Self Directed IRA LLCs Prohibited Transactions

If you have a self-directed IRA and a custodian has told you that your IRA can own 100% of a limited liability company that you manage, you have been told something true. What you may not have been told is that the LLC does not give your IRA money any new freedom. It gives you a checkbook and a much shorter distance between an ordinary mistake and the total destruction of your retirement account.

 

This article explains the rules that govern forming, owning and operating an LLC whose sole member is your IRA — the structure the industry calls a “checkbook control IRA,” a “checkbook IRA” or simply an “IRA LLC.” The heart of it is Internal Revenue Code § 4975, the prohibited transaction rules. Those rules are strict-liability rules. They do not ask whether you meant well, whether the IRA made money, or whether the terms were fair. They ask one question: did a prohibited person and the plan end up on opposite sides of a transaction?

 

When the answer is yes, IRC § 408(e)(2) does not fine you. It deletes the account. The entire IRA — not the offending investment, the entire IRA — is treated as distributed to you on January 1 of the year the violation occurred, at fair market value, taxable as ordinary income, plus a 10% additional tax if you were under 59½.

Arizona LLC and estate planning attorney Richard Keyt and his son, attorney and former CPA Richard C. Keyt, have formed more than 10,000 Arizona limited liability companies, including more than 350 IRA-owned LLCs. What follows is the law they apply when they form one.

What a Checkbook Control IRA LLC Actually Is

A self-directed IRA is an ordinary IRA held by a custodian or trustee who is willing to hold assets other than publicly traded securities — rental real estate, private notes, tax liens, precious metals, closely held company interests, farmland. The account is still governed by IRC § 408. The only thing “self-directed” means is that the custodian takes investment instructions from you instead of selling you its own mutual funds.

 

In a plain self-directed IRA, every transaction goes through the custodian. You want to buy a rental house? You submit a buy direction letter, the custodian wires the money, the custodian signs the deed, and title reads something like “ABC Trust Company, Custodian FBO John Smith IRA.” Every property tax bill, every plumbing invoice, every insurance premium goes back to the custodian for payment. Custodians charge per transaction and take days to act. In a competitive real estate market, that is a real handicap.

 

The IRA LLC is the workaround. Instead of buying assets directly, the IRA makes a single investment: it buys 100% of the membership interest in a newly formed LLC. The IRA owner is named manager of the LLC. The LLC opens its own bank account. From that moment the manager can write checks, sign contracts, hire contractors and close on property without asking the custodian for anything. That is the “checkbook control.”

 

The structure has three parties and you need to keep them straight for the rest of this article:

Party	Role	Legal status under § 4975
You	The IRA owner; also the manager of the LLC	A fiduciary under § 4975(e)(3), and therefore a disqualified person under § 4975(e)(2)(A)
The custodian	Holds legal title to the LLC membership interest for the benefit of your IRA; files Form 5498; processes contributions and distributions	A service provider and, depending on the agreement, a directed (non-discretionary) trustee
The LLC	Owns and operates the actual investments; the IRA owns 100% of it	A disqualified person under § 4975(e)(2)(G), and its assets are plan assets

Is an IRA-Owned LLC Legal? What Swanson Does and Does Not Say

Almost every IRA LLC promoter cites the same authority: Swanson v. Commissioner, 106 T.C. 76 (1996). It is worth understanding precisely what that case held, because it is routinely oversold.

The facts

James Swanson owned an S corporation, H&S Swansons' Tool Co. In January 1985 he organized a new corporation, Swansons' Worldwide, Inc., and served as its director and president. He then created an IRA, and on the day the IRA was created it subscribed for 2,500 newly issued shares of Worldwide, becoming the sole shareholder. Tool Co. paid sales commissions to Worldwide, and Worldwide paid roughly $593,602 of dividends to the IRA over four years. Swanson repeated the structure a few years later with a second corporation and a second IRA.

 

The IRS asserted that both the stock purchase and the dividends were prohibited transactions. Then the IRS conceded the issue. The published opinion at 106 T.C. 76 is technically a ruling on Swanson's request for litigation costs under IRC § 7430 — the Tax Court had to decide whether the government's abandoned position had been “substantially justified.” It held that it was not.

The reasoning that survived

The court's explanation is the part that matters. A corporation is a disqualified person under § 4975(e)(2)(G) only if 50% or more of it is owned by a disqualified person. At the instant the IRA subscribed for newly issued shares in a corporation that had never had a shareholder, nobody owned it. As the Eighth Circuit later summarized the point, Swanson “explain[ed] that a corporation without shares or shareholders does not fit within the definition of a disqualified person.” So the initial purchase was not a sale or exchange between the plan and a disqualified person.

 

The court also found that dividends flowing from the company to the IRA were not a transfer of plan assets for the benefit of a disqualified person, because Swanson's benefit came “solely… insofar as [the IRA] accumulated assets” — the ordinary benefit any IRA owner gets when his IRA grows.

