Neither a borrower nor a lender be

In order to enjoy an IRA's tax-deferred growth, its owners must abide by certain rules. One of those rules is that they must avoid engaging in what are known as prohibited transactions. All such transactions carry the same severe tax consequences: The entire individual retirement account in which the prohibited transaction occurred is deemed to have been distributed Jan. 1 of the year in which the prohibited transaction first took place. That means the loss of all future tax deferral, immediate taxation of the whole account and assessment of the 10% penalty for early distributions if the owner was younger than 591/2 at the time. One prohibited transaction that raised concern recently is a rule preventing the lending of money or other extension of credit between a plan and a disqualified person. An IRA owner is prohibited from borrowing from or lending money to any disqualified person, which includes, among other individuals, anyone acting in a fiduciary capacity with regard to the IRA, the IRA owner's spouse and lineal descendants and, most importantly in this case, the IRA owner himself or herself. On Dec. 12, the IRS issued an announcement that temporarily provides relief to certain taxpayers who have engaged in the prohibited transaction of extending credit between personal assets and IRA assets via a cross-collateralization agreement. The relief comes after a pair of opinion letters released by the Labor Department reinforcing that such agreements would be considered ex-tension of credit between IRA owners and their IRAs, and thus prohibited. The rules are interpreted in such a way that extension of credit is considered to be made when IRA owners personally guarantee a debt of their IRAs or when they use the IRA assets to guarantee their personal debt. In recent years, the Labor Department has been asked to rule on related issues on multiple occasions. The bottom line is that guaranteeing a debt of an IRA with non-IRA assets is a prohibited transaction. Issuance of earlier advisory opinion letters stirred up a hornet's nest of concern regarding the possibility that many individuals may have engaged in a prohibited transaction simply by executing their account agreements. In response, the IRS has provided relief to many clients who entered into an account agreement that used a cross-collateralization of IRA and non-IRA assets, creating a prohibited transaction at the time that the contract was signed. The announcement doesn't prescribe an actual time frame for which the relief is effective, but rather said that the relief will be effective until the IRS says otherwise. Even though a prohibited transaction technically occurs at the time that any such cross-collateralization contract is signed, the IRS treats it as a prohibited transaction if, and only if, any non-IRA money is used to satisfy outstanding debt of the IRA and/or vice versa. Announcement 2011-81 contains further good news for clients who have signed cross-collateralization agreements. In it, the IRS noted that it has been advised by the Labor Department that it is considering taking further steps that might exempt such cross-collateralization agreements from being prohibited. Apparently, the Labor Department expects to receive a request for a class action exemption which, if granted, would allow IRA owners to enter into these types of agreements permanently without being guilty of committing a prohibited transaction. Note that though the IRS can adjust how it will treat a prohibited transaction, only the Labor Department can issue an exemption, effectively allowing what otherwise would be a prohibited transaction. The granting of such an exemption could allow brokers to tap a client's non-IRA funds for losses in an IRA that exceed the value of the IRA assets. However, until such an exemption is granted, the use of any personal non-IRA assets to cover losses in an IRA, or vice versa, will constitute a prohibited transaction, for which there is no relief. Based on these developments, financial advisers should review clients' custodial/account agreements to see if they have any cross-collateralization provisions. If you find any such agreements, advise clients to consider transferring their assets to a new IRA until such time that the Labor Department has permanently exempted such agreements from being prohibited transactions. Remind them that the relief is temporary and could be amended at any time. Ed Slott (irahelp.com), a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group to help financial advisers and insurance companies become recognized leaders in the IRA marketplace.