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If you want to learn about legal issues related to forming and operating a limited liability company that has one or more members that is an IRA or a retirement plan, this is the place. My name is Richard Keyt. I am an Arizona limited liability company attorney who has formed over 2,400 Arizona LLCs, including many LLCs that have an IRA or retirement plan as a member.
Throughout this IRA LLC Law website, the term “IRA LLC” means a limited liability company formed under the laws of any state in the United States of which one or more members is a a traditional IRA, a Roth IRA, a 401(k), a profit sharing plan, a money purchase pension plan, a defined benefit pension plan or certain other ERISA retirement plans allowed to make self-directed investments.
I created this IRA LLC Law blog because:
- I want to inform and educate people who are considering making a self-directed investment through an LLC about the important legal issues that arise whenever they use IRA or retirement funds to buy assets or own and operate a business through a limited liability company.
- Nobody should make self-directed investments through an IRA LLC without first doing their homework and the IRA LLC Law website’s purpose is to help people do their homework.
- I want to correct a lot of of misinformation written on the internet about IRA LLCs, self-directed IRA investments and prohibited transactions.
- The consequences of not knowing and following the law can be economic disaster if the IRS disqualifies the IRA or retirement account because the result is the entire value of the IRA or disqualified account is included in the income of the IRA owner or retirement account participant in the year of the disqualification.
I invite you to bookmark this site and invest time reading the information presented here before you jump out of the frying pan of traditional investments and into the fire of nontraditional investments by making self-directed investment in an IRA LLC.
The best way to stay up-to-date with new information, articles and posts is to subscribe to our RSS feed by clicking on the RSS symbol on the top right corner of each page or by clicking on the Subscribe link on the navigation bar at the top of each page.
Question 1: Can I form a limited liability company in which my IRA is a member and use all or a portion of my IRA funds to make self directed investments through the LLC in various assets, including, but not limited to, real estate?
Answer: Yes, but there are some types of assets that cannot be acquired.
Question 2: Does it take a ton of money and a rocket scientist to form an LLC owned by an IRA (“IRA LLC”)?
No: I form Arizona IRA LLCs for $949. I’m not a rocket scientist, but I am an Arizona LLC and business attorney who has a masters degree in income tax law from New York University School of Law. I understand how to form IRA LLCs and have formed over 2,400 LLCs, including many IRA LLCs.
Why I Form IRA LLCs
Because I have formed 2,400+ limited liability companies, people frequently contact me and ask if I can create an Arizona LLC owned by one or more IRAs. The answer is yes. For the purpose of this article, when I use the term “IRA” it also includes Roth IRAs, 401(k) plans and traditional retirement plans such as money purchase pension plans and defined benefit pension plans. I have formed many LLCs that have one or more IRAs as a member (aka owner).
In 2005 I attended a three hour seminar presented by the Personal Real Estate Investor Magazine at which nationally known “real estate guru” Dolf de Roos (see John T. Reed’s analysis of Dolf de Roos’ book Real Estate Riches) explained how self-directed IRA funds could be used to invest in real estate purchased through an LLC. One of the speakers was an attorney not licensed in Arizona who created IRA LLCs for a “mere” $4,000.” Since I was only charging $599 to form an Arizona LLC I was shocked to hear that the out of state attorney was able to charge so much. I asked him what he did to justify $4,000 for an IRA LLC. When he was unable to justify such a high price, I decided that I would research the law concerning IRAs, LLCs and self-directed investments so that I could create high-quality IRA LLCs for a lot less than $4,000.
Why Form an IRA LLC?
There are several reasons to make self directed investments through an IRA LLC. Continue reading How to Use Self Directed IRA Funds to Form a Limited Liability Company to Make Nontraditional Investments
Question: Neither I nor my IRA custodian is a resident of or is located in Arizona. Can I form an IRA LLC in Arizona that will own and operate a business or own real estate in another state? If so, are there additional costs?
Answer: Yes. An entity (LLC, corporation or limited partnership) formed in one state can register to do business in any other state in the United States. Doing business includes owning real estate in a state other than the state in which the entity was formed. For example, if you are a resident of New York, your custodian is located in Ohio and your IRA LLC will own real estate in California, your IRA could form an Arizona limited liability company and then register it to do business in California. If hired, we will prepare the papers for an additional $200 (plus state filing fees) for each foreign state and file it with any state in which your IRA LLC will own real estate or own and operate a business. Note: If you hire us to form your IRA LLC and want us to register your IRA LLC to do business in another state, check the box on page two of my IRA LLC Formation Agreement that says “Register the IRA LLC to Do Business in Another State.”