 

Five years later, in Field Service Advice 200128011 (2001), the IRS national office reviewed a comparable structure and concluded that it “should not maintain” the position that an IRA's ownership of newly issued stock is a prohibited transaction. Field service advice is not precedent and cannot be cited as such under IRC § 6110(k)(3), but as a practical matter it told examining agents to stop making the argument.

What Swanson does not say

Here is where the promotional literature goes wrong. Swanson establishes only that the formation and initial capitalization of a wholly IRA-owned entity is not itself a prohibited transaction. It says nothing at all about what the entity may do afterward. The IRS has never conceded that point, and two courts have expressly reserved it.

 

In Ellis v. Commissioner, the Commissioner argued in the alternative that even the initial investment was prohibited because it was made as part of an arrangement under which the IRA owner would draw wages. The Tax Court ruled for the taxpayer on the capitalization issue on Swanson grounds and declined to reach the arrangement theory. The Eighth Circuit, affirming, said in footnote 4 that because the wages were prohibited anyway, “we need not consider whether the investment was prohibited as well.”

Why Everything Inside the LLC Is Still IRA Money

The most dangerous instinct an IRA LLC manager can have is to think of the LLC as a separate business that happens to have been funded by his IRA. Federal law does not see it that way.

 

The Department of Labor's plan asset regulation, 29 C.F.R. § 2510.3-101, decides when the underlying assets of an entity are treated as assets of a plan. By its own terms the regulation applies not only to ERISA but to “section 4975 of the Internal Revenue Code,” which is what makes it relevant to IRAs at all. The general rule is that a plan's investment in an entity makes the plan's asset the equity interest only — unless the entity is one whose equity is not publicly offered, in which case the plan's assets include an undivided interest in every underlying asset, subject to two escapes: the entity is an operating company, or benefit plan investors hold less than 25% of every class of equity.

 

Neither escape is available to a single-member IRA LLC. An IRA is a “benefit plan investor” because it is a plan described in § 4975(e)(1), and it holds 100% — far more than 25%. And paragraph (h)(3) of the regulation closes the door completely. It begins “Notwithstanding any other provision of this section” and then says:

Because that provision overrides everything else in the regulation, it does not matter whether your LLC is an operating company. If your IRA owns all of it, every dollar in the LLC bank account, every property on its balance sheet and every note receivable it holds is an asset of your IRA.

 

Two consequences follow immediately, and they are the foundation of everything else in this article.

 

First, you are a fiduciary. Under § 4975(e)(3) a fiduciary is anyone who “exercises any authority or control respecting management or disposition of” plan assets. Note that the statute does not require discretion for that prong — any authority or control is enough. The moment you are named manager and hold the LLC's checkbook, you are a fiduciary of your own IRA, and a fiduciary is a disqualified person under § 4975(e)(2)(A).

 

Second, the LLC is a disqualified person too. Under § 4975(e)(2)(G), an entity 50% or more of which is owned directly or indirectly by a fiduciary is a disqualified person. You are the individual for whose benefit an IRA is established, and that IRA owns 100% of the LLC. In Ellis, the parties agreed on exactly this point as to a 98%-owned LLC, and the Tax Court described the LLC and the IRA as “substantially the same entity.”

Who Is a Disqualified Person

Everything in § 4975 turns on the phrase “disqualified person.” If a transaction has a disqualified person on one side and the plan (or your IRA LLC) on the other, you have a problem. Section 4975(e)(2) lists nine categories. Translated into the language of an IRA LLC:

• (A) A fiduciary. You, because you manage the LLC and direct the IRA. Also anyone else you give discretion or investment-advice-for-a-fee authority over the account.
• (B) A person providing services to the plan. Your custodian, your IRA administrator, and arguably any professional the IRA or LLC pays for plan-related services.
• (C) and (D) An employer whose employees are covered by the plan, and a covered employee organization. Rarely relevant to an individual IRA, but relevant to SEP and SIMPLE IRAs.
• (E) A 50%-or-more owner of an employer or employee organization described in (C) or (D).
• (F) A member of the family of a person described in (A), (B), (C) or (E). Family is defined narrowly in § 4975(e)(6) — see below.
• (G) An entity 50% or more owned, directly or indirectly, by persons described in (A) through (E). This is the category that captures your IRA LLC, and every other company you or your spouse or children own half or more of.
• (H) An officer, director, 10%-or-more shareholder, or highly compensated employee of an entity described in (C), (D), (E) or (G).
• (I) A 10%-or-more partner or joint venturer of a person described in (C), (D), (E) or (G).

The family rule — and the sibling surprise

Section 4975(e)(6) defines the family of an individual as “his spouse, ancestor, lineal descendant, and any spouse of a lineal descendant.” That is the complete list. Both § 4975(e)(4) and § 4975(e)(5), which import the constructive ownership rules of IRC § 267(c), expressly override the broader § 267(c)(4) family definition and substitute the narrower § 4975(e)(6) list.

