Fun Facts About Self-Directed IRA LLCs & Prohibited Transactions
As you may already know, Individual Retirement Accounts (IRAs) exist in many forms. If you have income from working for yourself or someone else, you may set up and contribute to an IRA.
What you may not know is that there is a type of IRA that real estate investors especially have grown fond of, known as a Self-Directed IRA LLC.
The major advantages of using a Self-Directed IRA LLC are tax deductible contributions and the ability to invest in real estate, tax liens, stock and anything else you can think of. (Except collectibles, such as art.)
Fun Facts About Self-Directed IRA LLCs
- There are over 3 million Self-Directed IRAaccounts in the United States. They’re not just some “fad”.
- The Self-Directed IRA LLC structure was first approved in the case of Swanson v. Commissioner in 1996.
- Alternative investments such as real estate have always been permitted in IRAs, but the general public is just now becoming aware of this fact.
Financial institutions have no reason to recommend that you get a Self-Directed IRA LLC. They don’t want you to invest your money in something other than stocks, bonds or mutual funds. Why you ask?
As a thought experiment, think about that question from the perspective of bank executive.
Investors with Self-Directed IRA LLCs would not generate any profit for these financial institutions. These investors aren’t bound to the products offered by the financial institution alone. It’s no wonder they don’t tell you about alternative investments!
You Can Invest In Virtually Anything With A Self-Directed IRA LLC.
A Self-Directed IRA LLC offers you the ability to make any type of investment with your retirement dollars. Even better, you can do it all on your own without having to pay a custodian or ask for permission.
You truly can invest in anything, aside from life insurance, collectibles and certain “prohibited transaction” investments outlined in Internal Revenue Code Section 4975.
Popular Self-Directed IRA investments include real estate, private businesses, public and private stocks, cryptocurrencies, and tax liens.
Beware of Prohibited Transactions.
The one thing you have to watch out for with Self-Directed IRAs are “prohibited transactions.” Prohibited transactions occur when you invest in a business owned by your parents, family members, or certain business partners. These individuals are called disqualified persons.
In general, the easiest way to avoid engaging in a prohibited transaction is to avoid investing in a business you may have a “conflicting interest” in. Such as your own business, etc.
That doesn’t mean you can’t invest in a business you personally favor, it just means you can’t invest in a business you, your parents or your children, have a stake in.
An Example of a Major Prohibited Transaction Case
The Cherwenka case involved a Georgia statutory bankruptcy estate exemption for IRAs. The case involved a Self-Directed IRA held by Michael Cherwenka, who was in the house flipping business.
Michael Cherwenka used a Self-Directed IRA to buy real estate.
In this case, Cherwekna was not compensated for any property research he performed. He also wasn’t compensated for any recommendations, management or consulting services he provided relating to how the IRA properties were improved before resale.
Cherwekna explained his role in buying and selling of these properties as being limited to identifying the asset for purchase and later selling the asset.
Cherwenka engaged contractors to decide or oversee the scope of work which improved properties. Cherwenka testified that he “read and approved” the expense forms prior to the IRA custodian paying funds to reimburse the submitted expenses.
Contractors were paid by the job, which accounted for labor costs, but no management fee or additional cost was included in the expenses submitted to the IRA custodian.
Cherwenka stated he would inspect or confirm that work was completed through site visits or communication with his “team” before he would approve expenses to be paid by his IRA custodian.
Most Self-Directed IRA real estate investors tend to perform the same sort of tasks that Cherwenka performed. Such as:
- Locating the property.
- Reviewing transaction documents.
- Engaging contractors to perform property improvements.
- Inspection of improvements.
- Approval of expenses.
- Communicating with the IRA custodian regarding the real estate.
This case provides a clear legal foundation for the type of activities a Self-Directed IRA LLC investor can and cannot engage in without triggering a prohibited transaction.
You can learn more about Self-Directed IRA LLCs from many of our previous articles, which cover everything from how these entities work to how to fund businesses with them. Check out our piece on how to invest in real estate with your Self-Directed IRA LLC to learn more. If you’re ready to take control of your retirement dollars, schedule your consultation with Royal Legal Solutions today.