IRA LLC & Rental Property: A Common Mistake
By Jordan Sheppherd
I received a call from a woman in North Carolina who was interested in using the CheckBook IRA LLC structure to buy rental property. I had explained the process and how it works for about fifteen minutes or so, when we started talking about investments. She mentioned she was planning on buying some rentals near the coast to rent out to vacationers, and so I went through how that would work and what would be involved.
She asked me if it was ok to furnish the houses, and I replied that it was. She then told me that she would just buy some furniture and kitchen things with her own money because she didn’t want to deplete the funds in the IRA LLC. She said it in such an flippant way that I almost didn’t catch it. She started in on the next question, but I cut her off and asked if I had heard her correctly: did she really intend to buy the furnishings with her own funds instead of the IRA LLC? She did.
I spent some time going through the prohibited transactions with her again and calling her attention to the fact that she could not use personal funds to pay for anything to do with the CheckBook IRA LLC. She understood, and thanked me for spending the time to go through it all. Our conversation closed with me recommending that she bookmark the series of articles I wrote on the Prohibited Transaction Rules.
The lesson to be learned here is that, it can be easy to misstep with this kind of a structure if you don’t know the rules. It’s important to spend the time necessary so that you have a good understanding of where the limitations are when investing with a CheckBook IRA LLC. These rules can be confusing sometimes, but that’s why we’re here.
We’ve been doing this for a long time, and there’s not too much we haven’t run into. Our job is to make things easier and give you the peace of mind that things are done properly and according to law. After all, it’s always nice to have access to someone who really knows what they’re talking about. If you ever have any questions about the rules in general or how they would apply to a certain deal you have in mind, we’ll be more than happy to clear things up for you.
Invest intelligently. Enjoy the rewards.
If she bought the furniture and then reimbursed herself, would that have been ok? I get what you’re saying, but it doesn’t make sense that she can’t pay for the furniture. I’m new to the IRA LLC subject, but after all – it’s her IRA.
Hi TrustDeed Guy,
I understand what you’re saying about how it might not make sense that she can’t use her own money to buy the furniture considering the fact that it’s her IRA. The thing to remember is that even though it is her IRA, there are rules that govern her IRA’s ability to invest. Among those rules is a small list of people that can’t have any dealings with the IRA or it’s money; she is on that list as a prohibited party. So even though it may seem counterintuitive that she can’t use her own funds, doing that is specifically prohibited according to IRA rules.
In this case, the LLC owns the property, so any expenses relating to that property would need to be paid from the LLC, and could not come from her personally. Feel free to contact us if you have other questions at 1-800-482-2760. I would suggest you browse some of our posts on prohibited transactions to get a better feel for what can and can’t be done with the CheckBook IRA LLC.
Hey, I just wanted to stop by and say i love reading your blog! You guys talk about stuff I can’t find anywhere else. Your videos are good too. Will you be doing more?
Hi LandTrust Dude,
Thanks for the compliment 🙂 We’ll be doing more videos in the future explaining the process, and also a number of videos describing different investment ideas for IRA LLCs.
May I fund a business for my brother-in-law? He wants to open a hot dog store. I would like to own 100% of the company, fund it with my CheckBook IRA and have him run it. My thoughts would be to put $50k or so into a checking account using a ficticious name with my CheckBook IRA as the owner. He would run the business putting any deposits and writing any checks in the fictitious name checking account.
John,
Thanks for the question. Since your brother-in-law is not a prohibited party, your IRA LLC could fund his hot dog store. There are a number of ways to do it, but be aware that if the IRA LLC owned the business and he ran it, the income produced would almost certainly be taxed as business income under UBIT (Unrelated Business Income Tax).
There are generally ways to structure the deal so that the IRA LLC is not taxed, but it depends on what you have to work with. The CheckBook IRA could loan the funds to him, and he could pay a reasonable interest return. The IRA LLC could also own the stand or property the hot dog store is one and rent/lease it to him. To put it succinctly, you don’t want the IRA LLC to own the business outright because it will garner business income which is taxable. It is best to figure out some other way the IRA LLC can provide funding without direct ownership.
I’ll be to discuss the possibilities with you. You can contact me directly at jordan@checkbookira.com, or call us at 1-800-482-2760.
Can I buy rental property using IRA funds for the downpayment the balance being mortgaged, then have the IRA collect the rent and pay the mortgage? If the lender requires my personal guarantee, would that be allowed?
If so, how do I start?
Eric
PS. I’m very new to this but am already delighted to hav such a wonderful resource.
Hi Eric,
Yes, we are still in business, and we post articles and blogs on a regular basis. The article you commented on is one I wrote quite a while ago, and it may have been four years or so since someone commented on it.
To answer your question, yes the IRA can put a downpayment on a place, and finance the rest. There are a few things to keep in mind though:
1. The loan must be a non-recourse loan, so you can’t personally guarantee it. Because you’re the iRA owner, and a disqualified person, the code won’t let you extend your personal credit to the IRA, which is a trust, and an entity separate from you.
2. Financing property will trigger some taxes in an IRA. A portion of the rents or profits from the sale of the property would be subject to UDFI (Unrelated Debt-Finance Tax), which is a subset of UBIT (Unrelated Business Income Tax).
3. They figure the tax based on the net profits of the property, and tax only the portion of the income that was made with the financed money.
4. Ex: If a $100,000 house were to be bought, and your iRA put down $40,000 and financed the remaining $60,000 then at the end of the year when the house has thrown off however much rental income, you get a few deductions and exemptions, but once you figure the net profits, 40% of those profits slide off the table and aren’t taxed, because that was made with the IRA’s money. The remaining 60% of the profits was made with the bank’s money, and is subject to UDFI tax.
So, you certainly can finance property through an IRA, but those two main points above need to be kept in mind.
One thing you might consider over a IRA LLC is a Solo 401(k). If you qualify, I would recommend that structure, because the Solo 401(k) is exempt from the UDFI tax, when buying and financing real estate. There are a number of other things that recommend the Solo 401(k) over a IRA LLC, such as higher contribution limits, more flexibility, and most importantly that you get to be your own trustee, so you don’t need a custodian.
The 401(k) might be a good fit for you, or it may not be. Either way, I’m happy to answer any other questions you may have.
Thanks for the question.
I want to do short term rental (Airbnb) with a home I just purchased within the IRA. My city has a rule that to get a STR license, the property must be your principal residence. I am planning to travel for a year while a friend of mine lives on one level of the house and rents the rest on a short term basis. Is there a way to structure this so my friend has a free place to live and the short term rent will go to my IRA, not to him?
Hi Jan,
I can recommend a good attorney you can work with to structure the deal, but the only thing I can think of is to have some sort of arrangement with your friend, so that she rents the house out on Airbnb, treating the house as her primary residence, and then she and your IRA split the rental income. I have no idea what your local requirements are, so thats just a blue-sky idea. I’d recommend you work with an attorney who is familiar with both IRA rules, and local law.