Disqualified persons (family)	Not disqualified persons by family status alone
Your spouse	Your brothers and sisters (whole or half blood)
Your parents, grandparents and other ancestors	Your step-siblings
Your children, grandchildren and other lineal descendants	Your aunts, uncles, nieces, nephews and cousins
Your son-in-law and daughter-in-law (spouse of a lineal descendant)	Your parents-in-law

So your IRA LLC may buy a rental house from your brother. It may not buy one from your mother, your son, or your daughter-in-law.

The Six Prohibited Transactions

Section 4975(c)(1) prohibits six categories of transactions. Every one is prefaced with the words “any direct or indirect,” which is the textual hook courts use to reach through LLCs, corporations, partnerships and third parties.

(A) Sale, exchange or leasing of property

Any sale or exchange, or leasing, of any property between the plan and a disqualified person. Your IRA LLC cannot buy property from you, sell property to you, trade property with you, lease property to you, or rent property from you. It cannot do any of those things with your spouse, your parents, your children, or a company you half own either. Price is irrelevant. A sale at a bargain to the IRA is just as prohibited as a sale at a premium.

(B) Lending money or extending credit

Any lending of money or other extension of credit between the plan and a disqualified person, in either direction. You cannot lend money to your IRA LLC. Your IRA LLC cannot lend money to you. You cannot advance a repair bill and get reimbursed. You cannot put an earnest money deposit on your personal credit card. And — this is the one that destroys accounts — you cannot personally guarantee a loan to your IRA LLC. That is the holding of Peek and Thiessen, discussed below. Any loan the LLC takes must be true non-recourse debt with no personal guarantee and no recourse against you.

(C) Furnishing goods, services or facilities

Any furnishing of goods, services or facilities between the plan and a disqualified person. You may not perform the services yourself. You may not paint the rental, replace the water heater, mow the lot, or do the LLC's bookkeeping. You may not let the LLC store equipment in your garage or use your office. Your son the electrician may not rewire the property, paid or unpaid.

(D) Transfer to, or use by or for the benefit of, a disqualified person of plan income or assets

This is the broadest of the six and does not require any exchange at all. It covers anything that moves plan value toward a disqualified person or lets a disqualified person use plan property. Staying one night in the IRA-owned condo. Parking your car in the IRA-owned garage. Using the LLC's checkbook to pay a personal bill you intend to repay. Directing the LLC to pay you wages, as in Ellis. Depositing an LLC rent check into your personal account by mistake. Courts have held under (D) that no transfer of money to the disqualified person is even necessary — the potential for benefit is enough.

(E) Fiduciary self-dealing

Any act by a disqualified person who is a fiduciary whereby he deals with plan income or assets in his own interest or for his own account. You are always the fiduciary here, so (E) is always live. It reaches transactions where you are on both sides economically even if no disqualified person is technically a counterparty: directing the IRA LLC to invest in a startup you separately own a piece of, to buy an interest in a partnership with your own money in it, to lend to a borrower who has agreed to do something for you personally.

(F) Receipt of consideration from a party dealing with the plan

Receipt of any consideration for a fiduciary's own personal account from any party dealing with the plan in connection with a transaction involving plan income or assets. This is the kickback rule. A referral fee from the property manager, a commission on the sale, a rebate from a vendor, a finder's fee from a borrower, seller concessions paid to you personally — all prohibited.

Why the statutory exemptions do not rescue you

Section 4975(d) contains 23 exemptions. Two are commonly raised in IRA LLC discussions and both fail:

• § 4975(d)(2) exempts a reasonable arrangement with a disqualified person for office space or legal, accounting or other services “necessary for the establishment or operation of the plan” at no more than reasonable compensation.
• § 4975(d)(10) exempts receipt of reasonable compensation for services rendered “in the performance of his duties with the plan,” and reimbursement of expenses properly and actually incurred.

Neither one lets you take a salary or management fee from your IRA LLC, for two independent reasons.

 

The first is Ellis: § 4975(d)(10) covers compensation for plan duties, not for running a business. Terry Ellis was paid to be the general manager of a used car dealership, and the Eighth Circuit held that is not a plan duty.

 

The second is § 4975(f)(6), which most articles never mention. That subsection strips away every § 4975(d) exemption except (d)(9) and (d)(12) for three categories of transaction — plan loans to an owner-employee, plan payment of compensation for personal services rendered to the plan, and plan purchases from or sales to an owner-employee. And § 4975(f)(6)(B)(i)(II) expressly treats “a participant or beneficiary of an individual retirement plan” as an owner-employee. In other words, Congress specifically turned off the compensation exemption for IRA owners.

What Happens When You Break the Rules

For most disqualified persons, a prohibited transaction produces excise taxes: 15% of the amount involved for each year in the taxable period under § 4975(a), and 100% of the amount involved if the transaction is not corrected under § 4975(b), reported on Form 5330. Correction under § 4975(f)(5) means undoing the transaction and restoring the plan to no worse a position than it would have occupied under the highest fiduciary standards.

 

For the IRA owner, the law is harsher, not gentler. Section 4975(c)(3) exempts the IRA owner and his beneficiaries from the excise tax — because a different and far worse sanction applies instead.

