A recent phenomenon has been the advent of the IRA/LLC as a way for real estate investors and other investors who regularly invest in alternative assets with their retirement account.

An IRA/LLC is an investment structure whereby an IRA invests capital into a newly created limited liability company (“LLC”). The IRA owns the LLC units just like an IRA can own mutual funds or stock. Commonly an IRA/LLC is structured so that the IRA invests a designated amount of cash into the LLC in exchange for 100% of the membership units of the LLC. The LLC then, in turn, acquires the intended investment asset. For example, rental property. An IRA/LLC can also be formed with multiple IRAs owning the LLC with the ownership allocated between the different IRAs based on the amount each invested.

Self-directed IRA investors may prefer the IRA/LLC structure as it allows them to have signing control for the LLC to enter into contracts as well as access and signing authority on an LLC business checking account to more easily fund transactions and asset expenses.

When an IRA owns real estate the income and payments, as well as contracts and documents, flow through the IRA custodian. This requires interaction for instructions and authorizations for expenses or contracts with the custodian on the property. To avoid these interactions real estate investors may choose to use the IRA/LLC structure. The IRA owns the LLC, and the LLC, in turn, owns the real estate and operates the investments. The IRA owner can serve as manager of the LLC and, as manager of the LLC, the IRA owner has signing authority for the LLC for contracts and can use an LLC business checking account.

To establish an IRA/LLC, an investor must have a self-directed IRA account and a properly structured and restricted LLC. To ensure compliance, the IRA owner needs to operate the LLC in accordance with the laws affecting IRAs.

The first step is to create a self-directed IRA. A self-directed IRA is an IRA that can invest in any asset allowed by law. Common investments owned by self-directed IRAs are real estate, LLC, and LP interests, notes, private company stock, and VC/PE funds. Approximately 30 banks or trust companies, according to the Partnerships and Limited Liability Committee of the California Lawyers Association, offer self-directed IRAs. A self-directed IRA can be a traditional IRA, Roth IRA, or SEP IRA. The “self-directed” label means it can invest in assets off the public markets at the direction of the account owner. Most self-directed IRA accounts are funded by a transfer from an existing IRA at a brokerage to the new self-directed IRA account. Once the self-directed IRA account is established and funded with a transfer of cash from another retirement account, it is ready to invest into an alternative asset.

Once a self-directed IRA is established, then, the IRA must create a properly structured and drafted LLC. An IRA/LLC must be established as a manager-managed LLC and the manager may be the IRA owner so long as the operating agreement restricts certain actions that would violate the rules applicable to IRAs.

The federal tax code has significant restrictions on IRAs that limit with whom an IRA may transact business. These rules are known as the prohibited transaction rule. The rules will restrict the IRA owner from receiving compensation from the LLC and will restrict the LLC from transacting business with the IRA owner or persons disqualified associated with the IRA owner.

There are many ways the IRA/LLC structure if used incorrectly will be invalidated for tax purposes. In one case the IRA/LLC acquired precious metals which the IRA owner stored at his home. Precious metals can be owned by an IRA, however, the federal tax code requires that the metals be stored with a bank. The Tax Court ruled that the IRA owner violated the rules by storing the precious metals at his home and deemed the precious metals distributed.

In another tax court case the IRA owner was the manager of the IRA/LLC and took a salary for his services as manager. The Tax Court ruled that the salary to the IRA owner was a prohibited transaction and distributed the IRA.

IRA/LLCs are a popular and advantageous tool for self-directed IRA investors who need greater control in their investments. Real estate investors can benefit from an IRA/LLC by having easier transaction processes with the LLC and by having signing authority on an LLC business checking account.

If you have any questions about IRA/LLCs be sure to discuss them with a qualified business attorney.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.