In Part I, we talked about prohibited transaction rules in general; in Part II, we talked about prohibited parties specifically; and in Part III, we talked about prohibited entities. Now that we’ve covered some ground, let’s put it all together and look at some examples of how this would play out in real life, specifically with an IRA LLC. Reading through the tax code can, and generally does give one a headache, so let’s go through how this might actually work.
In one of my favorite movies The Philadelphia Story, Cary Grant remarks to Katherine Hepburn’s character “…you’re far and away your favorite person.” It’s safe to say that we relate well to ourselves, and if we use you and your CheckBook IRA LLC in these examples instead of some fictional character, you’ll probably come away with a better understanding of the rules.
Example 1:
Your father calls one day and remarks in passing that he has invented a pair of shoes to the bottom of which are attached a set of spikes, allowing the user to arriate his lawn while taking a stroll. He plans to begin production right away, but he needs some start-up capital and would like you to provide it by loaning some of your self directed IRA LLC money to his newly formed Corporation, of which he is the sole shareholder.
Question:
Can your CheckBook IRA LLC provide the necessary startup capital to your father’s Corporation? Or to your father individually?
Answer:
No, and no. The first question to ask is whether or not the parties involved in this transaction are disqualified or prohibited parties. According to IRC 26 § 4975 (e)(6), your father is a prohibited party or disqualified person, because he is your lineal descendant, so you couldn’t loan the money directly to him. What about a loan from the your Check Book IRA LLC to his company? If we refer to 26 § 4975 (e)(2)(G) we’re reminded that any entity owned 50% or more by a disqualified person is a prohibited or disqualified entity. Since your father, a prohibited party, is the sole or 100% owner of the Corporation, that company is a prohibited entity and is therefore off-limits as well.
It’s important to note here that any transaction of any form with your father or his Corporation would be a prohibited transaction. Even if the proposed deal was not a loan but something else. For example if the IRA LLC bought some equipment to build the shoes and then rented or leased that equipment to your father’s Corporation, or if you were to actually buy shares in the Corporation with the IRA LLC. You can see that it doesn’t matter what form the transaction takes, it’s still a transaction. So, with a prohibited party, the form of the transaction is not important. The point is that a transaction will take place, whatever form it may take.
Example 2:
You’ve purchased a lovely little house in the downtown area with your CheckBook IRA LLC. You bought the house from the bank in a short sale, and given the purchase price, you’re confident the rental income will pencil out to a profit. A week later you find that your son has been accepted to a University which sits not three block from the house. After having recovered from heart palpitations induced by the fact that the tuition fees amount to a small fortune, you come up with the idea that you could rent the lovely little house to your son; partly out of parental affection, but also so that you can recover some of those blasted tuition fees.
Question:
Could the CheckBook IRA LLC rent or lease the lovely little house to your son? Or could your son stay there for free?
Answer:
No, and again, no. Your son is a lineal descendant, and is therefore a prohibited party. So, if the IRA LLC rents or leases the house to him it would be a prohibited transaction. What about if he stayed there for free? There wouldn’t be any “deal or transaction” would there? Actually the code covers that as well. In IRC 26 § 4975 (c)(D) it states any use by or for the benefit of a disqualified person by the assets of the plan is a prohibited transaction. So, even though your son wouldn’t be paying any rent, he would be using an asset of the CheckBook IRA LLC. Result? Prohibited transaction.
Example 3
While reclining in your favorite lawn chair at the annual family picnic, your brother-in-law mentions he’s thinking of getting a home improvement loan. You know that his house is debt-free because he inherited it from his parents. When he tells you the amount he intends to borrow, you quickly do the math in your head and conclude that, assuming you could get a first mortgage position or trust deed, the loan amount compared to the value of the property is very low and would therefore be a low-risk investment.
Question:
Could the CheckBook IRA LLC loan the money to your brother-in-law with the property as collateral?
Answer:
Yes. If we look at the disqualified or prohibited parties list, we find that your brother-in-law does not fit within that category. He is not a lineal descendant, nor is he the spouse of a lineal descendant; neither is he a “fiduciary” to the IRA LLC. He is therefore not a prohibited party. As a result, any deal or transaction between him and the CheckBook IRA LLC would be allowed. Note that the transaction must be at fair market value; you couldn’t offer an unsecured loan with 0% interest.