The account is destroyed

IRC § 408(e)(2)(A) provides that if the individual for whose benefit the IRA is established engages in any § 4975 prohibited transaction with respect to the account, “such account ceases to be an individual retirement account as of the first day of such taxable year.” Subparagraph (B) then treats the entire fair market value of all assets in the account on that first day as distributed.

 

Three features of that rule cause most of the damage:

• It is retroactive to January 1. A violation in November is taxed as a January 1 distribution. In Thiessen, the IRAs were deemed to have been distributed on January 1, 2003 even though they did not exist on that date — the court held § 408(e)(2) deems them established and funded on that day for purposes of measuring the distribution.
• It is all-or-nothing. The statute disqualifies the account, not the investment. A $40,000 mistake inside an LLC held by a $900,000 IRA distributes $900,000.
• There is no cure. The DOL's Voluntary Fiduciary Correction Program and the related class exemption apply to ERISA Title I plans. They do not cover IRAs. Unwinding the transaction and putting the money back does not restore the account, and putting it back may itself be an excess contribution.

Everything that follows the deemed distribution

• Ordinary income tax on the full account value for a traditional IRA. For a Roth, the distribution rules of § 408A apply and a non-qualified distribution can produce tax on earnings.
• 10% additional tax under IRC § 72(t) if you were under 59½, as in Thiessen.
• Accuracy-related penalties of 20% under IRC § 6662. Both Peek and Ellis sustained them. In Peek the taxpayers' reliance on a CPA who was “an active promoter” of the structure was held not to be reasonable cause.
• A six-year statute of limitations instead of three, under IRC § 6501(e)(1)(A), whenever the deemed distribution exceeds 25% of the gross income you reported. That was the decisive holding in Thiessen: the three-year period had run, but a $432,076 omission against $46,962 of reported income opened the six-year window, and the return “offer[ed] not even a clue” to alert the IRS.
• Loss of bankruptcy protection. In Kellerman, because the account had ceased to be an IRA under § 408(e)(2)(A), it was no longer “retirement funds” exempt under § 408, and the debtor could not claim the bankruptcy exemption for it.
• The continuing violation problem. A guarantee or a lease is not a one-time event. In Peek, the court held the personal guarantees “remained in place and constituted a continuing prohibited transaction,” which is how transactions entered into in 2001 disqualified IRAs in tax year 2006. You cannot run out the clock on an ongoing arrangement.

Five Cases Every IRA LLC Owner Should Know

1. Peek v. Commissioner, 140 T.C. 216 (2013) — the personal guarantee

Lawrence Peek and Darrell Fleck each rolled retirement money into new self-directed IRAs. In September 2001 the two IRAs purchased all of the newly issued stock of FP Company, Inc., each paying about $309,000. FP Company then bought substantially all the assets of a fire safety business for $1.1 million, financed partly by a $200,000 promissory note to the sellers. Peek and Fleck personally guaranteed that note and secured it with deeds of trust on their homes. The guarantees stayed in place until the business was sold in 2006.

 

The Tax Court held the guarantees were indirect extensions of credit between the plan and a disqualified person under § 4975(c)(1)(B). The taxpayers argued they had extended credit to the company, not to the IRA. The court answered that § 4975 reaches indirect transactions, and that on January 1, 2006 “it remained true that Mr. Fleck and Mr. Peek guaranteed the loan to FP Company; if FP Company defaulted, they would pay.” The IRAs ceased to be IRAs, and the gain on the 2006 stock sale was taxed to the individuals, with 20% penalties.

2. Ellis v. Commissioner, T.C. Memo. 2013-245, aff'd, 787 F.3d 1213 (8th Cir. 2015) — the salary

Terry Ellis formed CST Investments, LLC to operate a used car business. His self-directed IRA, funded with about $319,500 of 401(k) rollovers, acquired 98% of CST; an unrelated person took 2%. CST named Ellis general manager and paid him wages of $9,754 in 2005 and $29,263 in 2006. He separately owned half of another LLC that leased property to CST.

 

The Tax Court found for Ellis on the initial capitalization under Swanson — and then found the wages were a prohibited transaction under § 4975(c)(1)(D) and (E). He had “engaged in the indirect transfer of the income and assets of the IRA for his own benefit” by directing a company funded almost entirely by his IRA to pay him. The Eighth Circuit affirmed, rejected the § 4975(d)(10) exemption, and rejected the plan asset regulation defense. The full $321,253 account value was deemed distributed; the deficiency was $135,936, plus a $27,187 accuracy-related penalty.

3. Thiessen v. Commissioner, 146 T.C. 100 (2016) — the guarantee, plus the six-year clock

James and Judith Thiessen rolled a total of $432,076 into self-directed IRAs, which bought all the stock of a new corporation. The corporation bought the assets of a metal fabrication shop for about $602,000, partly with a $200,000 note that both Thiessens personally guaranteed. Same holding as Peek on the guarantee. The important addition is the limitations holding: the ordinary three-year period had expired, but because the omitted deemed distribution was roughly 920% of the income they reported, § 6501(e) gave the IRS six years. The court also held it did not matter that the Thiessens did not know the guarantees were prohibited transactions.

