is required to maintain custody of the IRA assets, maintain the required records, and process transactions that involve IRA assets.

The IRS contended that Donna should be treated as having possession of the AE coins irrespective of Green Hill's existence, her status as its manager, and its purported ownership of the coins. The McNultys argued that the AE coins were assets of Green Hill and that Donna's physical receipt of them did not constitute taxable distributions from her IRA. Alternatively, they argued that an exception to the custodial requirement applied under Code Sec. 408(m) for the AE coins. Code Sec. 408(m) generally prohibits IRAs from investing in collectibles and treats an IRA's investment in collectibles as a taxable distribution. Certain coins and bullion are excluded from the definition of "collectibles," thus allowing IRAs to invest in them. According to the McNultys, the flush text of Code Sec. 408(m)(3) says that physical possession by a trustee is a condition of an IRA's ownership of bullion, and since the AE coins are not bullion, a trustee was therefore not required to have physical possession of the AE coins. The McNultys also argued that no penalties should apply because they acted with reasonable cause and in good faith under Code Sec. 6664(c)(1). They said they researched the LLC structure and reasonably concluded that they could take custody of AE coins purchased through an LLC with IRA funds without tax consequences. They also noted that Check Book's website advertised that taxpayers could purchase AE coins with their IRA funds and obtain physical possession of the coins without any tax consequences.


The Tax Court held that Donna received taxable distributions from her self-directed IRA equal to the cost of the AE coins upon her receipt of the coins. The court also held that the McNultys were liable for penalties for substantial understatements of income tax attributable to their failure to report taxable distributions from their IRAs.

The Tax Court found that the presence of a fiduciary is fundamentally important to the statutory scheme of IRAs, which is intended to encourage retirement savings and to protect those savings for retirement. Independent oversight by a third-party fiduciary to track and monitor investment activities, the court said, is one of the key aspects of the statutory scheme. The court found that when coins or bullion are in the physical possession of the IRA owner (in whatever capacity the owner may be acting), there is no independent oversight preventing the owner from invading his or her own retirement funds. According to the court, personal control over the IRA assets by an IRA owner is against the very nature of an IRA. The court found that Donna had complete, unfettered control over the AE coins and was free to use them in any way she chose. This was true, the court determined, irrespective of Green Hill's purported ownership of the AE coins and her status as Green Hill's manager. The court noted that once Donna received the AE coins, there were no limitations or restrictions on her use of the coins even though she asserted that she did not use them. While an IRA owner may act as a conduit or agent of the IRA custodian, the court found that he or she may do so only as long as such individual is not in constructive or actual receipt of the IRA assets. The court therefore concluded that an owner of a self-directed IRA may not take actual and unfettered possession of the IRA assets. Donna's possession of the AE coins was therefore a taxable distribution.

The court also rejected the McNultys' reliance on the language in Code Sec. 408(m)(3). The court found that the text cited by the McNultys did not create an exception to the custodial and fiduciary requirements of Code Sec. 408(a), irrespective of whether it applies to AE coins. The court concluded that, under the plain text of the statute, an IRA's bullion that is not in the physical possession of a trustee is a collectible, but that text does not address the fiduciary or custodial requirements of Code Sec. 408(a). The court noted that there was no evidence of legislative intent to discontinue the fiduciary requirements generally applicable to IRAs when it comes to IRA investments in coins or bullion.

Turning to the penalty issue, the court questioned whether Check Book's website and/or services could constitute professional advice upon which a reasonable person could rely for purposes of Code Sec. 6664(c)(1). In the court's view, a reasonable person would view the Check Book website as an advertisement of its products and services and understand the difference between professional advice and marketing materials. The court also noted that Check Book was not a disinterested party, as it benefitted financially from the McNultys' purchase of its services. The court also noted that the McNultys didn't ask their CPA for advice regarding their self-directed IRAs and failed to disclose the relevant information to their CPA. The court said that this showed a lack of good faith in tax reporting and, on that basis, it concluded that the McNultys did not act reasonably or in good faith. The court found that the McNultys were professionals who liquidated nearly $750,000 from their existing qualified retirement accounts to invest in a questionable internet scheme without disclosing the transactions to their CPA. They were therefore not entitled to the reasonable cause defense.

For a discussion of self-directed IRAs, see Parker Tax ¶134,505. For a discussion of abatement of penalties due to reasonable cause and acting in good faith, see Parker Tax ¶262,127.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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