Example 4
A friend of yours named Bob has invented and is close to securing a patent on a medical device that regrows skin by extracting a burn victim’s stem cells and spraying them back onto the burned area. Your friend needs an infusion of funds to complete the last leg of the patent process and would like you to provide it by holding an equity position in his company Skin ReGen, Corp. He is offering a 20% share for let’s say $100,000. There are several owners of Skin Regen, Corp. and a couple of them are members of your family. The ownership breakdown of Skin ReGen, Corp. is:
- Bob – 80%
- Your son – 8%
- Your mother – 12%
Neither your son, nor your mother have any management control of Skin Regen, Corp.
Question:
Could the CheckBook IRA LLC purchase a 20% equity position in Skin ReGen, Corp.?
Answer:
Yes…but. Let’s deal with the yes first. Since this transaction would be between the CheckBook IRA LLC and Skin ReGen, Corp., we must first see if Skin ReGen is a prohibited entity. Here’s the sequence: 1. Your son and mother are both prohibited parties to the IRA LLC. 2. Your son’s and mother’s combined ownership in Skin ReGen is 20%. 3. Any entity owned 50% or more by any one or more prohibited parties is a prohibited entity. Your son’s and mother’s combined interest is less than 50%… 4. Therefore, Skin ReGen (at least in terms of ownership) is not a prohibited entity.
But we have more to consider before you go ahead with this investment (this is the “but” part :))
We have to look at two more things: control and indirect benefit. In this example we know that neither your son nor your mother have any control over Skin ReGen. They aren’t Officers of the Corp., they’re not on the Board. They hold no fiduciary position whatsoever with the company; they’re just shareholders. That solves the control issue. Neither of them has sufficient control of the company to taint a possible transaction between Skin ReGen and the CheckBook IRA LLC.
Remember back in Part I, we pointed out language in the code that said a prohibited party could not benefit directly or indirectly from an investment of the IRA LLC. So, will your son or mother benefit directly or indirectly from this transaction? Using the information given in the example, they would not benefit directly or indirectly. But, here is an example of what could constitue a benefit thereby triggering a prohibited transaction:
- What if your son had been wanting to sell his shares in the company, but Skin ReGen had placed a restriction on his ability to sell the shares until more capital was brought into the company? There’s a good chance that by purchasing 20% of Skin ReGen, the CheckBook IRA LLC would be guilty of a prohibited transaction because it would enable your son to then sell his shares back to Skin ReGen. This is commonly referred to as an “enabling investment.” Look at it this way: if the IRA LLC had not bought shares in Skin ReGen, your son would not have been able to sell his shares. The investment by the IRA LLC makes possible something that was not (your son’s ability to sell his shares), and it makes it possible for a prohibited party (your son). Result? Prohibited transaction.
There are endless examples one could go through, and we’ll be posting more in the future. For now, try to focus on the underlying concept and principles. Understanding the prohibited transaction rules is of paramount importance because there are consequences for failing to abide by them. If you don’t understand these rules yet, you’re not ready for a CheckBook IRA LLC. Don’t hesitate to call us if you have questions about the rules, or a particular deal you’re thinking of doing. In the meantime…
Invest intelligently. Enjoy the rewards.
Prohibited Transaction Rules, Part I: An IRA LLC Primer
Prohibited Transaction Rules, Part II: Who is a Prohibited Person?
Prohibited Transaction Rules, Part III: Disqualified Entities
I have a situation where I want to loan money to my sister’s company. It would be a good normal deal, so nobody would be playing favorites. Could I do something like that? I know you talk about loaning money to your brother-in-law, but would my sister be ok?
Steve,
Your sister is not a prohibited party, so loaning money to her would be fine. If you want to loan money to her company, you’ll need to make sure that her company is a non-prohibited entity. If your sister owns the company outright, then a loan from your IRA LLC to her company is perfectly fine. On the other hand, if her company has multiple owners, you’ll need to make sure the other owners are not prohibited parties. If they are, you’ll need to look at the amount of ownership those prohibited parties have to ensure they total less than 50%. If there are multiple owners, and if they are prohibited parties, you are looking at a tricky transaction. I’ll be more than happy to review the transaction with you to ensure you aren’t running afoul of the rules.