4. In re Kellerman, 531 B.R. 219 (Bankr. E.D. Ark. 2015) — co-investing with your own company

Barry Kellerman's self-directed IRA, worth about $252,000, formed a 50/50 partnership with Panther Mountain Land Development, LLC, which he and his wife owned equally. The IRA contributed a four-acre parcel valued at $122,830 plus $40,524 in cash; Panther Mountain's contribution obligation was never paid. The court found prohibited transactions under § 4975(c)(1)(B), (D) and (E), noting the “real purpose for these transactions was to directly benefit Panther Mountain and the Kellermans.” The IRA lost its exempt status as of January 1, 2007 and, with it, its bankruptcy exemption.

 

Kellerman is the case that matters most to people who want to put a little of their own money alongside their IRA in a deal. Do not.

5. DOL Advisory Opinion 2006-01A — the pre-arranged deal

Mr. Berry proposed an LLC funded 49% by his IRA, 31% by another person's IRA and 20% by a third party, to buy a warehouse and lease it to an S corporation that Berry and his wife owned 68% of. Every ownership percentage was carefully kept below 50%. The DOL still found prohibited transactions, holding that “a prohibited transaction occurs when a plan invests in a corporation as part of an arrangement or understanding under which it is expected that the corporation will engage in a transaction with a party in interest,” and that Berry as fiduciary violated § 4975(c)(1)(D) and (E). The percentages did not save the structure because the plan did.

How to Form an Arizona IRA LLC, Step by Step

The order of operations matters. Doing these steps out of sequence is how people accidentally commit a prohibited transaction before the LLC has a bank account.

Step 1: Confirm your custodian will hold an LLC interest — before anything else

Not every self-directed custodian permits single-member IRA LLCs, and those that do have specific requirements: their own subscription documents, mandatory operating agreement language, restrictions on who may serve as manager, and in some cases a requirement that they review the LLC documents before funding. Ask for the requirements in writing first. Forming the LLC and then discovering the custodian will not fund it wastes money and creates timing problems.

Step 2: Open and fund the self-directed IRA

Establish the account and move money into it by direct trustee-to-trustee transfer or by rollover. The IRA must be funded before it subscribes for the LLC interest. If you pay any organizational cost personally — the filing fee, the attorney's fee, the publication cost — and expect the LLC to reimburse you, you have made a loan to a disqualified person under § 4975(c)(1)(B) before the company has done anything at all.

Step 3: Form the Arizona LLC with the correct member

Under A.R.S. § 29-3201, an Arizona LLC is formed by delivering articles of organization to the Arizona Corporation Commission. The articles must name the company, give a principal address, designate a statutory agent, and state whether the company is member-managed or manager-managed.

 

Two drafting points are specific to IRA LLCs:

• The member is the IRA, not you. The member should be identified in the form the custodian requires — typically “[Custodian Name], Custodian FBO [Your Name] IRA #[account number].” Naming yourself as the member, even “temporarily,” is a serious error.
• Manager-managed, with you as manager. Under A.R.S. § 29-3407, an Arizona LLC is member-managed unless the operating agreement provides otherwise. A manager-managed structure lets you sign for the company without the custodian being drawn into every signature, and it keeps the roles clear on paper.

Step 4: Designate a statutory agent and satisfy publication

A.R.S. § 29-3115 requires every Arizona LLC to designate and maintain a statutory agent in Arizona. Under § 29-3201, the company must publish notice of the filing in a newspaper of general circulation in the statutory agent's county for three consecutive publications within 60 days — unless the statutory agent's street address is in a county with a population over 800,000, in which case the Commission's database posting satisfies the requirement. Maricopa County and Pima County are over that threshold, so an LLC with a statutory agent address in either county does not have to publish.

 

When KEYTLaw forms your IRA LLC it is the LLC's statutory agent with an address in Maricopa County so the LLC does not have to publish notice of filing the Articles of Organization in a newspaper.

Step 5: Adopt an operating agreement written for an IRA-owned company

See the next section. A generic single-member operating agreement downloaded from the internet is affirmatively dangerous here, because most of them authorize exactly the things § 4975 forbids.

 

When KEYTLaw forms an IRA LLC it prepares a custom Operating Agreement that it emails to the manager and custodian for their digital signatures.

Step 6: Get the LLC its own EIN

The LLC applies for its own employer identification number. Do not use your Social Security number and do not use the IRA's or custodian's number. The responsible party question on the application should be answered consistently with the custodian's instructions — custodians differ, so ask.

 

KEYTLaw gets the EIN for all IRA LLCs it forms.

Step 7: Have the custodian subscribe for the membership interest

The IRA buys 100% of the membership interest by direction to the custodian. The custodian wires the subscription money from the IRA to the LLC's account. Keep the buy direction letter, the subscription agreement and the wire confirmation permanently. This is the transaction Swanson protects, and the paperwork proving it happened at formation, before the LLC had any other owner or any other business, is what you will want if the account is ever examined.

