Entrust Learning Center > 8. Newsletter Archive > Entity Investments in Your IRA: Advantages, Cautions, and Legal Considerations

Entity Investments in Your IRA: Advantages, Cautions, and Legal Considerations

There are special considerations when you invest your self-directed IRA in an entity such as a corporation, LLC, or trust. Find out what you need to know, before you invest.

By: H. Quincy Long

July IRA Insights

This article is part of a series of articles discussing some issues that may arise when investing your IRA into an entity, such as a limited liability company (LLC), corporation, limited partnership, or trust. On the weekend of August 21-22, 2010, I will be participating in a boot camp, along with Dyches Boddiford and David Worley, CPA; entitled “IRA-Owned LLCs and Trusts” in Atlanta, Georgia. More information about the boot camp can be found at www.assets101.com.

Next month’s article will be a discussion of the famous (or infamous, depending on your position) case of Swanson v. Commissioner, which started the whole idea of a “checkbook control” LLC. This idea has grown more popular in the self-directed IRA industry, and it’s important to understand what this case did— and almost as importantly—did not say.

There are advantages, cautions, and legal considerations when investing in an entity within your IRA. Advantages of having your IRA own an entity include:

·       Your IRA’s funds may be held in the entity’s name at a local bank. This can be an advantage when getting cashier’s checks for a foreclosure or tax lien auction, paying earnest money or option fees, or paying contractors who prefer local checks, among other things.

·       Certain types of investments, such as real estate closings or investments at foreclosure auctions, may in some circumstances be easier to facilitate through an entity.

·       Investing your IRA’s funds through an entity may give your IRA some asset protection. Always check with local legal counsel!

·       In certain limited circumstances, some people argue that you may be able to act as a manager, director, or officer of your IRA-owned entity without compensation.

·       If the entity’s shares are all that the IRA owns, administration fees may be lower.

·       If the director, officer, or manager is a trusted friend, you may more easily control what happens with your IRA’s funds.

Cautions and considerations when investing your IRA through an entity include:

·       Check with your CPA or tax advisor on the local, state, and federal tax implications of the entity you want your IRA to invest in. 

·       Select competent legal counsel, familiar with the restrictions imposed by the Internal Revenue Code, including the prohibited transaction rules of Section 4975, as well as the plan asset regulations. Otherwise, you may inadvertently engage in a prohibited transaction. Make sure that the investment in the entity is not prohibited in itself, and also that the company is not structured in a way that the operations of the company will lead to a prohibited transaction.

·       All fees for the formation of the entity and for the preparation of any necessary tax returns, as well as any taxes due, must be paid from funds belonging to the IRA.

·       Unless the entity is taxable itself, to the extent it owns debt-financed property or operates as a business, unrelated business income tax (UBIT) may attach to the profits from the entity. Remember, there is no distinction between general and limited partners.

·       Your third-party administrator or custodian does not review the formation document, by-laws, operating agreement, or partnership agreement.  The nature of a self-directed IRA is that the IRA holder is responsible for the contents of the agreement, and usually must read and approve the subscription agreement and operating or partnership agreement prior to the administrator or custodian signing. Typically, the only review that is done is to make sure that the ownership of the asset is correctly listed in the name of the IRA. Also, bear in mind that the administrator or custodian does not review any investment for compliance with IRS guidelines. The IRA holder and his or her advisors should be very familiar with any restrictions.

·       You will have to have a fair market valuation of your IRA’s interest in the entity done each year. Assets and activity within the entity may need to be disclosed to the administrator or custodian, and you will need to hire a third-party appraiser to complete the business valuation process. This can add layers of complexity and expense.

Other things for you and your legal counsel to consider:

·       Review the entity agreements to make sure that an IRA or qualified plan is permitted to be a shareholder, member, or partner. The agreement should specify the voting procedure for shares held by an IRA or qualified plan.

·       There should be no transfer or buy-sell restrictions that would restrict the shares if the IRA is distributed because the IRA holder dies, because the shares are distributed as part of a Required Minimum Distribution (RMD), or because the IRA holder decides to move the shares to a different custodian or administrator.

·       The IRA holder and other related disqualified persons can’t receive compensation from the company.

·       Depending on the ownership percentage by the IRA and other disqualified persons, additional capital calls may be problematic. Many custodians only allow the amount of the initial commitment to be funded. If the IRA and other disqualified persons fund more than 50% of the entity, the entity will become a disqualified person and future capital contributions might be considered to be prohibited transactions.

·       If the IRA holder is or may soon be subject to Required Minimum Distributions (RMD), the IRA holder must have sufficient resources left in the subscribing IRA or other traditional IRAs to cover the RMD; unless there will be guaranteed sufficient distributions from the entity to fund the RMD. Otherwise, shares of the entity may have to be distributed. This would cause significant difficulties both for the IRA holder and for the entity.

·       Because of the limited review of the formation documents and the investment by the custodian or administrator, the IRA holder and his or her advisor should do the normal due diligence on the company. This includes investigating all of the principals involved, reviewing the financial strength of the company, and verifying with the Secretary of State that the company is in good standing. The IRA holder should also check with the Securities and Exchange Commission, the Better Business Bureau, and any other government or non-government agency to see if any complaints have been filed against the company. The IRA holder is 100% responsible for evaluating the company and the investment.

 If you are serious about your IRA owning an entity of some sort, you owe it to yourself to find out more about the rules and regulations.  I hope to see you in Atlanta, Georgia next month.

H. Quincy Long is Certified IRA Services Professional (CISP) and an attorney, and is President of Entrust Retirement Services, Inc., serving clients in the State of Texas with offices in Houston and Dallas. He may be reached by email at QLong@EntrustTexas.com. Nothing in this article is intended as tax, legal or investment advice.

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