Feel free to contact me directly at jordan@checkbookira.com or call us at 1-800-482-2760.
I have 2 questions.
1: I purchased a vacation rental with my checkbook Ira LLC. I hired a management company to find renters in the summer time for revenue. If I wanted to let a friend or non-disqualified person use it, do I have to charge them for staying there?
2: if I purchased new furniture for the place using Ira funds can I actually be inside the unit when it gets delivered and help to stage it or would this be considered a prohibited contribution?
Thank you
Hi Dan,
Thanks for the questions; they’re good ones.
1. Its probably not a good idea to let your friends stay at the house for free. The purpose of the IRA is to make money for your retirement, and as the Manager of the LLC, you have a fiduciary responsibility to act in the best interest of the company. Someone walking in off the street who wanted to stay in the house would be required to pay the normal rent, and to give it to anyone for free would run against normal business practices; the fact that they are personal friends of yours would muddy the waters even more.
2. You could certainly be present in the unit when the furniture is delivered, and stage the furniture if need be. As Manager of the LLC, you have certain responsibilities and powers to direct the investments of the company. Being present to stage furniture is certainly within those powers. To provide a counter example: if the property needed to be painted, re-roofed, and re-carpeted, it would be inappropriate for you as the Manager to go do those things, because those repairs require an involvement beyond your role as Manager. In that case, you would need to hire a third-party contractor to do that work.
Let us know if you have any other questions.
I am the new owner of my checkbook IRA.
1. So far I’ve been using it to pay mortgage payments on an investment lot in a country in Central America. I have another lot there that I am making mortgage payments on with my own money. Can I sell my investment lot, recoup the money and put it on the lot I am planning on keeping for myself? Or am I able to sell the investment lot and change my checkbook IRA back into a standard IRA so that I can buy and live with the money I want to spend. Is this a complex thing to do?
2. I’ve found another lot in a close by country that I would like to own and live on. I am guessing that I cannot use my checkbook IRA to put a down payment on it, correct or not?
3. I will have to pay taxes for the first time this year because I didn’t withhold enough $ from my salary. I suspect I can’t use my checkbook IRA to pay that, correct or not?
Thank you for your help.
Hi Kathy,
You would not be able to use the funds within the iRA or the LLC to pay for anything you own personally. There can be no crossover between your personal finances and investments, and what the LLC is doing; you have to keep that separate. To use those retirement account funds for personal use, you’d first have to take a distribution and pay taxes on the amount coming out of the IRA.
I’m a little unclear on your question about the lots. Are you a client of ours? If not, you should contact the company that set you up, as they can probably answer your question about the lots more fully that I can.
Thank you for your prompt answer.
I’m looking to purchase a home in the near future could I open a bitcoin IRA then invest it to my down payment and as my home goes up in value it increases the value of my new home? Causing a increase in my bitcoin??
Hi Sherry,
You couldn’t do that unfortunately. In order to use the funds to make a downpayment on the house, you’d have to make a taxable distribution from the IRA. Maybe I’m misunderstanding what you’re asking – I’m assuming the home you’re wanting to buy is a home you would live in. If that’s the case, then you’d have to distribute funds from the IRA in order to make the downpayment.
I’m self employed with employees that contribute to a simple IRA. Can I transfer my simple ira into a checkbook ira? Do all of my employees have to follow suit and are they required to get a checkbook ira like I do as employer?
Hi Geof,
It is generally best to avoid setting up a Check Book IRA with a SIMPLE IRA. SIMPLE IRAs are subject to ERISA, and some subtle differences result in regards to what rules apply to the account.
The best option is to transfer funds from your SIMPLE to a Traditional IRA, but you should be aware that in order to be able to do that, the SIMPLE has to have been open for 5 years or more.
You’d need to have a CPA look at the plan document for the SIMPLE IRA to find out how any changes would affect your employees. I’d be happy to go over your situation to see what your options are. You can call our office at 1-800-482-2760.
I am a licensed real estate agent (not the Broker). Can my broker or another agent in my office list a property owned in my IRA LLC? I “assume” I cannot represent myself, which is why I would use another agent in my office.
