Self-directed investors relying on LLCs for purchasing real estate and nontraditional assets often do so for reasons related to speed and cost efficiency.
Utilising an IRA/LLC provides “checkbook control”, and may reduce transaction fees compared with going through your IRA custodian for each purchase. However, it’s essential that you are aware of prohibited transactions and other potential pitfalls before using one of these funds.
Legality
Self-Directed IRA investors frequently choose an LLC owned by their IRA as this structure offers numerous advantages including limited liability protection, pass-through income streams and diversification options.
However, it is essential that when creating an LLC you work with an experienced legal professional familiar with IRA rules. Furthermore, your operating agreement should contain safeguards which prevent your company from engaging in illegal transactions.
Prohibited transaction rules are intended to safeguard IRA owners and disqualified persons from improperly benefitting from investments held within an IRA. For instance, the IRS prohibits IRAs from transacting with entities owned by disqualified persons such as themselves or family members of their IRA owner. Swanson v. Commissioner (106 Tax Court 276) held that purchasing 100% initial ownership in a corporation by an IRA did not fall under this prohibition since no existing ownership existed at that point in time.
Taxes
While the IRS allows LLCs to invest in many of the same assets as Self Directed IRAs, certain restrictions must be observed when investing via an IRA-owned LLC. Most importantly, an IRA-owned LLC cannot engage in certain prohibited transactions which would otherwise take place through another account.
Transactions that violate these restrictions include those with disqualified individuals. A disqualified person includes an IRA owner, their spouse, lineal ascendants and descendants as well as spouses of lineal descendants as well as certain companies that the IRA owner does business with such as their employer and certain family members of that employer.
Additionally, when an LLC purchases assets using both retirement and non-retirement funds, any part attributed to retirement accounts will receive tax deferral benefits while any non-retirement purchases made using regular funds will owe taxes under what’s known as Unrelated Business Income Tax (UBTI).
Investments
Many self-directed IRA (SDIRA) owners prefer LLC investments due to the IRS’s wide array of permissible alternative investments, which includes real estate, precious metals and private equity – with only three exceptions being collectibles, life insurance policies or S-Corporations being prohibited from inclusion in an SDIRA portfolio.
LLCs benefit from pass-through tax treatment, meaning profits flow directly into an IRA owner’s pocket instead of needing to file separate federal returns for the LLC, saving time and effort with tax filing procedures and processing fees.
There are a few considerations when setting up an IRA/LLC structure, such as prohibited transactions and dealing with disqualified persons. To comply with IRS rules, it’s advisable to work with a financial advisor who can incorporate safeguards into the LLC operating agreement that prevent your IRA from engaging in prohibited transactions.
Keep in mind that an IRA should only ever be used for retirement planning and withdrawing funds before age 59 1/2 can incur a 10% early withdrawal penalty, destabilizing your plans and counteracting its intent.
Checkbook Control
Checkbook control IRAs allow IRA owners to write checks directly into an LLC bank account that can be used for investing, giving you greater control of your assets and the flexibility to respond swiftly to investment opportunities or expenses without waiting for approval from a custodian.
However, it’s crucial that IRA owners understand the complexities associated with owning an LLC through an IRA and any restrictions placed upon prohibited transactions by the IRS. Failure to do so could incur penalties and taxes for your IRA.
Be sure to work with an experienced Self-Directed IRA specialist and consult an attorney if you intend on opening a checkbook control IRA; since drafting of specialized language for an IRA account is key and professional accounting must be done. Furthermore, avoid investing with disqualified persons or receiving indirect benefits as this could constitute prohibited transactions; it would therefore be prudent to work with an experienced LLC facilitator like Advanta IRA LLC facilitator for this transaction.
