Real estate developers and home builders who need private financing often turn to investors like your IRA for assistance. This form of investment offers high yields of return secured by a promissory note secured against the property itself.
If you choose a nontraditional investment strategy, it is crucial that you work with a dependable custodian who has your best interests at heart and can safeguard you from potential pitfalls such as brand new investments without an established track record or claims of unrealistically high returns.
IRS Rules
IRS rules and regulations surrounding lending money to an LLC may seem complex and opaque, but one important point to keep in mind is that your SDIRA and the LLC are two separate entities; any income generated by any lending activities by either should be reported separately on tax returns for both.
By doing this, it can help avoid taxes related to Unrelated Business Taxable Income (UBTI) and Unrelated Debt-Financed Income (UDFI). Any income generated by SDIRA loans should come directly out of its funds instead of coming directly from you personally.
Your LLC allows you to offer both unsecured and secured loans, with complete control over who is eligible to take them out. A few disqualified parties include you, your spouse, lineal ascendants or descendants as well as any entity where you own 50%+ interest. In order to protect your IRA should it go into default you may also choose to secure it with collateral if loan default occurs.
Taxes
Self-directed IRAs offer an attractive alternative investment option, but the IRS imposes strict guidelines and restrictions regarding what can and cannot be done with them. Violating any of those rules could result in costly tax bills and penalties; for example, your IRA cannot be used to purchase property that you live in or rent to family members, nor for investing in noncompliance assets such as life insurance and precious metals that do not meet purity standards.
An LLC may allow you to invest in rental properties through your self-directed IRA if it manages them as the owner and manager. An expense account should be set up with this LLC and the IRA funds should be used to pay bills; this process is known as checkbook control IRA and takes longer and usually has fees than using standard custodian services for this type of account.
Due Diligence
Clients tend to utilize LLCs within their self-directed IRA for limited liability protection purposes, shielding IRA assets from being attacked by creditors should the LLC experience financial problems or be sued.
Under IRS rules, lenders are required to conduct due diligence when lending money to an LLC. This involves researching their borrower and setting loan terms based on what you discover. This task can either be conducted independently or with help from their SDIRA provider/custodian.
Due diligence can involve researching what services and products an enterprise provides, its competitors, its current performance, as well as product due diligence comparing costs with profits generated. With this knowledge at hand, due diligence can help determine if an investment fits within an IRA, as well as help avoid potentially prohibited transactions.
Risk
Though IRA LLCs are often associated with real estate investments, they can also give you greater control by enabling direct financial transactions without needing approval from your custodian. For example, investing in private debt such as promissory notes or private loans might benefit from having their own investment vehicle in place as an IRA LLC may provide greater autonomy when conducting private placement offerings or participating in similar offerings.
Alternative assets often require more stringent due diligence, as they tend to have less liquidity than publicly traded securities and some may even not even be audited, leading to potentially inaccurate financial information.
Risks associated with lending to an LLC include default on its loans. Therefore, it’s crucial that borrowers undergo thorough due diligence prior to borrowing from you and only accept loans from creditworthy borrowers.