Thank you for sharing all your knowledge through this site!
Kathy
Hi Kathy,
That’s a good question. On first glance, it doesn’t appear that it would be a problem for a broker or another agent in your office to list a property owned by the IRA LLC.
You’d have to make sure that the broker or agent are not partners with you in any other ventures, as that would most likely make them a prohibited party. The other argument against it, is that you might get undue benefit by having someone in the office list the property, as opposed to going outside the firm. That’s a bit of a weak argument in my opinion, but its just that – my opinion.
I am 66 years old. I have a self directed IRA that I opened on Jan 2010 so my 5 years is on Jan 1st 2015. I think I have created myself a prohibited transaction by working for a company my IRA LLC loaned money to. If so will I have to start a new IRA and start my 5 year waiting period all over again.
Thanks
Kent
Hi Kent,
Its possible that the transaction you describe was prohibited, but its possible it was not prohibited. Merely working for a company your IRA LLC has loaned money to, does not in and of itself create a prohibited transaction. There are a number of things that would need to be taken into consideration before it could be said the IRA LLC did something impermissible.
Feel free to call our office at 1-800-482-2760, and we’ll be happy to at least give you some guidance on the subject.
I am considering a checkbook ira to invest in houses to flip. I will not have any other involvement other than investing and paying the bills for renovation, etc. My wife will be arranging for contractors, workers, buying materials, etc., but for no compensation.
Your web stated that the founder flipped 50+ homes inside his checkbook ira. Is my plan within the IRS guidelines? If not, what changes would I have to make.
Thanks,
Hi Bill,
Your wife can be a co-Manager of the LLC if you’d like, and I would suggest it, if she is going to be involved in managing the affairs of the LLC.
Certainly flipping houses is fine within an IRA structure. There is some question as to how many per year you can flip before the IRS would consider your activity a “business activity”, which would make the profits of the flips taxable under the UBIT section of the code. From everything I’ve seen, you would need to be flipping a large number of houses per year to trigger that tax, but its a good idea to talk with someone about it, to get an idea of how many you plan to do.
Give us a call if you’d like, and I’ll be happy to look at your situation.
My wife and I both have self directed Roth IRA’s. We are now over the income limit to contribute to them so we started traditional IRAs. We also own a C-Corp that leases equipment (forklifts, etc.) all over the country for purposes of conducting business within our C-Corp. Can we use a checkbook IRA LLC to purchase the needed equipment and lease them to our C-Corp as a passive investment? We do understand our C-Corp is a disqualified entity but, does the rule still apply? Additionaly, can the purchased equipment be leased to any non-disqualified entities at a profit and not trigger UBIT.
Hi Matt,
Do you and your wife have any outside, full-time W2 employees in the C-Corp? If not, then I’d seriously consider setting up a self-sponsored 401(k) for the C-Corp. Your contribution limits to the plan, between you and your wife, would be between $106,000 and $118,000 per year, and you’d have more flexibility in your ability to possibly deal with the C-Corp. There are some cool things you could do possibly factoring the C-Corps accounts receivable through the 401(k) as well, due to a DOL class exemption.
I am considering a check book IRA. My situation is as follows: I have 50,000 shares of a current 2,000,000 in a company primarily owned by a non-prohibited person (old colleague). I plan to purchase an additional 220,000 shares for $110,000 in a friends and family round. I currently am the Chief Medical Officer of the company. I plan to take a more active role in the company once revenue increases to support my involvement. If I continues at the Chief Medical Officer and was an employee with ownership is that restricted? If I left the CMO position and became a board member would that be restricted?
Hi Doug,
This is a hard question to answer through a comment, because given the situation, we’d need to talk through all the factors to see if the transaction would be allowed. Given what you’ve represented, there doesn’t seem to be an issue, but the rules on this sort of thing are a bit tricky.
I’d suggest you call our office, so we can review.