To register an Arizona LLC to do business in California involves preparing and filing a registration form an paying a $70 filing fee. It’s a relatively simple procedure. The problem, however, with doing business in money-starved California is that it has an annual $800 minimum gross receipts tax on LLCs, regardless of where the LLC is formed. An entity formed outside California that does business in California is subject to a $100/day fine for failing to register to do business in the state.
Possible Additional Costs for an Arizona LLC that Does Business in Another State
If your IRA forms an Arizona IRA LLC and then qualifies to do business in another state, the IRA LLC probably will be required by the other state to pay an annual fee and file an annual report. Unlike Arizona, which does not require Arizona LLC’s to file an annual report or pay an annual fee after it is formed, most states do impose an annual fee tax on companies formed in the state and companies formed outside the state that do business in the state. Bottom line is that even if your IRA LLC were to be formed in the state in which it will do business, it would still be subject to the annual fee and report requirements of the state.
Warren Baker’s post on the WealthCounsel blog states: “Let’s assume for a moment that your client’s goal is to invest into a piece of residential rental real estate. Your client can either: (1) request that the new custodian purchase the property directly on behalf of the IRA; or (2) direct the custodian to first invest the IRA into a Limited Liability Company (“LLC”) that is thereafter 100% owned by the IRA and purchase the property using the LL (note: your client will act as the Manager of this LLC). The latter option gives your client the flexibility to purchase the property using a check from the LLC’s checking account, which depending on the custodian’s ability to move quickly, will be quicker than option number one.”
Question: Can I cause my self-directed IRA to invest in any type of asset I desire?
Answer: No. Section 408(a)(3) of the Internal Revenue Code says that an IRA may not invest in life insurance contracts (life insurance). The IRS also restriction investments in “collectibles.” Here is what IRS Publication 590 says about IRAs investing in collectibles:
“If your traditional IRA invests in collectibles, the amount invested is considered distributed to you in the year invested. You may have to pay the 10% additional tax on early distributions, discussed later.
Collectibles. These include:
- Artworks,
- Rugs,
- Antiques,
- Metals,
- Gems,
- Stamps,
- Coins,
- Alcoholic beverages, and
- Certain other tangible personal property.
Exception. Your IRA can invest in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.”
Department of Labor Regulation 29 CFR 2510.3-101 contains what are commonly called the Plan Asset Rules. These rules can be complex, but they are important for all IRA LLCs because a violation of the plan asset regulation can be a prohibited transaction. The Department of Labor says:
“The plan asset regulation describes circumstances in which there is a ‘look through,’ which, if applicable, treats not only the interests in an investment fund owned by ERISA covered plans as ‘plan assets,’ but also the assets of the investment fund as ‘plan assets.’ If the look through applies, the ERISA fiduciary and prohibited transaction sections apply to parties dealing with the assets of the investment fund, such as the investment fund’s investment manager.”
The plan asset rules set forth the circumstances that can cause assets owned by an entity to be deemed to be assets of the ERISA qualified plan or the IRA unless an exemption applies. When the plan asset rules cause the assets of an entity to be deemed to be assets of the IRA, any transaction involving the entity and a disqualified person will be a prohibited transaction. If an IRA owns 25% or more of any class of equity interests in an entity the plan asset rules say that the assets of the entity are deemed to be assets of the plan. If your IRA owns 25% or more of the membership interests a limited liability company, the assets of the LLC are deemed to be assets of the IRA.
Here are some additional explanations of the plan asset rules:
Question: I want to form an IRA LLC to be owned by my IRA. Can I pay the costs and expenses to be incurred to form the LLC?
No: The owner of an IRA may not pay any amounts incurred to form an IRA LLC. If the IRA owner pays any debt or obligation of the IRA LLC, it is a prohibited transaction. It is the equivalent of a loan from the IRA owner to the plan, which is prohibited under Internal Revenue Code Section 4975(c)(1)(B). The IRS deems any payment by the IRA owner of the IRA LLC’s debts or expenses as a disguised contribution of money to the IRA.
Notice the net result to the IRA in the following two examples and you will see why it is a prohibited transaction for the IRA owner to pay expenses of the IRA LLC:
Example 1:
$ 1,000 = IRA LLC formation expenses paid by the IRA owner from his/her bank account
$50,000 = total capital contributed to the IRA LLC by the IRA
$50,000 = net amount held in the IRA LLC’s bank account after paying formation expenses
Example 2:
$ 1,000 = IRA LLC formation expenses paid by the IRA LLC from its bank account
$50,000 = total capital contributed to the IRA LLC by the IRA
$49,000 = net amount held in the IRA LLC’s bank account after paying formation expenses
The proper way to pay the IRA LLC’s formation expenses is to:
- First form the IRA LLC,
- Open a bank account in the name of the IRA LLC,
- Cause the custodian to write a check payable to the IRA LLC for the entire amount of the IRA’s capital contribution to the IRA LLC,
- Deposit the check in the IRA LLC’s bank account, and
- Write a check or checks from the IRA LLC’s bank account to pay the formation expenses.
