Don’t Put Your Self-Directed IRA LLC at Risk for Prohibited Transactions!
Published on December 16, 2021
An IRA LLC (or “checkbook IRA”) is when the account holder of a self-directed IRA gains direct control over the IRA funds. This is achieved when the individual sets up and manages a self-directed IRA LLC, which in turn, as a business entity, establishes a checking account (for purposes of making/managing investments). The LLC is funded with cash from the IRA, which can then be deployed from the LLC’s checking account.
This approach allows self-directed IRA holders to manage their cash and account assets directly as the LLC manager, with total signing authority over an account with access to the retirement funds.
There are certain investments that may require an IRA LLC, such as cryptocurrency or foreign real estate investments, or an investor may choose to use one as a matter of preference. While a self-directed IRA LLC offers enhanced freedom, there are important rules to follow to maintain the account’s tax-advantaged status.
What NOT to do with your IRA LLC
As detailed in a recent article, the U.S. Tax Court in McNulty v. Commissioner, 157 T.C. No. 10 (Nov. 18, 2021) concluded that an individual who purchased gold coins using her IRA received a de facto distribution of those coins when she took physical possession and stored them at home (rather than a precious metals depository as outlined in this blog article). The individual did not buy the coins directly through her IRA, but used a separate bank account in the name of an “IRA LLC” created and held by her IRA.
While the court found that she had “unfettered command” over her IRA assets, it also found there was no “independent oversight” by the custodian, resulting in a deemed distribution of those assets.
The entire transaction was conducted via the IRA using cash from the retirement plan to a bank account in the name of the LLC, so the court found that the IRA custodian “did not have any role in the management of [the LLC], the purchase of the (American Eagle) coins.” The custodian filed annual Forms 5498 reporting the value of the IRA assets, but relied solely on the owner’s reported valuation for the LLC.
What this ruling means
Even with “checkbook control” (another term for this type of investment strategy) over the funds in a self-directed IRA and an account owner’s right to fully direct the investments, according to the court in McNulty v. Commissioner, an IRA trustee must be a bank or IRS-approved non-bank custodian that will “administer” the trust in accordance with the requirements of Internal Revenue Code section 408.
The court’s ruling stipulates that a self-directed IRA custodian (like Next Generation Trust Company) is responsible for the management and disposition of the property held within a self-directed IRA. However, using an IRA LLC places more responsibility on the account holder to ensure that they NEVER take personal possession of ANY assets (whether precious metals or not) directly from their IRA LLC. If they wish to take a distribution, they must work with the custodian to deploy funds from the LLC back to the IRA itself, and then request a distribution directly from their custodian.
Mitigating risk for IRA LLCs
As you can see, checkbook control over IRA assets offers investing freedom but carries with it an element of risk regarding compliance and prohibited transactions.
It is the responsibility of self-directed investors to conduct full due diligence on their investments and their retirement plans. However, as custodians for our clients’ self-directed IRAs, we provide guidance with respect to prohibited transactions associated with use of funds through an IRA LLC—transactions over which we do not have the same level of oversight as compared to those that are held directly in the name of the IRA.
When it comes to IRA LLCs, prohibited transactions and potentially improper use of IRA funds are often not discovered until account owners are required to provide fair market values and statements from the LLC itself.
At Next Generation, we want to make sure our clients with IRA LLCs protect their retirement plan’s tax-advantaged status by avoiding prohibited transactions. That’s why we require them to:
1 – Establish and maintain the IRA LLC with an ERISA attorney (ERISA stands for Employment Retirement Income Security Act of 1974, a federal law that sets minimum standards for most voluntarily established retirement and health plans), and
2 – Sign a disclosure acknowledging what they cannot do with the LLC, per IRS guidelines regarding prohibited transactions.
If you have questions about how IRA LLCs work, what it means to have checkbook control, best practices when using an IRA LLC, or any other questions about self-direction as a retirement wealth-building strategy, Next Generation is here to help. You may schedule a complimentary educational session, or contact our team at NewAcounts@NextGenerationTrust.com or call 888-857-8058.