By Walter Updegrave@CNNMoneyDecember 5, 2012: 5:39 AM ET
NEW YORK (Money Magazine)
Can I invest in antique cars through a self-directed IRA? -- Larry Peterson
Opening a self-directed IRA and having your retirement savings riding on a 1931 Bugatti Royale Coupe or a 1955 Mercedes Benz 300SL may seem a lot more exciting than investing in boring old stock and bond mutual funds.
The question, though, is whether the Internal Revenue Service would okay such an investment. IRS Publication 590, Individual Retirement Arrangements, rules out collectibles as IRA investments, noting that any amount you invest in collectibles with IRA funds "is considered distributed to you in the year invested."
That means you would owe income tax on however much you paid for a collectible, plus a 10% early withdrawal penalty if you're under age 59 ½.
But not everyone believes the collectibles prohibition applies to collector cars. For example, a southern California company has been touting a private, limited partnership, Family Classic Cars Fund I, to IRA and other retirement investors. The fund plans to invest some $120 million in, among other things, collector cars like the 1953 DB-Series Aston Martin and the 1958 Ferrari 250 GT.
To get into the fund, you've got to pony up at least $10,000, and you have to be an accredited investor, which means you must have a net worth greater than $1 million --excluding the value of your primary residence -- or annual income of more than $200,000 (or $300,000 with a spouse) the past two years and a reasonable expectation of meeting that standard the current year.
Paul Charles, the fund manager, says the fund does not offer legal, investment or tax advice to investors. That said, he gives two reasons why he thinks the partnership should pass muster as an IRA investment. First, although collectibles in IRAs are clearly prohibited, he says the section of the Internal Revenue Code dealing with the prohibition doesn't mention cars. The second is that even if cars do fall into the collectibles camp, the IRA funds are being used not to purchase collector cars per se, but shares of a partnership that owns collector cars.
The IRS wouldn't get into the specifics of this partnership. But a spokesperson sent me a copy of the regulations the IRS uses for guidance on such matters. The regs don't mention cars specifically, but they do note that the term "collectible" could apply to "any other tangible personal property which the [IRS] Commissioner determines is a 'collectible'."
And when I asked Wolters Kluwer legal analyst Nick Kaster whether he thought the IRS would consider collector cars collectibles, he emailed me a letter the Treasury Department sent to Sen. Richard Lugar when he inquired about this very issue almost 25 years ago. "Collector cars are considered collectibles" the letter flatly states. Says Kaster, "I have no reason to believe that this isn't still the prevailing view of the IRS."
As for the argument that an IRA wouldn't own cars but a share of a partnership that owns cars, Ed Slott, publisher of Ed Slott's IRA Advisor Newsletter and one of the most knowledgeable people I know when it comes to IRAs, isn't convinced by it. "If you can't buy things like cars or art directly in your IRA, why would you be able to buy them through a partnership?"
And in fact, the regs the IRS sent me define the acquisition of a collectible as "any method by which an individual retirement account or individually-directed account may directly or indirectly acquire a collectible."
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Typically, when a company takes a new approach that may be at odds with existing tax law, it relies on IRS guidance in the form of a private letter ruling to clear up the issue. Charles told me his fund is seeking such a ruling, but has yet to receive it.
Given the clear prohibition on collectibles and the lack of a specific IRS ruling on the fund's strategy, I think it would be foolish for anyone to invest IRA money in this fund or any fund like it. Ed Slott agrees: "I wouldn't go near it."
In fact, even if this gambit turns out to be okay, I still wouldn't be too eager to jump on board. I know that alternative investments are all the rage these days. But as I've noted, nontraditional investments can be difficult to evaluate and a hassle to own, especially in heavily regulated vehicles like IRAs.
Such investments can also carry burdensome fees that drag down potential returns. In this case, the fund has adopted the same fee structure as many hedge funds: a 2% annual management fee, plus 20% of any profits. Throw in the annual fee of Summit Trust, the company that's providing custodial services for IRA owners who buy the fund, and I estimate you would be paying 4.25% a year on a $10,000 investment and 2.63% annually on a $100,000 investment -- and that's before giving back 20% of any profits.
Bottom line: If you have some extra cash you want to take a flier with on some cool cars, fine. But don't do it with money you'll actually be depending on in retirement.