Question: Two years ago my spouse and I caused our IRAs to make self-directed investments into an LLC that purchased a rental home. Each IRA is a 50% member of the LLC. The property needs repairs that will cost more money than the LLC has available. Can we cause our IRAs to make additional capital contributions to the LLC to fund the repairs?
Answer: No. If either IRA were to make an additional capital contribution to the LLC, it would create a prohibited transaction under Internal Revenue Code Section 4975(c), which provides that a:
“prohibited transaction” means any direct or indirect— . . . transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan”
Because the two IRAs each own 50% of the LLC, the LLC is a disqualified person under Section 4975(e)(2)(G). This provision says that a disqualified person is an entity 50% or more of which is owned by a fiduciary. Each IRA custodian is a fiduciary with respect to its IRA account and because the custodian owns 50% of the LLC, the LLC is a disqualified person. Therefor a transfer of money from the custodian to the disqualified person (the LLC) to fund the repairs is a prohibited transaction.
Local Online News TV: “In 2010, anyone may convert a traditional IRA to a Roth IRA. No income limits will stand in the way of the conversion. Should you do it? Here’s why it may (or may not) make sense for you to go Roth this year.”
Forbes: “An inherited retirement account is more than a simple pot of cash. Often, an heir can stretch out withdrawals from an individual retirement account over his or her life expectancy, gaining decades of tax-deferred or (in the case of a Roth IRA) tax-free investment growth. But the IRS rules for doing this can be tricky. If you’re inheriting an IRA or 401(k), here’s what you need to know.”
North Carolina Estate Planning Blog: “When it comes to inheriting an IRA, spouses have more flexibility than other heirs. Here are the basic rules;”
Here are a number of articles that I found on the net that discuss the pros and cons of converting a traditional IRA to a Roth IRA.
- April 4, 2010. “The Debate Goes On: To Roth or Not to Roth?” – InvestmentNews: “For the superwealthy, conversion is a slam-dunk; others should be more careful. The following is an edited transcript of an InvestmentNews.com webcast held in New York on March 9. . . . To listen to the archive of the webcast, visit Investmentnews.com/rothtranscript and click ‘View archive’.” One of the panelists was Ed Slott, the renowned IRA expert.
- January 16, 2010. “Ready to Roth: How You Fund an IRA Conversion Through the ‘Back Door’” – Wall St. Journal: “Individual retirement accounts funded with 401(k) assets count among your traditional IRA assets during a Roth IRA conversion. The language is confusing, since many custodians refer to such accounts as rollover IRAs. But they are technically traditional IRAs. Any IRA labeled as a SEP, SIMPLE or contributory is included, as well. . . . Here is where the ‘back-door’ method comes into play:”
- December 10, 2010. “Beware the Roth IRA Conversion Trap” – The Wandering Tax Pro: “For several years now tax professionals, myself included, and personal finance and tax bloggers, again myself included, and financial writers have been talking about 2010 being the year to convert to a ROTH IRA. . . . What we all have forgotten to remind you when discussing this issue is the way one calculates the taxable portion of a ROTH conversion.”
- November 23, 2009. “2010 Roth Conversion: Factors to Consider Before Making a Decision” – FreeMoneyFinance: “For more than a decade, Roth IRAs have been offering investors a number of benefits generally including tax free growth in earnings, tax free withdrawals assuming you begin your withdrawals after the age of 59 1/2 and have held the Roth account for the minimum five-year holding period, and no required minimum distributions as is the case with traditional IRAs. Through the end of 2009, conversion to a Roth IRA from other retirement accounts including a traditional IRA or 401(k) plan is limited to people with a modified adjusted gross income of $100,000 or less. But as of January 1, 2010, all investors will be eligible to convert funds from a traditional IRA or 401(k) to a Roth IRA, regardless of income level. While this change will present some attractive options for certain investors, people should weigh the costs and the benefits unique to their own specific financial plans and tax situation before deciding if a Roth IRA conversion is right for them.”
- November 8, 2009. “Roth IRA Conversion has Perks” – Arizona Republic: “By now, word has gotten out that 2010 will be a big year for converting traditional individual retirement accounts into Roth IRAs. That’s when tough eligibility rules, which have prevented higher-income people from making the switch, will be repealed. Plus, traditional-to-Roth conversions done in 2010 come with a special sweetener: Normally, you must pay any taxes due in the year you make the switch, but in 2010 only, investors can elect to defer the tax bite and spread it over the following two years, 2011 and 2012.”
