When it comes to making investments with a self-directed IRA LLC, the IRS doesn't tell you what you can invest in. What's funny is they only what you can't invest in. They made a few rules about the subject. These include prohibited transactions, and a series of other regulations.
Besides the Prohibited Transaction rules, the IRS imposes a levy or tax on certain transactions involving IRA funds.
Let's say you use IRA funds to invest in an active business. Active businesses include restaurants, stores, and factories operated through a pass through entity such as an LLC.
They could also be operating through nonrecourse financing, such as a nonrecourse loan or margin in a stock or trading account. In any case, a percentage of net profits or income generated by that activity could be subject to a tax.
The tax imposed is often referred to as Unrelated Business Taxable Income or UBIT/UBTI. The UBTI rules are outlined in Internal Revenue Code Sections 512-514. For your convenience, we've broken down what self-directed investors should know about UBTI/UBIT in a separate article.
The reason the UBTI tax rules do not impact most retirement investors, is that Internal Revenue Code Section 512(b) provides a general exemption for the following categories of income generated by a retirement account:
Since the majority of retirement investors purchase publicly traded company stock, which is exempted from the UBTI tax, the UBTI tax rules are not widely known.
When it comes to investing in options with a self-directed IRA LLC, the question then becomes whether the investment would trigger the UBTI rules. This brings us to a fan-favorite UBTI exempt investment: stock options.
An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date.
An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties.
According to the IRS, any gain from the lapse or termination of options to buy or sell securities is excluded from unrelated business taxable income.
Note: The exclusion is not available if the organization is engaged in the trade or business of writing options or if the options are held by the organization as inventory or for sale to customers in the ordinary course of a trade or business.
If option trading is not being done as an active trade or business, then using a self-directed IRA LLC to invest in options would not trigger the UBTI tax rules.
Congratulations, you're on your way to a happier and more comfortable retirement.
If you have any more questions, fire them away in the comments below, or check out our other free resources about self-directed IRAs. You can also contact Royal Legal Solutions directly or explore our Self-Directed IRA LLC service. We'd love to help you!
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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