Tax Law ✦ Retirement
Self-Directed IRAs Reward Discipline and Punish Shortcuts.
A self-directed IRA can own Colorado rental property, a private company, or a note portfolio, and one prohibited transaction can make the entire account taxable in a single year. North Star Law Firm structures self-directed accounts, reviews transactions before they happen, handles UBIT reporting, and plans distributions and conversions with the Colorado retirement subtraction in view.
Overview
Retirement accounts as a planning tool, and a minefield
Qualified plans and IRAs are the most protected assets most Coloradans own: exempt from creditors under C.R.S. § 13-54-102(1)(s), tax-deferred or tax-free, and, with a self-directed custodian, able to hold assets far beyond mutual funds. The rules that come with them are strict and mechanical. Section 4975 prohibits any dealing between the account and its owner’s family or businesses. Unrelated business income tax applies to leveraged real estate and operating businesses inside the account. Required minimum distributions carry their own excise tax. And Roth conversions, contributions, and distributions each have a Colorado consequence under the state’s retirement income subtraction. We set up the structure, review each transaction in advance, and file what the account needs to file.
- Self-directed IRA and solo 401(k) structuring, including checkbook LLCs
- Prohibited transaction review before every alternative investment
- UBIT analysis and Form 990-T preparation
- Valuation and reporting for hard-to-value assets
- Roth conversion planning with the Colorado flat rate modeled
- Required minimum distribution compliance and excise tax waivers
- Colorado pension and Social Security subtraction planning
- Plan correction when a mistake has already happened
Rules
The rules that decide whether a self-directed account works
| Rule | Authority | Consequence of getting it wrong |
|---|---|---|
| Prohibited transactions | I.R.C. § 4975 | Entire IRA deemed distributed on January 1 of the year; income tax and penalties on the full balance |
| Unrelated business income | I.R.C. §§ 511 to 514 | Tax at trust rates on active business and debt-financed income; Form 990-T required above $1,000 |
| Required minimum distributions | I.R.C. § 401(a)(9); § 4974 | 25% excise tax on the shortfall (10% if timely corrected); waivable for reasonable cause |
| Roth conversions | I.R.C. § 408A | Full amount taxable in the conversion year, federal and Colorado; no recharacterization |
| Colorado retirement subtraction | C.R.S. § 39-22-104(4)(f) | Subtraction of qualifying pension and annuity income up to the age-based cap; Social Security fully subtractable at 65 and older |
The Attorney-CPA Difference
The IRS finds prohibited transactions in the bookkeeping.
An IRA-owned rental with a repair paid from the owner’s personal card, a checkbook LLC whose manager took a fee, a private company the owner also works for: these are ordinary bookkeeping facts that become account-ending prohibited transactions when an examiner reads the ledger. We keep the ledger clean, review the transactions before they occur, and, when something has already gone wrong, evaluate the correction options before the IRS gets there.
- Structure reviewed against § 4975 before funding
- Transaction-by-transaction review for alternative assets
- UBIT computed and reported where it applies
- Conversion and distribution planning with the Colorado subtraction
- Corrections and voluntary compliance when a mistake surfaces
Questions & Answers
Retirement & Self-Directed IRAs questions, answered
What is a prohibited transaction, and why is it so dangerous?
A transaction between your IRA and a disqualified person (you, your spouse, your ancestors and descendants, and entities you control) that I.R.C. § 4975 forbids: selling property to your IRA, using IRA-owned property personally, lending to it, or being paid by it. The penalty is not a tax on the transaction; the whole IRA is treated as distributed on January 1 of that year, and the entire balance becomes taxable income plus penalties. One mistake can end the account.
Can my IRA own real estate or a business?
Yes, through a self-directed custodian, and Colorado investors do it often. The IRA can own rental property, private company stock, notes, and other alternative assets, subject to the prohibited transaction rules, the unrelated business income tax on debt-financed and active-business income, and valuation and reporting requirements. The structure has to be built correctly before the first dollar is invested.
What is UBIT and when does it hit an IRA?
Unrelated business income tax applies when an IRA earns income from an active trade or business (directly or through a pass-through entity) or from debt-financed property. The IRA files Form 990-T and pays tax at trust rates, which reach the top bracket quickly. Most real estate rentals owned outright avoid it; leveraged real estate and operating businesses do not.
How does Colorado tax retirement income?
Colorado allows a subtraction for pension and annuity income, including IRA and 401(k) distributions, up to a set amount that depends on age, and taxpayers 65 and older can subtract all of their Social Security benefits. Roth conversions are taxed at the flat Colorado rate in the year of conversion, so conversion planning runs the state number alongside the federal one.
I’m behind on required minimum distributions. What now?
The excise tax on a missed RMD is 25 percent of the shortfall, reduced to 10 percent if corrected within the correction window, and the IRS waives it for reasonable cause on a Form 5329 request. Take the distribution, file the form with a statement, and let us write the reasonable-cause explanation. The waiver is granted more often than people expect when the request is done right.
Plan the tax before the transaction, not after.
A free consultation with an attorney-CPA who can draft the structure and run the numbers in the same meeting.