- September 22, 2009. “To Roth or Not to Roth: Analyzing the Conversion Opportunity for 2010 and Beyond” – University of Illinois Professor of Law Richard L. Kaplan wrote a popular article on whether to convert a traditional IRA to a Roth IRA (click on the download link then click on the link to one of the download sites).
“Beginning in 2010, all taxpayers will be able to convert their existing Individual Retirement Accounts (IRA) to Roth IRAs, without regard to their level of income or marital status. In effect, taxpayers will be able to lock in current income tax rates on account values that have been eroded by recent investment market declines. This article analyzes who should take advantage of this opportunity, using the barest minimum of arithmetic (and no calculus).”
- September 6, 2009. “Is a Roth conversion right for you?” – Arizona Republic business reporter Russ Wiles says in his article:
“Roth individual retirement accounts have emerged as a popular tax-sheltered way to invest, and they’ll only get better next year. Starting in January, Congress will drop the eligibility barriers so that any investor, regardless of income, will be able to transfer money from traditional, deductible IRAs to a Roth.”
From the using your IRA or retirement account to self-direct investments department. Bloomberg: “Here’s how it typically works: An investor sets up a corporation, establishes a new 401(k) plan there, rolls over his or her existing 401(k) or Individual Retirement Account, and then uses part or all of the plan’s assets to buy shares of the new company. This funds the new business, while keeping the tax- advantages of the retirement plan.”
Question: My IRA is the sole member of my IRA LLC. Can my IRA LLC loan money to my grandchild?
Answer: Legally yes, but the loan would be a transaction between the IRA LLC and a disqualified person, which is a prohibited transaction under Section 4975(c) of the Internal Revenue Code. A disqualified person includes ascendants (parents and grandparents) and descendants (children, grandchildren, etc.) of the owner of the IRA and spouses of descendants.
Consequences of a Prohibited Transaction
An IRA LLC that engages in a prohibited transaction will cause the IRA to lose its tax-exempt status as of the first day of the tax year in which the prohibited transaction occurs. This means that the IRA is deemed to have distributed to the IRA owner all of the assets in the IRA and the IRA owner must include in income for the year the fair market value of the assets as of the first day of the year unless the IRA is a Roth IRA. If the IRA owner is under 59 1/2, the distribution will also cause a ten percent penalty.
Question: Why do some document preparers and attorneys charge substantially more than the $997 you charge to form an IRA LLC?
Answer: Because they can get away with it. Most attorneys who may routinely form limited liability companies never form an LLC that has an IRA or a retirement plan as a member so they are unlikely to form this type of LLC when asked. Most of the small number of attorneys and document preparers who actually form IRA LLCs charge far too much because they have little, if any competition, and they know that is it very unlikely a prospective client/customer will be able to find somebody else with the knowledge and experience to form an IRA LLC. These types charge far too much because they believe they have a monopoly and can set a high price because clients/customers have no other place to go to form an IRA LLC.
A few years ago I went to a seminar here in Phoenix, Arizona, about how to use self-directed IRA funds to invest in real estate through an IRA LLC. The person who gave the presentation was an attorney not licensed to practice law in Arizona. He told the group the many reasons they should form an IRA LLC, and said he formed them for $4,000. Since I was forming Arizona LLCs (not IRA LLCs) at that time for $599 including all the costs, (which is the same amount I charge today) I was shocked that he not only charged so much, but that people actually paid him that off the charts amount. I asked the speaker how he justified charging that much, but the answer he gave did not justify the price in my mind. That is when I decided I would learn about IRA LLCs so I could form them for my clients at a much lower cost and provide an outstanding total package.
No Specific Language Required by IRS or Tax Law to Form an IRA LLC
If an attorney or document preparer tells you that there are some “magic” provisions that must be in the Articles of Organization or in the Operating Agreement or some special hoops that must be jumped through to form an IRA LLC, that person is not being truthful. LLCs are formed pursuant to state laws, which do not require any special provisions or actions to be taken to form an LLC just because an IRA or a retirement plan will be a member of the LLC. Nor does the Internal Revenue Code of 1986, as amended, require that the Articles of Organization, the Operating Agreement or any other documents used in connection with the formation of an IRA LLC contain any specific language.
