Self-Directed IRA LLC
The term, IRA, is familiar to most people. The Individual Retirement Account (“IRA”) has become a staple component of most financial plans. An IRA is a trust. Under specific statutory language, an IRA holder contributes an asset (cash) to the trust. The trust then directs its corpus to a particular investment, typically stocks, bonds and annuities. This action of investing implicates a trustee who owes various duties to the IRA. Typically, a stock broker manages the account's investment (as a fiduciary) and serves as the IRA's trustee. The broker exercises virtually all fiduciary power in crafting the investment.
With a Self-Directed IRA, the IRA holder keeps most of this power. He or she directs the investment, instead of a broker. A custodial trustee holds and administers an IRA account. The investor determines which investment(s) are appropriate for the IRA, and tells the custodian where to invest the IRA account.
Taking this a step further, the Internal Revenue Service (“IRS”) does not put many limits on the types of assets in which an IRA may invest. While IRAs typically invest in public stocks or mutual funds, Self-Directed IRAs commonly invest in real estate, private business entities and commercial paper. The only investments precluded by the IRS are life insurance, collectibles and certain “prohibited transactions” listed under Internal Revenue Code Section 4975.
How the Self Directed IRA Process Works?
1. Form a Self Directed IRA LLC and get a Self Directed IRA LLC Operating Agreement.
2. If necessary, transfer funds from your current Custodian financial institution to a new Custodian that allows Self Directed IRA investments.
3. Direct the Custodian to transfer the IRA funds to your new Self Directed IRA LLC bank account. The IRA Account would then become a member of the Self Directed IRA LLC.
4. You as the Manager of the Self Directed LLC could choose appropriate investments for your Self Directed IRA LLC.
5. When making an investment through your Self Directed IRA LLC, you as Manager would write a check from the Self Directed IRA LLC bank account.
6. The investment is then made and held in the name of your Self Directed IRA LLC.
7. You manage the investment made through the Self Directed IRA LLC.
Advantages of Using a Self-Directed IRA
With a Self-Directed IRA, the IRA holder keeps most of this power. He or she directs the investment, instead of a broker. Aside from life insurance, collectibles and certain “prohibited transaction” investments outlined in Internal Revenue Code Section 4975, a Self-Directed IRAs can invest in most commonly made investments, including real estate, private business entities, public stocks, private stocks, and commercial paper. In the case of a self-directed IRA, the IRA holder is typically the person that serves as manager of the LLC.
Within that investment, any gains (or losses) accumulate with all IRA tax advantages. In fact, all traditional IRA rules apply to Self-Directed IRAs, including contribution limits, tax deferral or exemption rules, and required minimum distributions.
What are the Types of Investments I Cannot Make with a Self-Directed IRA?
Internal Revenue Code Sections 4975 & 408 prohibit fiduciary and other disqualified persons from engaging in certain type of transactions. The definition of a disqualified person (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRS holder, any ancestors or lineal descendants of the IRS holder, and entities in which the IRS holder holds a controlling equity or management interest.
Under Internal Revenue Code Section 4975, “prohibited transactions” generally include the following transactions.
1. A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person.
2. Any act of a fiduciary by which he or she deals with plan income or assets in his or her own interest.
3. The receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets.
4. Any of the following acts between the plan and a disqualified person.
a. Selling, exchanging, or leasing property.
b. Lending money or extending credit.
c. Furnishing goods, services, or facilities.
In addition, under Internal Revenue Code Section 408, a Self Directed IRA shall not be permitted to make (a) investments in life insurance contracts, (ii) pledge an IRA or any IRA asset as a security for a loan, or (iii) invest in collectibles.
Common Prohibited Transactions
- Borrowing money from an self-directed IRA
- Using the self-directed IRA as security for a loan
- Selling personal assets to the self-directed IRA
- Buying property in the self-directed IRA for personal use
- Purchasing property from a disqualified relative i.e. Spouse, Children, Parents of the self-directed IRA holder.
However, certain transactions are exempt from being treated as prohibited transactions. For example, a prohibited transaction does not take place if you are a disqualified person and receive any benefit to which you are entitled as a plan participant or beneficiary. However, the benefit must be figured and paid under the same terms as for all other participants and beneficiaries. For other transactions that are exempt, see section 4975 and its regulations.
An IRA owner may not invest in property that he/she, a relative, or his/her business, already owns. Prohibited transactions are transactions that occur between the self-directed IRA and disqualified person(s). The following are, generally, considered disqualified persons.
- The IRA holder
- The IRA holder’s spouse
- The IRA holder’s ancestors and lineal descendants
- Spouses of the IRA holder’s lineal descendants
- Investment managers and advisors
- Anyone providing services to the plan (IRA), e.g., the IRA trustee or custodian
- Any corporation, partnership, trust, or estate in which the IRA holder has a 50% or greater interest
What are the Consequences of a Prohibited Transaction?
If an IRA holder is found to have engaged in a prohibited transaction under Internal Revenue Code Sections 4975 or 408 with IRA funds, it will result in a “deemed distribution” of the IRA. The taxes and penalties are severe and are applicable to all of the IRA’s assets on the first day of the year in which the prohibited transaction occurred. If this deemed “distribution” occurs, it will be subject to ordinary income tax and, if you were under the age of 591/2 at that time, a ten (10%) percent excise tax on premature distributions may also be assessed. In addition, if the “prohibited transaction” is not corrected within the taxable period, Internal Revenue Code Section 4975(b) imposes a tax equal to 100 percent of the amount involved.
What is a Self-Directed IRA Custodian
The Custodian is a bank or savings and loan association, as defined in IRC 408(n), or any other entity that has the approval of the IRS to act as Custodian. In order to have a self-directed IRA, it needs to be held with a Custodian who will allow investments into non-traditional investments.
It is important to remember that at no point in either setting up an account or funding an investment should the IRA holder receive a distribution of any part of his or her IRA account. Setting up a Self-Directed IRA simply involves the movement of funds from one IRA account to another, presuming the IRA holder is not creating the Self- Directed IRA account with a new deposit.
Why Do I Need a Self Directed IRA LLC Operating Agreement?
The LLC Operating Agreement is the core document that is referred to when issues concerning the LLC need to be resolved. The LLC Operating Agreement is the most important document for your Self Directed IRA. It is extremely important that you create an Operating Agreement for your Self Directed IRA LLC.
The standard LLC Operating Agreement will not meet the requirements for your Self Directed IRA LLC. In general, a self directed IRA LLC Operating Agreement should include special tax provisions relating to “Investment Retirement Accounts” and “Prohibited Transactions” pursuant to Internal Revenue Code Sections 408 and 4975. In addition, since the LLC will be managed by a manager and not the member, the Operating Agreement would need to include special management provisions.