Step 8: Open the LLC bank account correctly

The account is opened in the LLC's name, using the LLC's EIN, with you as the authorized signer in your capacity as manager. It is never a joint account, never has your name on it as an individual owner, and never receives a personal deposit. Nothing personal ever touches it.

What the Operating Agreement Must Say

Arizona gives the operating agreement broad authority. Under A.R.S. § 29-3105, the operating agreement governs relations among the members and managers and the activities of the company, and it may contain any provision not contrary to law, subject to a list of non-waivable items in subsection (C). That flexibility is what lets a properly drafted agreement build the § 4975 rules into the company's own governing document.

 

An IRA LLC operating agreement should include, at a minimum:

• A prohibited transaction covenant. An express prohibition on the company engaging in any transaction described in § 4975(c)(1) with any disqualified person as defined in § 4975(e)(2), with the manager's authority limited accordingly. Anything the manager purports to do in violation is void.
• No compensation to the manager. A flat statement that the manager serves without compensation of any kind, direct or indirect, and receives no reimbursement other than as the custodian approves in writing.
• No personal guarantees. A prohibition on the company incurring any debt that is guaranteed by, or recourse to, the member, the manager or any disqualified person. Borrowing, if any, must be non-recourse.
• No commingling. A requirement that the company maintain its own bank accounts and books and that no company asset be commingled with the property of any disqualified person.
• Purpose limits. The purposes for which the company is organized, drafted narrowly enough that the manager cannot drift into an operating business that generates unrelated business taxable income without deliberate action.
• Distribution mechanics. Distributions go only to the member — that is, to the IRA at the custodian — and never to the manager.
• Custodian direction provisions. How the member (the custodian) gives direction, what actions require the custodian's written consent, and how the manager is removed and replaced.
• Valuation and reporting cooperation. An obligation on the manager to deliver an annual fair market value of the company to the custodian in time for Form 5498 reporting, and to deliver the information needed for any Form 990-T.
• Succession on death or disability. Who manages the company if you die or become incapacitated, and how the IRA beneficiary designation interacts with the company. This is the provision most operating agreements omit and most families eventually need.
• Dissolution and liquidation. How the company winds up and returns assets to the IRA, which matters when required minimum distributions begin or the strategy ends.

Operating Rules: Bank Account, Title, Expenses and Records

The one-account rule

Every dollar in and every dollar out moves through the LLC's own bank account. Rent goes into that account. Property taxes, insurance, repairs, HOA dues, management fees and utilities come out of it. If the LLC ever runs short, the money to cover the shortfall comes from the IRA through the custodian as an additional capital contribution — never from your pocket, never from a credit card, never from a “temporary” personal advance.

How title is held

Assets acquired by the LLC are titled in the LLC's name. A deed reads “Smith Investments LLC, an Arizona limited liability company,” not your name and not the custodian's. Notes payable to the LLC name the LLC as payee. Insurance policies name the LLC as the insured. Contracts are signed “Smith Investments LLC, by [your name], Manager.”

Records to keep permanently

• Articles of organization, operating agreement, EIN letter and all custodian direction letters.
• The subscription agreement and wire confirmation for the IRA's original purchase of the membership interest.
• A complete bank statement file, with an explanation attached to any unusual item.
• Every invoice from every vendor, showing that unrelated third parties did the work.
• Annual valuations, with the appraiser's or valuation firm's report.
• Closing statements, leases, notes, deeds of trust and any loan documents showing non-recourse terms.

If the IRS examines an IRA LLC, the examination is a documentary one. The taxpayer who can produce a clean file usually survives it; the taxpayer who reconstructs from memory usually does not.

The Do and Do-Not List

Permitted	Prohibited
Buying a rental house from an unrelated seller	Buying any property from you, your spouse, your parents or your children
Renting to an unrelated tenant at market rent	Renting to yourself, your child, your parent, or a company you half own — even at above-market rent
Hiring an unrelated property manager, contractor or bookkeeper	Doing the work yourself, paid or unpaid, or hiring your son to do it
Lending IRA money to an unrelated borrower on arm's-length terms	Lending to yourself or family, or borrowing from your IRA LLC
Borrowing on a true non-recourse basis from an unrelated lender	Signing any personal guarantee, or pledging personal assets, for LLC debt
Paying LLC bills from the LLC bank account	Paying an LLC bill personally and taking reimbursement
Investing alongside genuinely unrelated third parties	Investing alongside your own personal funds, or a company you control
Selling an LLC asset to an unrelated buyer	Selling it to yourself or family, at any price
Serving as manager without pay	Taking a salary, management fee, commission or reimbursement of your time
Distributing profits back to the IRA at the custodian	Taking money out of the LLC directly
Buying a vacation rental and renting it to strangers	Staying in it yourself for even one night
Buying raw land and holding it for appreciation	Storing your equipment, boat or RV on it

UBTI and UDFI: When Your IRA Owes Income Tax

Most people assume an IRA never pays income tax until distribution. That is wrong, and IRA LLCs are where it goes wrong most often. Section 408(e)(1) exempts an IRA from tax “notwithstanding” which it is expressly “subject to the taxes imposed by section 511” — the unrelated business income tax.

