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Last chance to get extended interest-free, tax-free loan from IRAs

Earlier this year, IRS announced that it would: a) rescind its long-standing, liberal interpretation of the “one IRA rollover per year rule” under which taxpayers were allowed one rollover per year from each of their IRAs; and b) adopt a new rule allowing only one rollover per year from all of a taxpayer’s IRAs. However, to give taxpayers and IRA trustees time to adjust to this major reinterpretation, IRS said the new interpretation will not apply to any rollover that involves a distribution occurring before Jan. 1, 2015. That leaves time for some taxpayers with multiple IRAs to initiate a strategy that can generate a five-month-plus interest-free, tax-free loan.

Tax-free IRA rollovers. A tax-free rollover involves taking assets out of an IRA and then redepositing them to the same (or another) IRA no later than 60 days after the day the distribution is received. For example, a taxpayer may need an immediate infusion of cash for an emergency or for an investment opportunity. If the money is rolled back into an IRA within the 60-day limit, the taxpayer has obtained a tax-free loan from his IRA. A tax-free rollover from an IRA into another IRA may be made only once a year, and the one-year period begins on the date the taxpayer receives the IRA distribution, not on the date when he rolls it over into another IRA.

Before 2015, the one-year rule applies separately to each IRA an individual owns, enabling a taxpayer with multiple IRAs to generate a surprisingly long interest-free, tax-free loan.

RIA illustration Mr. Baker has the opportunity to buy valuable investment land at a bargain price of $100,000, but the $100,000 inheritance he’s counting on to finance it is tied up in paperwork and won’t be paid until January, 2015. Baker, however, has six-figure balances in each of IRA-A, IRA-B, and IRA-C. Here’s how Baker can arrange for a short-term tax-free “bridge loan” of $100,000 until his inheritance comes through.

1. On Aug. 11, Baker withdraws $100,000 from IRA-A and uses it to pay for the investment land.
2. On Oct. 6, which is 56 days after he made the withdrawal from IRA-A (and thus within the 60 day limit), Baker withdraws $100,000 from IRA-B and rolls it over into IRA-A.
3. On Dec. 1, which is 55 days after he made the withdrawal from IRA-B, Baker withdraws $100,000 from IRA-C and rolls it over into IRA-B.
4. Baker receives his $100,000 inheritance in January, 2015, and, no later than Jan. 30, 2015, which is the 60th day after the withdrawal from IRA-B, he deposits it into IRA-C.

Result: Baker has managed to arrange a “bridge loan” of $100,000 from his IRAs for about 5.5 months without having to pay a tax.
RIA observation: Obviously, a conventional short-term loan from a bank would be a lot simpler. But where that option isn’t available or feasible, the IRA borrowing strategy can fill the bill if the taxpayer strictly adheres to the timing rules and is certain to have the outside cash necessary to make the “closing transaction,” i.e., the final deposit into the IRA.
RIA caution: In our example, above, the last withdrawal in the chain must take place before Jan. 1, 2015. For example, if Baker were to start his borrowing program later in 2014, and withdraw $100,000 from IRA-C on January 1, 2015, an attempted rollover back into IRA-C would run afoul of the new aggregation rule. Under this rule, an individual won’t be able to make an IRA-to-IRA rollover if he or she made such a rollover involving any of the individual’s IRAs in the preceding one-year period. (See Weekly Alert ¶  33  02/06/2014 and Weekly Alert ¶  12  03/27/2014 ).
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