Specific Language I Include in the Operating Agreement of an IRA LLC
Even though neither Arizona law nor federal income tax law require that any IRA specific provisions be included in the formation documents of an IRA LLC, I do include IRA and retirement plan provisions in the Operating Agreement I prepare for my IRA LLCs. My Operating Agreement contains selected language from Internal Revenue Code Sections 408 and 4975 (prohibited transactions). Section 408 prohibits an IRA from pledging any of its assets as security for a loan and from investing in collectibles. Section 4975 contains the prohibited transaction rules.
I include these IRA specific provisions in my Operating Agreement because:
- I want the people involved with my IRA LLCs to where to find the prohibited transaction rules and the other restrictions that if violated by the IRA LLC could cause tax penalties and/or disqualification of the IRA.
- I hope the people involved with my IRA LLCs will actually read the provisions.
Why I Charge $997 for an IRA LLC & $599 for a non-IRA LLC
I charge more to prepare an IRA LLC than I charge to form a non-IRA LLC because:
- I do add the Internal Revenue Code Section 408 and 4975 language in the Operating Agreement, which I believe does add value, but not $3,000 of value.
- I do not require payment in advance, which I do require for non-IRA LLCs. My IRA LLC’s must pay my fee from money deposited in the IRA LLC’s bank account after I form the IRA LLC.
- I get a federal employer ID number for each IRA LLC, which in not included in the $599 price for a non-IRA LLC unless the client pays an additional $75.
- I am an attorney who does not charge for questions about forming IRA LLCs.
- The entire package I give my IRA LLC clients is worth a lot more than the $997. See “What We Do When Hired to Form Your IRA LLC.”
IRS Publication 590 is entitled “Individual Retirement Arrangements.” The following text is from page 43 of Publication 590:
What Acts Result in Penalties or Additional Taxes?
The tax advantages of using traditional lRAs for retirement savings can be offset by additional taxes and penalties if you do not follow the rules. There are additions to the regular tax for using your IRA funds in prohibited transactions. There are also additional taxes for the following activities.
- Investing in collectibles.
- Making excess contributions.
- Taking early distributions.
- Allowing excess amounts to accumulate (failing to take required distributions).
There are penalties for overstating the amount of nondeductible contributions and for failure to file Form 8606, if required.
This chapter discusses those acts that you should avoid and the additional taxes and other costs, including loss of IRA status, that apply if you do not avoid those acts.
Prohibited Transactions
Generally, a prohibited transaction is any improper use of your traditional IRA account or annuity by you, your beneficiary, or any disqualified person.
Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).
The following are examples of prohibited transactions with a traditional IRA.
- Borrowing money from it.
- Selling property to it.
- Receiving unreasonable compensation for managing it.
- Using it as security for a loan.
- Buying property for personal use (present or future) with IRA funds.
Fiduciary. For these purposes, a fiduciary includes anyone who does any of the following.
- Exercises any discretionary authority or discretionary control in managing your IRA or exercises any authority or control in managing or disposing of its assets.
- Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so.
- Has any discretionary authority or discretionary responsibility in administering your IRA.
Effect on an IRA account.
Generally, if you or your beneficiary engages in a prohibited transaction in connection with your traditional IRA account at any time during the year, the account stops being an IRA as of the first day of that year.
Effect on you or your beneficiary.
If your account stops being an IRA because you or your beneficiary engaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market values on the first day of the year. If the total of those values is more than your basis in the IRA, you will have a taxable gain that is includible in your income. For information on figuring your gain and reporting it in income, see Are Distributions Taxable, earlier. The distribution may be subject to additional taxes or penalties.
Because the Internal Revenue Code prohibits an IRA LLC from engaging in transactions with a disqualified person, every member and manager of an IRA LLC must know the people and entities that are disqualified persons. Internal Revenue Code Section 4975(e)(2) contains the definition of a disqualified person. This section states that a disqualified person is:
(A) a fiduciary [the IRA owner is a fiduciary];
(B) a person providing services to the plan;
(C) an employer any of whose employees are covered by the plan;
(D) an employee organization any of whose members are covered by the plan;
(E) an owner, direct or indirect, of 50 percent or more of—
(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation,
(ii) the capital interest or the profits interest of a partnership, or
(iii) the beneficial interest of a trust or unincorporated enterprise, which is an employer or an employee organization described in subparagraph (C) or (D);
(F) a member of the family (as defined in paragraph (6) [which states: the family of any individual shall include his spouse, ancestor, lineal descendant, and any spouse of a lineal descendant]) of any individual described in subparagraph (A), (B), (C), or (E);
(G) a corporation, partnership, or trust or estate of which (or in which) 50 percent or more of—
(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,
(ii) the capital interest or profits interest of such partnership, or
(iii) the beneficial interest of such trust or estate, is owned directly or indirectly, or held by persons described in subparagraph (A) [a fiduciary], (B) [a person providing services to the plan] , (C) [an employer any of whose employees are covered by the plan], (D) [an employee organization any of whose members are covered by the plan], or (E) [the IRA owner - this subsection (G)(iii) is what makes an entity a disqualified person if the IRA owner owns 50% or more of the entity];
(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G); or
(I) a 10 percent or more (in capital or profits) partner or joint venturer of a person described in subparagraph (C) [an employer any of whose employees are covered by the plan], (D) [an employee organization any of whose members are covered by the plan], (E) [the IRA owner], or (G).
