Self Directed IRA with LLC holding Real Estate

[BHoffman]

I searched and found some older thread that talked about this, but not with the LLC angle. My client wants one, and has asked me questions I cannot answer quickly. Wondering if anyone knows about these things off the top of their heads while I read up on it?

As I understand it, client will roll over her 401k into the self directed IRA. She will be the self-directed custodian.

She will open an LLC as the manager. The IRA will fund the LLC. The LLC will own the real estate. All rental operations will be reported under the LLC.

I guess I'm concerned mostly about some inadvertent self-dealing and/or prohibited transactions.

Can anyone (well, almost anyone) please share their thoughts?

In the meantime, I'll be pub crawling and searching.

[Koss]

Self-Directed

Looks good on paper, but it probably won't fly.

An IRA--any type of IRA--is technically a trust. The person funding the IRA is the grantor and also the beneficiary. In other words, when you put money in an IRA, you are setting up a trust for your own retirement.

In order for it to qualify as an IRA, you can't also be the trustee.

There has to be a financial institution, or other qualified trustee, managing the assets.

A "self-directed" IRA is one where the person gets to choose investments, such as mutual funds or individual stocks, or even more exotic stuff, such as options and futures contracts. But it's still an IRA account that is technically managed by a broker.

It is possible to invest in real estate within an IRA. But there has to be an independent trustee or custodian. The owner of the IRA cannot go around collecting rent, depositing rental income into a bank account, and then writing checks from that account to pay expenses of the rental property. You can't be your own trustee. It violates a fundamental barrier, and it would make it too easy for the person to borrow funds from the IRA. What if they actually take a distribution? You can't issue a 1099-R to yourself.

The core concept works. But the LLC cannot be managed by the beneficiary of the IRA.

BMK

[BHoffman]

Koss - it's always a huge relief when you respond Thanks for the advice.

[Koss]

References

Here's a couple things to read about this sort of thing...

The first is a straightforward MSN MoneyCentral article that appears to be written by a tax attorney. It is intended for a nonprofessional audience.

http://articles.moneycentral.msn.com/Investing/RealEstate/GroundYourRetirementFundWithRealEstate.aspx

Next is a dense, 15-page IRS notice that is over a year old, but it's still an eye-opener. It discusses in broad terms the potential problems involved in using retirement plan funds to start a business. I know your client isn't exactly talking about starting a business, as in, say, buying a sub shop franchise or something. Real estate is a legitimate investment. But your client is still talking about contributing retirement plan assets to a newly-formed LLC. And rental property is, by definition, a trade or business. So some of what's in this notice might be relevant.

http://www.irs.gov/pub/irs-tege/rollover_guidelines.pdf

BMK

[BHoffman]

Hi Burton - thank you for the links. I will read them.

This is what she wants to do:

http://www.theentrustgroup.com/elc/knowledge/article/14/62/

It seems that her self directed IRA will invest in her LLC. The LLC, which she will manage, will own the real estate. I get your point about her managing the investment AND directing the IRA.

[Koss]

Entrust

Entrust is mentioned in the MSN article.

That's a legitimate, qualified IRA custodian.

I think maybe your client has misunderstood the degree of control she will have over day-to-day operations and cash flow.

My limited understanding of these things is that the fees charged by the custodians are extremely high...

BMK

[BHoffman]

Checkbook IRA

This has to be what she's talking about: A Checkbook IRA

http://www.checkbookira.com/

I'll ask her about the fees and I bet they are expensive.

I wonder what kind of tax return is filed for the LLC?