What is excluded

IRC § 512(b) excludes from unrelated business taxable income most of what a passive IRA earns: dividends, interest, royalties, rents from real property, and gains from the sale or exchange of property. That is why a self-directed IRA that buys a rental house for cash and sells it years later ordinarily owes nothing.

UBTI: when the IRA is running a business

The exclusions do not cover income from an active trade or business regularly carried on. If the IRA LLC operates a business — a car dealership, a restaurant, a landscaping company — or holds an interest in an operating partnership or LLC taxed as a partnership, the IRA's share of that business income is UBTI. Note also that § 512(b)(5) excludes gains from property sales except property held as inventory or stock in trade. An IRA LLC that buys, rehabs and flips houses in volume is a dealer, and dealer gains are fully taxable UBTI. That surprises people every year.

UDFI: when the IRA borrows

IRC § 514 pulls debt-financed income back into UBTI. If the LLC buys a $400,000 rental with $200,000 of IRA cash and a $200,000 non-recourse loan, roughly the debt-financed percentage of the rental income — average acquisition indebtedness over average adjusted basis — is taxable, and the same percentage of the gain is taxable when the property is sold. Section 514(c)(2)(A) treats property acquired subject to a mortgage as debt-financed even if the LLC never assumed the debt.

The rate is what hurts

An IRA is a trust, so § 511(b)(1) taxes its unrelated business taxable income at the trust rates of § 1(e), after a $1,000 specific deduction under § 512(b)(12). Trust brackets compress fast. Under Rev. Proc. 2025-32, the 2026 estate and trust brackets are:

2026 taxable income (estates and trusts)	Tax
Not over $3,300	10%
$3,300 to $11,700	$330 plus 24% of the excess over $3,300
$11,700 to $16,000	$2,346 plus 35% of the excess over $11,700
Over $16,000	$3,851 plus 37% of the excess over $16,000

Your IRA reaches the top 37% federal rate at $16,000 of net unrelated business taxable income. A leveraged rental portfolio can produce that in a single year.

Filing Form 990-T

If the IRA has $1,000 or more of gross unrelated business income, a Form 990-T is required. Four points people get wrong:

• The threshold is $1,000 of gross unrelated business income, not net.
• The IRA is treated as a separate trust and must have its own EIN for this purpose — which is not the LLC's EIN.
• The trustee or custodian files and signs, though in practice most self-directed custodians require the IRA owner to have the return prepared and then sign it as trustee. Ask your custodian well before the deadline.
• For a calendar-year IRA the return is due the 15th day of the fourth month after year end — April 15, not the May 15 date that applies to exempt organizations. Extensions are requested on Form 8868.

The tax is paid from the IRA, not by you. Paying your IRA's 990-T liability with personal funds is both a prohibited transaction and an unreported contribution.

Annual Valuation, Form 5498 and What the IRS Sees

Every year your custodian must report the December 31 fair market value of your account on Form 5498, box 5. When the only asset is a membership interest in your LLC, the custodian cannot look up a price. It will require you to supply a supportable value — and most custodians require third-party support, meaning an appraisal for real estate or a valuation report for an operating business, not a spreadsheet you wrote.

 

Boxes 15a and 15b of Form 5498 exist specifically to flag hard-to-value assets. Box 15b carries a code, and the code for your structure is Code C — ownership interest in a limited liability company or similar entity. Code D is real estate, Code B is a non-traded debt obligation, Code E is a partnership or trust interest, and Code H means more than two categories are held.

Form 5498 is filed with the IRS by May 31; the fair market value and RMD statement must be furnished to you by January 31. Build the valuation into your December routine so the custodian has it in time.

Required Minimum Distributions From an Illiquid IRA

Traditional IRA owners must begin required minimum distributions at the applicable age, and the RMD is computed from the December 31 account value — which, for a checkbook IRA, is the value of an LLC that may hold nothing but a rental house and $3,000 of cash. The obligation is to distribute; the asset is illiquid. That mismatch has to be planned for, not discovered.

 

The workable options are limited, and the tempting ones are prohibited:

• Keep cash in the LLC and distribute it up. The LLC distributes cash to the IRA; the IRA distributes cash to you. This is the clean answer and it requires planning cash flow years ahead.
• Keep other assets in a second IRA. Because RMDs from multiple traditional IRAs may generally be aggregated and taken from one account, many owners keep a liquid IRA alongside the checkbook IRA specifically to satisfy RMDs.
• Sell the asset to an unrelated buyer. Always available, rarely convenient.
• Distribute a percentage of the LLC interest in kind. Possible, but it requires an accurate valuation, custodian cooperation, and it starts creating a co-ownership between your IRA and you personally — which then makes every subsequent LLC transaction a transaction between the plan and a disqualified person. Approach this one with counsel.
• What you may not do: buy the property out of the LLC yourself to create liquidity. That is a § 4975(c)(1)(A) sale between the plan and a disqualified person, at any price.