If your IRA is a member of an IRA LLC, you must know and follow the prohibited transaction rules set forth in Internal Revenue Code Section 4975. Many prohibited transaction rules are obvious such as the IRA LLC cannot loan money to the IRA owner or buy, sell or lease property with the IRA owner.
The prohibited transaction rules also contain a general, but nebulous rule some times referred to as the “indirect benefits” rule. If the IRA LLC engages in a transaction that creates an “indirect benefit” for the IRA owner, it is also a prohibited transaction that will disqualify the IRA, cause the IRA to lose its tax-exempt status and result in a deemed distribution of the all the assets to the IRA owner as of the first day of the tax year in which the prohibited transaction occurred.
The indirect benefit rule is codified in Internal Revenue Code Section 4975(c)(1) (E), which states that a:
“prohibited transaction means any direct or indirect . . . act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account;”
Before an IRA LLC engages in a transaction, its members and managers must be able to answer the following question with a clear NO!
If the IRA LLC engages in the proposed transaction, will the IRA owner receive an indirect benefit?
This rule does not apply if the only indirect benefit is that the IRA LLC will make a profit some or of all of which will ultimately be distributed to the IRA and then to the IRA owner.
Here are some examples of common situations that involve violations of the indirect benefit rule and that will result in the disqualification of the IRA from its tax-exempt status. The IRA owner or a member of his or her family (defined in Internal Revenue Code Section 4975(e)(6) as a spouse, ancestor, lineal descendant, and any spouse of a lineal descendant) or any other disqualified person:
- lives in a home owned by the IRA LLC.
- uses a ski boat owned by the IRA LLC.
- is an employee of the IRA LLC and is paid a salary.
The following is a list of sections from the Internal Revenue Code of 1986, as amended, that affect IRAs and IRA LLCs:
- Section 408(e)(2) – This section provides that an IRA that engages in a prohibited transaction will lose its tax-exempt status if it engages in a prohibited transaction. The consequences of a traditional IRA that loses its tax-exemption is that the fair market value of all of the IRA’s assets are included in the income of the IRA owner in the year of the prohibited transaction.
- Section 408(e)(4) – This section prohibits an IRA from pledging any of its assets as security for a loan.
- Section 408(m) – This is the section that prohibits an IRA from investing in collectibles.
- Section 408(a)(3) – This is the section that prohibits IRAs from investing in life insurance contracts.
- Section 4975 – This lengthy section contains the critically important prohibited transactions rules.
There are also important United States Treasury Regulations that state what happens if an IRA engages in a prohibited transaction, pledges IRA assets as security for a loan, and the prohibition on investing in life insurance contracts. These regulations are:
- Treasury Regulation Sections 1.408-1(c)(2), (3) and (4)
- Treasury Regulation Section 1.408-2(b)(3)
IRS Publications Concerning IRAs & Small Business Plans
IRS Publications Concerning Health Savings & Education Plans
When people hire me to form an IRA LLC, I don’t just fill in the blanks in a state created form, file it with the Arizona Corporation Commission and give you an Operating Agreement created for non-IRA LLCs. Here is a list of the 23 things I provide when I am hired to form an Arizona IRA LLC:
- Unlimited telephone calls with Arizona IRA LLC attorney Richard Keyt about forming the Company. If you have questions about forming an IRA LLC, call me at 602-906-4953, extension 1. I do not charge for questions about forming IRA LLCs.
- Name selection advice. Call if you want me to check to see if a desired name is available as an LLC name in Arizona.
- Prepare custom drafted Articles of Organization to be reviewed and approved by the contact person and the Custodian.
- Discuss any formation issues and the Articles of Organization with the contact person & the Custodian and make any changes to the Articles requested by the contact person or the Custodian.
- File the Articles of Organization approved by the contact person and the Custodian with the Arizona Corporation Commission (“ACC”) on an expedited basis. I always file Articles of Organization with the ACC by paying the $85 expedited filing fee to obtain the ACC’s approval in the shortest time period possible. Expedited filing takes approximately one week for ACC approval, but regular filing can take as long a a month for approval.
