The most exciting aspect for owners of a Self-Directed IRA with checkbook control is to have more direct authority and oversight over the investment and management decisions regarding the funds and investments held in the retirement account. The driving factor is to avoid having to submit documentation for each investment transaction or transfer of funds to the IRA custodian for their review and approval. This review process can take up to 2-3 days and moreover, the custodian usually charges a fee for (1) this review and approval process and (2) the transfer of funds to the investment. Ouch! Why waste your retirement funds on such administrative overheads?
One way to achieve greater discretionary and more immediate control over the funds in your self-directed IRA is to form an IRS-approved legal entity into which the funds of the IRA are invested and you as the IRA owner and the manager/trustee of that legal entity, can assume direct control over those funds by your management role with that entity. Business trusts and limited liability companies (“LLCs”) are the two types of entities typically selected for this purpose for which the self-directed IRA would transfer the funds for investment. With a Business Trust the IRA owner will serve as the Trustee. With a LLC, the IRA owner will serve as the Manager.
With a Business Trust the Checkbook IRA account makes an investment in the trust by acquiring 100% of the “beneficial interests” of the business trust. Acquiring the beneficial interests of the business trust is similar to an IRA account acquiring the “membership interests” of a limited liability company or shares of a corporation. Essentially, the term “beneficial interests” is the title for the “equity interests” in the business trust that are acquired when the investment is made in a business trust.
By acquiring 100% of the “beneficial interests” of the business Trust, the IRA account has now become both (i) the “trustor,” or “settlor,” of the business trust (i.e. the party that has transferred assets into the business trust) and (ii) the “beneficiary” (i.e. the party that holds the “beneficial interests” of the business trust).
We believe that the Business Trust is a better type of entity to choose for your self directed IRA with checkbook control for the following reasons and as illustrated here.
When an LLC is formed, it must (1) Name and Agent for Service Of Process in the Articles Of Organization and (2) File the Articles Of Organization with the Secretary of State in the state of organization. The IRA owner is typically going to list himself or herself as the Agent. Once the filing is complete, the LLC and all details of the owner become public record and there goes the confidentiality of the owner. If there are substantial funds in the LLC transferred from the self-directed IRA, this transparency could compromise the privacy for the owner.
In contrast, there is no public filing requirement when forming a business trust. The Declaration of Trust, or Trust Agreement, remains a private and confidential document. Moreover, while the IRA owner will typically serve as the trustee of the business trust, there is no automatic publication of the name of trustee. Thus there is a higher level of privacy and confidentiality available with a business trust.
Both a business trust and an LLC will be classified for tax purposes as a partnership under federal and state income tax regulations. If classified as a partnership, then the business trust and LLC must file income tax returns with the IRS and the respective state agency. However, an entity classified as a partnership that has only one owner will be “disregarded as an entity separate from its owner.” Once classified as a “disregarded entity” then that entity will not have to file federal income tax returns.
A limited liability company with just one member will be classified for federal and state income tax purposes as a “disregarded entity.” With this classification, the LLC will avoid having to prepare and file a federal income tax return. But not so at the state level, at least not in California. Despite being a “disregarded entity” for California state income tax purposes, the LLC must still comply with California return filing requirements because this is method for the LLC to pay the California minimum franchise tax imposed on LLCs.
In contrast, if a business trust has only a single holder of its “beneficial interests,” it will then be classified as a “disregarded entity” and, as a result, not have to file either a federal or state income tax return. Thus the fees and costs of preparing a state income tax return, as well as a federal income tax return, are avoided.
Making investments in commercial and residential real estate is quite common by owners of a Self-directed IRA with checkbook control. If that real estate investment is in a property in a state that is different than the state where the LLC is formed, then the LLC would have to file appropriate documents in that foreign state in order to "qualify to do business" in that state. For this purpose, unless the IRA owner/LLC manager has someone they know in that state, who is willing to serve as the registered agent for the LLC in that state, the LLC owner would need to hire an independent registered agent in that state just to remain compliant. Although the fees for such registered agents are in the low $100s, it is an annual expense nonetheless from your retirement funds - unnecessary overhead which can legally be avoided.
But if a Business Trust as the holding entity for the Checkbook IRA is used to make these real estate investments in states other than the IRA owner’s state of residence, there is no requirement or need to hire an agent in that “foreign” state. This is because the business trust does not have to file any documentation to “qualify to do business” in that state in order to purchase real estate for investment purposes. Thus you as the IRA owner can avoid having to pay the fees typically required with such filing as well as avoiding having to pay any annual fees to an agent in that state. These all add up in the long run as hard money that go directly to increase your account balance.
As Wikipedia states so correctly, "Franchise tax is a tax charged by some U.S. states to corporations with a nexus (aka a filing obligation) with those states. The common feature of a state's franchise tax is that it is not based on income. "This is a mandatory requirement for any LLC that wants to be "qualified to do business" in that state. Depending on the state, these fees can be quite high, which erodes the funds in your Checkbook IRA account year after year or as long as your LLC wants to remain “qualified to do business” in that other state.
There is no such franchise tax requirement for Business Trusts.
As you can understand when a Business Trust is used as the holding entity for a self directed IRA with checkbook control, you as the Trustee and Owner can enjoy the best of both worlds - freedom to invest, divest, manage any qualified investments at any time from your retirement funds and also be able to prevent unnecessary overheads from fees, taxes and expenses with full confidentiality.
My specialty is in structuring companies to protect and hide assets in anticipation of litigation. 100% of my clients are real estate investors, and I am an investor myself. Whether you are looking to protect your personal assets, set up a self-directed IRA, or need estate planning, I can help.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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