Plan Asset Rules

The Department of Labor (“DOL”) Plan Asset Rules were generally enacted to limit an investment fund participant from using his retirement funds to transact with the investment fund or its assets. The Plan Asset Rules set forth the circumstances that can cause assets owned by an entity to be deemed to be assets of an ERISA qualified plan (i.e. 401(k) Plan) or an IRA unless an exemption applies.

Under the Plan Assets Rules, if an IRA/401(k) Plan owns greater than 25% of an investment entity that is neither a “publicly-offered security” nor a mutual fund, the equity interests and assets of the “investment company” will be deemed assets of the IRA/401(k). This is sometimes referred to as the “Look- Through Rule.” Under the Look-Through Rules, if a retirement plan owns 25% or more of any class of equity interests in an “investment company”, the Plan Asset Rules state that the assets of the entire “investment company” are deemed to be assets of the IRA/401(k). In other words, if your IRA owns 25% or more of the membership interests of an LLC engaged in passive investments (i.e. private equity fund, hedge fund, or real estate fund), the assets of the LLC are deemed to be assets of the IRA.

If the Plan Asset Rules cause the assets of an “investment company” to be deemed to be assets of the IRA/401(k), any transaction involving the “investment company” and a disqualified person will be a prohibited transaction.

Plan Asset Rules

The DOL’s Plan Asset Rules essentially define when the assets of an entity are considered “Plan” assets. Under the rules, IRAs are frequently viewed as pension plans subjecting them to the Plan Asset Rules. Under the Plan Asset Rules, if the aggregate plan (IRA/401(k)) ownership of an entity is 25% or more of all the assets of the entity, then the equity interests and assets of the “investment entity” are viewed as assets of the investing IRA/401(k) for purposes of the prohibited transactions rules, unless an exception applies.

Also, if a plan (i.e. IRA or 401(k)) or group of related plans owns 100% of an “operating company”, the operating company exception will not apply and the company’s assets will still be treated as plan assets.

In summary, the Plan Asset Rules can be triggered if:

• 100% of an “operating company” is owned by one or more IRAs/401(k) and disqualified persons, in which case all the assets of the “operating company” are deemed Plan assets (assets of the IRA/401(k)), or
• If 25% or more of an “investment company” is owned by IRAs/401(k) and disqualified persons, in which case all the assets of the “investment company” are deemed Plan assets (assets of the IRA/401(k)). In determining whether the 25% threshold is met, all IRAs/401(k) owners are considered, even if they are owned by unrelated individuals.

Exceptions to the Plan Asset Rules

The Plan Asset look-through rules do not apply if the entity is an operating company or the partnership interests or membership interests are publicly offered or registered under the Investment Company Act of 1940 (e.g., REITs). They also do not apply if the entity is an “operating company,” which refers to a partnership or LLC that is primarily engaged in the real estate development, venture capital or companies making or providing goods and services, such as a gas station, unless the “operating company” is owned 100% by a Plan and/or disqualified persons.

In other words, if an IRA or 401(k) Plan owns less than 100% of an LLC that is engaged in an active trade or business, such as a restaurant or manufacturing plant, the Plan Asset Rules would not apply. However, the IRA or 401(k) Plan investment may still be treated as a prohibited transaction under Internal Revenue Code Section 4975. In addition, the Unrelated Business Taxable Income may apply to subject to the IRA or 401(k) Plan to tax on the income or gains generated from the operating business.

How can the Plan Asset Rules Impact my IRA/401(k) Plan Investments ?

The Plan Asset Rules are typically only triggered if your IRA/401(k) Plan assets will own greater than 25% of an investment company (i.e. a passive investment fund) or will own 100% of an operating company (i.e. gas station). In general, the majority of investments involving IRA/401(k) Plan funds will not cause the Plan Asset Rules to trigger a prohibited transaction.

For example, any direct purchase of real estate, precious metals, tax liens, or lending transaction not involving a disqualified person will likely not trigger the prohibited transaction rules or Plan Asset Rules. Even if the Plan Asset Rules were to apply, as long as a disqualified person is not involve in a transaction with the investment entity, the prohibited transaction rules would not apply.

Consequences of a Transaction Falling under the Plan Asset Rules

If your Self Directed IRA LLC or 401(k) Plan investment involves an investment in one of the following: (i) an “operating company” that your IRA will own 100% of, or (ii) an investment company in which 25% of more of the “investment company” is owned by IRAs/401(K) Plans and disqualified persons, then all assets of the entity are deemed owned by the IRA/401(k) and all transactions between the investment entity or its assets and a disqualified person may be prohibited.

Note: The fact that a transaction does not trigger the Plan Asset Rules does not mean that the transaction may not be deemed a prohibited transaction under Internal Revenue Code Section 4975. In other words, a transaction that does not fall under the Plan Asset Rules can still be treated as a prohibited transaction.

The following are a number of examples that demonstrate the scope of the Plan Asset Rules:

Example 1: A general partner of a hedge fund wishes to invest his Self Directed IRA LLC in the hedge fund he manages. If the percentage of IRA ownership, including what it would be after the General Partner invests his IRA in the fund, equals or exceeds 25% of the equity interests, then the fund’s assets are considered “plan asset.” That means that a transaction between the general partner, as a disqualified person, and the fund, could be deemed a prohibited transaction because the assets of the fund are viewed as assets of his IRA, since a disqualified person cannot transact with the assets of his plan or IRA.

Accordingly, the General Partner cannot receive benefits from his IRA investment into the fund. Thus the General Partner would not be permitted to receive any management fees associated with the IRA’s ownership interest in the fund because he would be receiving a personal benefit from his IRA. Note – the General Partner’s IRA investment in the fund may also be deemed a direct or indirect prohibited transaction under Internal Revenue Code Section 4975.

Example 2: Jane ‘s Self Directed IRA LLC owns 100% of ABC, LLC, which operates a retail store. ABC, LLC makes a loan to Jane. The loan is subject to the Plan Asset Rules and will also be considered a prohibited transaction pursuant to Internal Revenue Code Section 4975. Note – any income generated by ABC, LLC that is allocated to the Self Directed IRA LLC would also likely be subject to the Unrelated Business Income tax.

Example 3: Steve’s Self Directed IRA LLC owns 15% of ABC, LLC, an investment company. Allan’s IRA owns 20% of ABC, LLC. Steve and Allan are unrelated. Since IRAs (Plans) own greater than 25% of ABC, LLC, an “investment company”, assets of ABC, LLC are Plan Assets and deemed owned by each IRA. Thus, if ABC, LLC makes a loan to Steve’s father, the loan would be a prohibited transaction under Internal Revenue Code Section 4975.

Example 4: Robert’s Self Directed IRA LLC invests in ABC, LLC, which will purchase a gas station, an “operating company”. Robert will take an annual salary of $50,000 to run the gas station. The payment of the salary would be a “prohibited transaction under Internal Revenue Code Section 4975 (self dealing indirect prohibited transaction). Note – any income generated by the as station that is allocated to the Self-Directed IRA LLC would also likely be subject to the Unrelated Business Income tax.

The plan asset rules are in place so that the fiduciary invests those assets prudently, and must diversify to lessen the risk of a great loss. These obligations are in place to ensure that no IRS rules are being broken. It’s always best to speak to your plan provider with regards to the rules that govern your retirement plan.