I would like to invest in property and equity in a foreign country with money in my Roth Ira. However, there is no US domiciled bank in that country which can serve as a Custodian for the Roth. So I would be forced to redeem money from the Roth which I am loath to do for obvious reasons. Can I setup a company which raises capital from the Roth and then use the money for the foreign investments ? The idea is that since the company is owned by the Roth, the invested capital is not a redemption but an investment. The proceeds, upon liquidation or otherwise disposal of this company’s investments would naturally flow back tax-free into the
Roth just as any other stock or debt sale in the markets. Please tell me whether this idea fits into the alt-ira framework and if so what are the constraints that will feature in the design of the structure.
Shankar,
You’ve hit the nail on the head. If you set up an LLC owned by the Roth IRA, that LLC can invest in the country you’re talking about, and it is not a redemption or distribution, but simply an asset owned by the LLC, that is owned by the IRA. All roads lead back to the Roth IRA, so to speak.
One thing to keep in mind when investing offshore – every country will be different in regards to their requirements when it comes to investments. Some countries will allow an entity from another jurisdiction to directly own the property in their country, and others require that you set up a domestic entity. Always make sure you’re dealing with knowledgable professionals, who understand the specific rules of that country.
I’ve a checkbook IRA LLC (with Check Book IRA) and my funds is currently in a TDAmeritrade, the custodian of IRA LLC is IRA Services. I have been wanting to invest in property, but was short of funds.
I am going to start a new solo 401K account, I am self-employed. I am wondering if I can pool solo-K and Trad IRA funds together.
Question: Can I combine IRA LLC funds with solo 401K money to invest in a property? Should I set up solo 401K with IRA Services in order to self-direct investment in properties? (vs. solo-K account at TDAmeritrade). Thank you.
Lieng,
Yes, you can certainly roll your Traditional IRA funds into the new Solo 401(k). The only account that cannot be rolled into a 401(k) is a Roth IRA.
If you’re wanting to set up a Solo 401(k), there are a number of options. It really comes down to what you want to do with the account. If you go with a TD Ameritrade, they construct the plan so that you can’t do anything but invest in the stock market. If you go with an IRA Services, you will have a third-party administrator involved in your transactions that will charge transaction and yearly fees.
If you’re looking for total control, with no third-party in the mix so to speak, you would typically go with a company like ours, who sets up the plan, but has no involvement other than to maintain the plan documents. The plans we set up are entirely controlled by the client, with no transaction fees or assets fees, etc. So, depending on what you’re looking to do, you can choose the appropriate plan structure.
We’re always happy to walk you through your options, so feel free to contact us, if you’d like to do that.
Hi, I’m exploring using a self-directed 401k to invest in an LLC that is unafilliated to my business.Any thoughts on whether this transaction would be prohibited?
Scenario: I am 50% owner in a partnership and am opening a self-directed 401k that will be funded by rolling over a traditional IRA from a prior job.
Investment: Use the funds from the self-directed 401k to purchase a 10% interest in a new LLC that sells produce and is completely unrelated to my existing business which I am a 50% owner. The new LLC will have seven members, including the 401K, that are all unrelated (not family). Additionally, anyone member will not own more than 33% of the LLC. Additionally, the 401K LLC will not be a managing member – I (the 401K) will not be on the board nor have authority over any operational decisions.
Question: Is this a prohibited transaction? After reading this article my gut tells me no…..
Thanks so much for your advice and help!
Hey John,
Based on what you’ve represented here, I don’t see a problem with the transaction. Are any of the other members of the LLC retirement accounts? If not, less than 25% of the ownership of the LLC would be comprised of retirement funds, which triggers the “plan asset rule”. Generally speaking, if less than 25% of a company’s assets are made up of retirement funds, again generally speaking, the self-dealing provisions of 4975 will not apply to that entity.
One thing to keep in mind though – if the new LLC is going to be in the business of selling produce, the profits that flow back to the 401(k) will be subject to UBIT, and at the trust tax rate, no less. The only time this wouldn’t be the case is if the LLC has chosen to be treated as a C-Corp for tax purposes, in which case the company would pay it’s own tax, and pass the dividends back to the 401(k) tax-deferred. The LLC would not be able to have S-Corp status, because a retirement account is not a person, and cannot hold S-Corp stock.
There are ways to structure this deal to avoid incurring the UBIT income. If you’d like to go through those options, feel free to contact us.
thanks,
Jordan
Hi,
My father-in-law has a significant amount in his IRA but has no interest in doing the legwork required for creating a SDIRA and finding investments for it.