Roth IRAs have no lifetime RMD for the owner, which is one reason a Roth checkbook IRA is often the better home for a truly illiquid long-hold asset.

Arizona-Specific Requirements

• No annual report. Arizona does not require LLCs to file an annual report with the Arizona Corporation Commission or pay an annual fee, which is one reason Arizona is a comfortable home state for a long-hold IRA LLC.
• Statutory agent. Required and must be maintained continuously under A.R.S. § 29-3115. Do not name yourself if you move often; a professional statutory agent avoids administrative dissolution for a missed notice.
• Publication. Required within 60 days under A.R.S. § 29-3201 unless the statutory agent's street address is in Maricopa or Pima County.
• Out-of-state property. If the IRA LLC buys real estate outside Arizona, the LLC will generally have to register as a foreign LLC in that state and comply with its filing, agent and tax requirements.
• Rental property registration. An Arizona residential rental property must be registered with the county assessor under A.R.S. § 33-1902, and an out-of-state owner must designate a statutory agent in Arizona for that purpose.
• Transaction privilege tax. Arizona's treatment of rental income varies by property type and locality; commercial rental and short-term rental activity have their own tax consequences. Confirm the LLC's obligations with your accountant before the first tenant moves in.
• Community property. Arizona is a community property state. If you are married, the interaction between community property law, your spouse's status as a disqualified person, and the LLC's operations deserves attention — particularly if your spouse also has a self-directed IRA.

Promoter Claims That Are Not True

“The IRS approved checkbook IRAs in Swanson.”

The Tax Court held that a newly organized entity with no shareholders is not a disqualified person, in an opinion awarding litigation costs after the IRS conceded. Nothing in Swanson approves how the entity is operated afterward, and both the Tax Court and the Eighth Circuit in Ellis expressly left open whether a purchase made as part of an arrangement to benefit the owner is prohibited.

“Keep your ownership under 50% and the rules do not apply.”

The 50% test in § 4975(e)(2)(G) determines when an entity is automatically a disqualified person. It is a floor, not a safe harbor. Rollins found prohibited transactions at 9% to 33% ownership, and DOL Advisory Opinion 2006-01A found them in a structure engineered entirely below 50%.

“You can pay yourself a reasonable management fee.”

No. Ellis holds § 4975(d)(10) does not cover compensation for operating a business, and § 4975(f)(6) strips the compensation exemptions for IRA participants by treating them as owner-employees.

“A guarantee is not a loan to the IRA.”

Peek and Thiessen both hold that a personal guarantee of a loan to an IRA-owned company is an indirect extension of credit between the plan and a disqualified person under § 4975(c)(1)(B), and that it continues for as long as the guarantee is outstanding.

“Put some of your own money in alongside the IRA to get the deal done.”

Kellerman. A partnership between an IRA and an entity controlled by the IRA owner produced violations of § 4975(c)(1)(B), (D) and (E), destroyed the IRA and cost the debtor his bankruptcy exemption.

“If something goes wrong, you can just undo it.”

Correction relieves the second-tier 100% excise tax for disqualified persons who owe it. It does not undo § 408(e)(2) disqualification of the account. There is no IRS or DOL self-correction program that covers IRA prohibited transactions — the DOL's Voluntary Fiduciary Correction Program and the related class exemption apply to ERISA plans only.

“Everyone does it and nobody gets caught.”

Your custodian reports your LLC to the IRS every year on Form 5498, box 15b, code C. And the six-year statute of limitations in § 6501(e) applies to exactly these facts, as Thiessen demonstrates.

“Congress is about to change these rules.”

In July 2026, Senator John Barrasso introduced the SMART Savings Act of 2026 (S. 5204), which would remove IRAs from the § 4975 prohibited transaction framework while retaining a self-dealing prohibition. As of the date of this article the bill has been introduced and referred to committee. It is not law, and the rules described here apply in full.

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Talk to an Arizona IRA LLC Attorney

Arizona LLC attorneys Richard Keyt and his son, attorney and former CPA Richard C. Keyt, have formed 10,000+ Arizona limited liability companies, including more than 350 LLCs owned by self-directed IRAs. We form Arizona IRA LLCs for a flat fee of $1,997, which includes forming the LLC with the Arizona Corporation Commission, the statutory agent designation, publication where required, obtaining the LLC's EIN, and a custom operating agreement written for an IRA-owned company — with the prohibited transaction restrictions, the no-compensation and no-guarantee covenants, the custodian direction provisions and the valuation and succession terms described in this article.

 

To discuss whether an IRA LLC fits your situation, call Richard Keyt at 480-664-7478 or email him at rk@keytlaw.com.

 

To hire us to form an IRA LLC submit our online questionnaire at keytlaw.com/llcq.