Using a Self-Directed IRA to Invest in an LLC
There are many ways to invest with your Self-Directed IRA, one of which is to invest in an LLC using your Self-Directed IRA.
What an LLC Is
LLC is an acronym for limited liability company. It's a legal structure that limits the legal responsibility of the people within it. In the same manner as incorporation, the creation of this legal entity shelters its owners from being personally responsible for the company’s debts and obligations. LLCs have the added benefit of being taxed at the individual tax rate, as opposed to the corporate rate.
A person with an ownership interest in the LLC is called a member. Investments in the LLC are referred to as membership interests or units. In specific states where LLCs are legally considered securities, the people and/or entities wishing to invest in them are required to meet certain state regulations before doing so.
The Process of Establishing an LLC
LLCs can be created with little time and are considered as pass through entities for tax purposes. The process includes writing an LLC operating agreement and filing paperwork in the state where the LLC will be domiciled. The LLC might be subject to an annual fee, depending on the state in which it’s established.
Consulting legal counsel that is familiar with state laws governing this type of entity is advisable. An attorney familiar with the IRA rules can build parameters into the LLC’s operating agreement that would prevent the LLC from conducting prohibited transactions.
LLCs set up to provide pass-through tax treatment are not taxed at the corporate level, which allows profits to flow through to IRAs or other self-directed savings accounts. The LLC can be incorporated in the state where the investments are made so the IRA owner will not have to pay additional filing costs in both the state of domicile and the states where the LLC is making investments.
Major Benefits of Owning an LLC in Your Self-Directed IRA
Typically, executing transactions through your retirement accounts requires filing paperwork or communicating electronically with your IRA custodian to purchase assets, send proceeds, etc.—leaving you (and your transactions) at the mercy of your custodian’s processing speed. If you establish checkbook control through your IRA LLC, you’re able to skip all of that.
You deposit funds into your LLC’s checking account and they’re readily available. Transactions become as simple as writing a check (but keep in mind, you should not pay yourself directly).
Fewer Administrative Fees
Bypassing your IRA administrator for transactions involving the LLC saves you the associated processing fees. By establishing checkbook control, you can save money and ultimately have more funds to invest in your retirement.
As the IRA’s investment is the LLC, not its underlying investments, there is also a cost savings where IRA recordkeeping fees are concerned. For example, if the LLC purchases multiple properties, the fees will still be based on one investment (the LLC), and not the multiple investments within the LLC.
Many investors have used LLCs as liability protection for the investments held within their IRAs. Consult with your legal advisor to determine if you would benefit from the liability protection of an LLC.
Checkbook control is the ability to manage your Self-Directed IRA funds with the ease of a checkbook. Rather than contacting your account administrator to direct your IRA funds, you can simply write a check from the LLC.
As its own entity, your Self-Directed IRA LLC is allowed to have its own checking account. If you are named the managing member of the LLC, you will manage the business checking account, which is funded by the cash (uninvested funds) in your IRA. Thus, you hold the checkbook linked to the business checking account of the LLC, which is in turn linked to your IRA funds.
Bear in mind that checkbook control is a strategy for Self-Directed IRA investing, and the same rules that apply to your IRA will apply to using checkbook control. You cannot write checks for personal reasons.
LLCs and Tax Benefits
Using an LLC in your Self-Directed IRA doesn’t provide any additional tax advantages. Your IRA invests in and owns the LLC. An IRA is a tax-deferred entity, so there is no taxable event in your IRA when investing directly or through the LLC. It is vital however, that any income from the LLC be paid back to the IRA, which holds membership with the LLC to avoid taxation. Income from the LLC cannot be paid directly to you.
Depending on the type of income received by the LLC, income received by the IRA may be subject to unrelated business income tax (UBIT). Since the IRA owns the LLC, an IRA may have to file a tax return if the income it receives is taxable.
Taxable income received by an IRA, which is considered a trust, is taxed at trust tax rates. Income derived from a trade or business is taxable to the IRA. Income received from a leveraged investment will be taxable on the leveraged portion. Other incomes such as interest, rents, royalties aren't taxable income to the IRA. The IRS Publication 598 sheds additional light on this topic.
UBIT and Its Triggers
UBIT, or “unrelated business income tax,” is imposed on investments owned by charities or accounts that would otherwise be tax exempt, like IRAs. The most common triggers of UBIT are businesses, like limited partnerships or LLCs that have trade or business income, conducted within a tax-exempt retirement account, and IRA-owned real estate that is debt-financed.
For UBIT to apply, the income generated must meet the following criteria:
- It is derived from a trade or business activity. Example: the sale of goods or services.
- The business occurs regularly. Example: you receive monthly or quarterly income.
- The business activity is not related to the tax-exempt status of the account.
What an IRA-owned LLC Can Invest In
The same types of investments that are allowed in Self-Directed IRAs are also allowed in LLCs, from real estate to precious metals to private placements. The same three restrictions apply: you can’t invest in collectibles, s-corporations or life insurance.
Transactions You Can’t Make Through Your IRA LLC
LLCs and Partnering
Partnering with other people or entities can be a great way to raise additional capital. You can partner with another IRA or another LLC.
You can even partner with a disqualified person if you do it when the IRA LLC is first created. Consulting your tax or legal advisor before proceeding with this type of arrangement is advised.
You can derive many benefits from investing in an LLC with your SDIRA. We make investing in an LLC easy. If you think a Self-Directed IRA LLC is right for you, contact us.
Entrust does not establish LLCs. We recommend consulting with a tax, or legal professional.