I have multiple investor friends that would pay well for loans from that money.
would it be possible for my father-in-law to create a SDIRA with an LLC (checkbook) in which I was the managing partner and not him? and then I could arrange the loans?
I would have no benefit from doing this as all the principal and interest payments would go back to his IRA. But is my involvement in this way a prohibited transaction?
Thanks,
Pedro
Hi Pedro,
Its possible for you to be the Manager of his IRA LLC, so long as everything is done correctly from the start. Does your father-in-law have any self-employment income? If so, it would be better to do what you’re talking about through a Solo 401(k) instead of an IRA LLC. You can be a co-Trustee of the plan, or even the sole Trustee. The 401(k) is a different animal, and will let you do things you can’t do in an IRA.
Give us a call, and we’ll discuss your situation.
I am considering opening a check book IRA to invest in foreclosure homes for resale understanding that there is a limit as to how many homes I can purchase in one year.
I have a friend that is very experienced in flipping homes and does this as his primary source of income. My plan is to invest with him as a 50% owner of the property or be a 50% beneficiary on the property. Can I hire subs to do repairs and upgrades, ie, drywall, carpet and paint? Can I also be involved in doing the actual repairs myself?
Hi William,
There are a number of ways you can do what you’re wanting to. So long as your friend is not a disqualified person, you could certainly loan funds to him and have the IRA LLC hold a mortgage or trust deed on the property for protection. Certainly subs can be hired to handle any repairs. As the IRA owner and disqualified person, you wouldn’t be able to do any of the repairs yourself, because you’re not allowed to deal with the IRA. Hope that helps.
Your answers have been very helpful.
Then could I form an IRA LLC to invest in a RE development corporation in which I have 45% interest (other two unrelated partners own 45% and 10%). Or does it have to be structured in a different way to comply with the rules?
Jay,
Looking at the figures you quoted, I’d stay away from investing in that RE development corporation. Even though you own 45% of the company, which is under the 50% that the IRS considers a majority interest, you’re still pretty close to 50%. Not that it can’t be done, but investing in a closely held business with retirement funds is a really complex thing. If its something you’re wanting to pursue, I’ll put you in touch with an attorney who specializes in that sort of thing.
Hello, if I have a checkbook Ira that owns rental property can I use a LLC management company owned 60 percent by the IRA LLC and 40 percent by my son? My son would be a member of a manager managed LLC of which the IRA LLC is the manager.
Because your son is a disqualified person to your IRA and IRA LLC, he wouldn’t be able to provide any services to the IRA LLC or deal with any of the assets of the LLC. If you are going to have the property managed, it should be done by a non-disqualified person, not your son.
Can I use a Checkbook controlled IRA to partner up on a JV deal with a non-disqualified person. Lets say We each put in 50K and bought a property worth 100K and held it in a land trust and used it for rentals (but had it managed by a 3rd party). Would that be OK? My check book controlled IRA would be 50% owner of the land trust and his LLC would own 50%.
Hi Michael,
Thanks for the question. Sure it is fine for an IRA LLC to joint venture with a non-disqualifed person. Your example of the property would be fine, and its smart to have a third party manage the property, so they can split expenses and profits between the owners.
I know you plan on holding the property in a land trust, but just so you know, and for others reading this comment, its also fine to hold joint title as tenants-in-common, though you should not generally hold title to IRA owned property as joint-tenants-in-common, as that way of titling has survivorship issues that can be problematic to retirement accounts.
Hope that helps.
Hello Jordan,
I am considering a Check Book IRA with your company. I am looking at property that offers owner financing. Can I make payments under a Private Contract with funds from my Check Book IRA? The only collateral would be the land, thus I think it would be considered a non-recourse loan.
Thank you!
Ketch
Hey Ketch, yes you certainly can. As you mentioned, you’d need to make sure the carry-back on the property by the owner does not include anything resembling a personal guarantee, and you might also check for any “bad boy carve-outs”, which are clauses that would trigger personal liability in the event of certain bad boy behaviors, as they’re called. Sounds weird I know, but its something that some lenders have begun putting in their non-recourse loan documents. I doubt it would be an issue on an owner-finance like this, but just something to watch for.