- Prepare the ACC cover sheet and file it with the ACC. The ACC will not accept the Articles of Organization without this cover sheet.
- On the day we file the Articles of Organization or the next business day, we will email to the contact person a copy of the Articles of Organization submitted to the ACC with the ACC’s “received” stamp. With this document and the federal employer id number that we get for the IRA LLC, the manager can open the IRA LLC’s bank account within one or two business days after we email the document and the EIN.
- Obtain a federal employer ID number from the IRS for the IRA LLC and email it to the contact person. We usually get the EIN the same day we file the Articles of Organization with the ACC. Note: Before we can get the EIN, the manager of the IRA LLC must complete, sign and return to us an IRS form SS-4 found here: www.keytlaw.com/azllc/ss-4.pdf.
- Give the contact person a digital generic version of Rick Keyt’s Arizona-specific 100+ page book called the “Arizona LLC Quick Start Guide” immediately after we receive this completed and signed IRA LLC Formation Agreement. The digital version of the Quick Start Guide is sent to the contact person by email. If you do not get an email from me with the QSG soon after you send me your IRA LLC Formation Agreement, contact my legal assistant Katie at 602-906-4953, extension 7.
- Give the contact person a hard copy version of the Arizona LLC Quick Start Guide customized specifically for your IRA LLC, including chapter 2 that is a checklist of 25+ to do items that should be done in the first 75 days. The checklist due dates are based on the actual filing date of the Articles of Organization of the IRA LLC. The checklist also states who is responsible for each task. Most of the tasks are our responsibility, but some are the manager’s and some are the company’s accountant. The contact person will get periodic reminders of the due dates of upcoming tasks in emails sent to the contact person by our LLC compliance alert system.
- Give the contact person a copy of the filed Articles of Organization stamped with the ACC’s “approved” stamp.
- Prepare a Notice of Publication per the requirements of Arizona LLC law.
- Publish the Notice of Publication in a newspaper approved by the Arizona Corporation Commission in the appropriate Arizona county before the statutory deadline.
- Obtain an Affidavit of Publication from the newspaper and file it with the ACC before the statutory deadline.
- Prepare Rick Keyt’s 40+ page Charging Order Enhanced(TM) Operating Agreement custom drafted for your IRA LLC with provisions specifically applicable only to IRA LLCs and members that are IRAs.
- Act as the IRA LLC’s statutory agent for its first year at no charge. Every LLC and corporation formed in Arizona must have a statutory agent (aka resident agent in some states).
- Prepare organizational resolutions of the members authorizing the issuance of membership interests.
- Prepare membership certificates for all members that are used to prove ownership of the IRA LLC. Membership certificates are the LLC equivalent of a corporate stock certificate.
- Give the contact person a copy of the IRS statutes & regulations applicable to IRA LLCs.
- Give the contact person a copy of Rick Keyt’s article called “Frequently Asked Questions about Prohibited Transactions,” which explains the most common transactions the IRA LLC must avoid to stay in good standing with the IRS. This is an extremely important document because it describes prohibited transactions most commonly encountered by IRA LLCs. The manager(s) of the IRA LLC and its IRA members must know what is permissible and what can cause the disqualification of the IRA.
- Give the contact person a high-quality Arizona LLC Portfolio with tabs in which to keep all important IRA LLC documents.
- Give the contact person a free one year membership in our LLC Concierge(TM ) program ($297 value). This is our unique email tickler system that sends email throughout the first year after formation reminding the contact person of LLC administrative tasks (such as getting all members to sign the Operating Agreement and to set up a bookkeeping system) that should be accomplished.
- If PENSCO Trust is a Custodian: Rick Keyt will sign and deliver to PENSCO a Special Advisor Engagement and Representation Letter, which is required by PENSCO for certain IRA LLCs. If PENSCO Trust is a custodian and the IRA LLC is a single member LLC or a two member LLC owned by a husband and wife and/or their IRAs or retirement plans, PENSCO requires certain language in the IRA LLC’s Operating Agreement (I will insert it in if needed) and that a CPA or attorney sign the Special Advisor Engagement and Representation Letter in front of a notary and deliver the signed original to PENSCO.
If you have any questions about any thing mentioned above or about forming an IRA LLC, call me at 602-906-4953, extension 1.
We create IRAs and retirement plans to provide income during our retirement years, but we also expect that on our deaths our loved ones will inherit a sizable sum of money from the IRA or the retirement plan. Everyone knows or should know that the proper way to transfer IRA and retirement plan assets on the death of the IRA owner or plan participant is by a beneficiary designation.
I believe that IRA owners and retirement plan participants should do more than simply complete a beneficiary designation form. They should also educate their adult beneficiaries about fundamental IRA concepts to prevent them from immediately cash out the inherited IRA or plan and blow the money on an expensive car or other foolish expenditures.
