An individual retirement account, or IRA, is a vital way to save for your future, golden years. An IRA allows account owners to invest in stocks, bonds, and mutual funds. While those avenues can create a large nest egg, a self-directed IRA, also known as a SDIRA, has options that go beyond those choices.
Investment Opportunities with a SDIRA
A SDIRA has many benefits, including investment opportunities in real estate, foreign currency, precious metals and more. For many, however, the opportunity to invest in real estate is one of the biggest draws. When the decision is made to invest in real estate, you can choose between two options:
- Holding the title in your SDIRA account, or
- Creating a business entity into which your SDIRA funds will be invested.
While it is ultimately your choice, most experts agree that establishing an entity is the best way to protect your finances and identity from potential issues and lawsuits.
Entities and SDIRAs
As the owner of a SDIRA, there are several type of entities you can create. A business trust is one such entity you could choose to create. With a business trust, when you invest in a property’s title, you are considered to be investing in the “beneficial interest” of the entity. Often, a SDIRA owner acquires 100% of the beneficial interests of a business trust. When this occurs, the SDIRA becomes both the “trustor” and “beneficiary” of the business trust. (It is important to remember that the Internal Revenue Services (IRS) has many complex regulations that govern a SDIRA account. While you, as the owner, are the account manager. Hiring a professional firm, like Royal Legal Solutions can ensure you do not violate any regulations.)
How to Use Your Business Trust
Establishing your business trust is not as hard as you may believe. In fact, while state laws and banking institutions may have their own rules, the process can be typically broken down into four steps.
Step 1: Establish the “Declaration of Trust”
Unlike many other entity options, you do not have to publicly file when you form a business trust. This helps to protect the confidentiality and identity of the owner. Therefore, the first step of forming a business trust is to prepare a document known as the “Declaration of Trust”. Often referred to as a trust agreement, this document’s establishes the purposes and objectives of the trust itself. Making appropriate investments that are for the exclusive benefit of the SDIRA is, of course, the purpose of the business trust. The trust agreement will also establish the rights and duties of the beneficiary and trustee. Typically, both the beneficiary and trustee will be given broad powers. Because the SDIRA itself is the beneficiary, the trustee will be granted independent authority to make investment and management decisions. Doing so means that, if you want to make an investment, you do not need the approval of your custodian to do so. (This is particularly important because your custodian is prohibited by the IRS from making financial decisions regarding your SDIRA.)
Step 2: Obtain an EIN
Once you have create the trust agreement, you will want to file for a tax identification number, also known as an EIN. This number, provided by the IRS, is required. In today’s world, you can easily file the required SS-4 Form online to request your EIN.
Step 3: Open a Bank Account
After you obtain an EIN, your business trust should establish a bank account. This bank account, opened in the name of the business trust itself, will authorize the trustee to be the signor. As you are filing for an account on behalf of a business trust, the bank will require that you fill out a “Certification of Trust.” This form establishes several things: you are the trustee, there is a Declaration of Trust, and you have the authority to open the account. In providing a Certification of Trust, you do not have to provide the actual trust agreement. In the end, opening a bank account in the name of your business trust will give you complete checkbook control over investment decisions.
Step 4: Transfer the SDIRA Funds
Finally, you would provide your custodian with the directions necessary to transfer the funds from your SDIRA account to the business trust’s bank account. For most account owners, a wire transfer of the funds is the preferred method and can be quite easily accomplished.
Business Trust Taxation Classifications
Tax regulations can be quite complicated and hard to understand, which is why hiring a custodian, like RLS, is highly recommended. When it comes to filing tax returns, a business trust is classified as a partnership, which is subject to both federal and state income taxes. However, if you are the sole owner and investor of the beneficial interests, the business trust becomes a “disregarded entity.” As such, the business trust becomes exempt from filing federal or state income tax returns. Additionally, there are no franchise taxes for a business trust. Avoiding a franchise tax, which is typically charged by a state in order to gain approval to do business within its borders, means you keep more money in your account for investment purposes.
Your SDIRA, Your Business Trust, Your Future
Establishing a SDIRA is a great financial decision for those who want to invest in more than just stocks, bonds, and mutual funds. With the increases potential for diversity and higher returns, SDIRAs are becoming increasingly popular. However, as with most things in life, higher rewards often come with bigger risks. When investing in real estate, establishing an entity will help protect your confidentiality, finances, and investment potential.
Royal Legal Solutions is here to help. Tax regulations, amongst other things, can be convoluted. Hiring a firm that specializes in SDIRAs, as well as business trusts, can help ensure you stay within the boundaries established by the IRS. If you would like to learn more about retirement accounts, business trusts, or other related topics, contact us today.