Forbes has a great article called “Five Rules For Inherited IRAs” that is a must read article for anybody whose IRA or retirement plan may leave substantial assets to loved ones. The article begins:
“Before they inherited $3 million in retirement accounts from their father last year, the three middle-aged siblings didn’t know it was possible for heirs to stretch out the tax benefits of such accounts for decades. But what they also discovered after his death is that doing this is tricky–and in some cases impossible–if the original owner of the accounts didn’t fill out his beneficiary forms just so. Although their 78-year-old dad was a lawyer, “He may never have realized that it made any difference,” says a daughter, who has spent days trying to sort it all out.”
The five rules are:
- Do no harm
- Beneficiary forms rule
- Employer plans are different
- Spouses have more options
- Watch for distribution traps
I recommend you read the article, make a copy of it for your records, give a copy of the article to all of your adult beneficiaries and keep a copy in the file where you keep your estate plan documents or your IRA or retirement plan documents.
See my article called “How Your Family Can Become IRA Millionaires Using an IRA Inheritance Trust® that Protects the Funds from Ex-Spouses, Creditors & Bankruptcy Court.”
Ann Siford, Manager of Professional Network at Equity Trust Company writes: ”Roth IRA conversions involve more than accounting and tax expertise; successful conversions will require well-orchestrated, collaborative efforts by masters of their financial and legal trades. Navigate any financial website, trade publication or financial practitioner event and you’ll find the words “Roth conversion” indexed among the resources or debated in conversations. The key though, is to not only wade through the abundance of information and walk away with the ‘how-to’s’, but to also meticulously apply expert techniques to a client’s conversion strategy. To explore further, we turned to Robert Keebler, CPA, MST, AEP and partner with Baker Tilly, for his perspective on what CPAs, advisors and attorneys should be doing as they begin to examine the feasibility of a conversion for their clients.”
Todd Senff, Real Estate Channel Manager, at Equity Trust Company writes: “Historically, real estate has given many Americans a stable investment vehicle that provides both income and appreciation. One of the greatest tools available to real estate investors is government-sponsored retirement plans, such as IRAs and 401(k)s, which can provide generous tax-advantages to their investment. . . . 7 Things to Know When Planning to Self-Direct IRA in Real Estate.”
Equity Trust Company: “If your . . . IRA owns an asset or interest that produces unrelated business taxable income (UBTI), their IRA may be subject to an unrelated business income tax (UBIT) pursuant to Section 511-514 of the Internal Revenue Code. However, before we can address the tax, we must first identify situations when unrelated business taxable income is generated.
Ann Siford, Manager of Professional Network at Equity Trust Company writes: “Precious metals have long been considered one of the few ways to protect assets from high inflation and economic uncertainty. Clients are investing their IRAs in gold, silver and more. . . . The only thing certain about today’s market is its uncertainty. To mitigate this questionable time, more clients and their advisors are seeking precious metals as an asset class to further diversify their retirement portfolio. Precious metals are often attractive to investors because of their liquidity. A self-directed IRA can hold gold, silver, platinum and palladium bullion which meet minimum fineness requirements.”
Gene Fox, President of Triple Net Houses writes: “The key to this unique strategy is utilizing the long-used triple net lease, which is used commonly by real estate investors on commercial properties, such as Dollar General Stores and fast food restaurants. Triple Net Houses takes that same leasing principle, but transfers it to single-family homes. Investors can now get all the benefits of owning rental properties, without the hassles of managing or maintaining them.”
Ned Coyle, Commercial RE Investment Specialist, writes: “Have you considered investing in a commercial real estate property only to back-off because you didn’t want the management hassles? OK, fair enough. Did you then invest those funds in the stock market, perhaps a Real Estate Investment Trust (REIT) because it was the easy thing to do? No one has to tell you the direction your stock portfolio has taken, right? It probably has about the same value today as it did in 2002. Where would your net worth be today if you had taken a portion of those funds and invested it in real estate? We are not talking a REIT stock here but a purchase, in a fee simple manner, of a commercial office, retail or light industrial distribution property.”
Laurie Bachelder, Principal of NUA Advisors, LLC, writes: “Investors tired of watching their retirement accounts ride the Wall St. rollercoaster are searching for other ways to create wealth in their retirement accounts. If you turn to most business or financial publications or websites you will find many articles about investing in real estate with a Self Directed Retirement Account (‘SDRA’). The majority of articles written about investing with a SDRA pertain to real estate as a popular choice for an alternative investment, and why wouldn’t it be. Real estate offers several advantages.”
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