I work in the field of Self Directed IRAs & 401(k)s. Based on the phone calls and emails we receive, by far the most discussed topic is checkbook control. Some people want it; others don’t. Some service providers support it; others discourage it.
What is it?
What most people are referring to when they say checkbook control is an investment structure that is formed as follows:
- A person opens an IRA account at a self directed custodian and transfers other retirement account funds into it.
- The accountholder has a Special Purpose LLC created and names themselves as LLC manager.
- The accountholder directs their custodian to invest some or all of the IRA funds into the newly created LLC.
- The LLC further invests its funds, often into real estate, private companies, or mortgage notes. The LLC is owned by the IRA, but managed by the IRA accountholder. Because the manager is the authorized signor on all LLC accounts, this is known as checkbook control.
The legitimacy of this structure was verified in a tax court decision.
Why would somebody WANT checkbook control?
- Eliminate transaction based custodian fees
- No delay for custodian to process the transaction
- Remove custodian’s prohibition on certain legally allowable investments
- Invest in stock market with margin
- Invest in foreign assets with more ease
Why would somebody NOT want checkbook control?
Here’s where the confusion and disagreement occurs. The argument against checkbook control is based on compliance, mostly with prohibited transactions, which in a nutshell are “self dealing” transactions. Self dealing means the accountholder causing the retirement account to buy, sell, or otherwise enter into a transaction with a disqualified person. This category of people includes the accountholder, most of his relatives, and anyone who provides services to the retirement account. So the argument goes like this:
“Prohibited transactions are costly. Without a custodian overseeing your transactions, you are at higher risk of doing a prohibited transaction and paying large tax penalties as a consequence.”
I always do my best to maintain an objective, balanced viewpoint. In light of the above argument, I formed the opinion that it’s good for some people to have checkbook control and risky for others. Therefore, whether checkbook control is appropriate is dependent on the circumstances of the accountholder. I operated under this thinking for over a year…
Then I learned more about the actual matter at hand.
… and have come to a completely different conclusion. Here are the newly discovered facts:
- A custodian cannot advise you on whether a proposed transaction is compliant. It is a legal matter, and only an attorney can give you legal information that you can act and rely upon.
- A custodian will not allow you to open an account unless you hold them harmless for their guidance and actions relating to prohibited transactions and legal compliance.
- In every retirement account, the person solely responsible for prohibited transaction compliance is the decision maker (aka fiduciary – the one who has discretion over how plan assets are invested). A custodian is not a fiduciary. You make the decision, they only follow through with them.
- In the event of a prohibited transaction in a self directed account, the accountholder will suffer the consequences regardless of whether they had checkbook control.
Okay, so all in all, #4 is what’s important. The idea here is that transacting without checkbook control does not take you off the hook in terms of PTs.
It is easy to know if there is PT risk
Determining whether a proposed transaction is actually a PT is hard. But determining whether something might be a PT is easy. Here’s the 3 step process:
- Make a list of disqualified persons. This list should include your spouse, ancestors, lineal descendants (children, grandchildren, etc), and spouses of lineal descendants. Also include anyone who provides services to your retirement plan.
- If a proposed transaction involves (or is expected to involve in the future) a person on the DQP list in any way, stop. It might be a PT. Either don’t do the transaction or get help before proceeding.
- Seriously, don’t proceed without help.
It’s important to note that “involves in any way” (from #2 above) includes involvement of an LLC, trust, corporation or any other entity that has a DQP as part or whole owner, director, officer, employee, etc. PTs also include any scheme that intends to use plan assets to benefit a DQP even if indirectly.
If you can’t follow that 3 step process, you shouldn’t have a self directed account regardless of checkbook control because the risks are the same. If you are at risk of paying absolutely no attention to PT rules, then a custodian’s “we’ll keep you safe” vow doesn’t jive with their account terms and conditions, and you’ll be paying the price of your naivety if they overlook a PT.
Again, it’s easy to determine PT risk. If there’s a potential PT, only an attorney can give you definitive, binding advice. Your risk is absolutely identical with or without checkbook control: It’s your risk and your responsibility.
Are there any other reasons to want to transact at the custodial level?
The only other possible benefit of transacting at the custodial level is bookkeeping. If you can’t balance a checkbook or put bank statements, contracts, and settlements statements in a file folder… then you will have problems keeping your LLC’s books. Then again, if you don’t understand basic recordkeeping, you shouldn’t be a self directed investor yet, now should you?
What about FDIC insurace?
I’ve noticed FDIC insurance is a frequent component of this topic as well. IRAs have $250,000 of coverage while regular bank accounts have $100,000 of coverage. This should be of no consequence:
- With free checking, why not open multiple bank accounts for LLC cash reserves of over $100,000?
- When’s the last time you used your FDIC insurance coverage?
- It only kicks in during a banking disaster. If there’s a banking disaster, U.S. Dollars may become entirely worthless. Here, the FDIC might as well be giving you Monopoly money.
- The currency is already declining; you shouldn’t have more than $100,000 wasting away from currency debasement anyways.
What about extra tax returns?
Checkbook control makes use of a single member LLC which the IRS disregards for tax purposes. In other words, there is no tax return required. If your IRA or LLC were to invest into a multiple member LLC partnership, a 1065 partnership return needs to be filed, but this is the case with or without checkbook control. Checkbook control creates no unique additional filing requirements.
Back to the big picture for risk of PT noncompliance:
If you pay no attention to PT rules and you transact at the custodial level, you are at high risk.
If you pay no attention to PT rules and you transact with checkbook control, you are at high risk.
If you follow the simple 3 step PT risk determination process described above and you transact at the custodial level, you are at low risk.
If you follow the simple 3 step PT risk determination process described above with checkbook control, you are at low risk.
If you do a PT at the custodial level, you pay the consequences.
If you do a PT with checkbook control, you pay the consequences.
You see, when you really break it down, there is actually no substance to the anti-checkbook-control argument.
But I’ve heard that the government is about to prohibit checkbook control?!
I dare you to find an official written source of this claim. I’ll give you a hint, your best chance is in the magazines you look at while waiting in line at the supermarket.
If you think that government prohibition of checkbook control is actually likely, consider that 401(k) plans (in fact all qualified plans) have never had a custodian requirement in the first place. That’s 27 years of checkbook control with no sign of change. Really think about this for a second. The government allows you to prepare your own tax return. You can lie and cheat on it if you are stupid enough. Outlawing checkbook control of retirement accounts is on par with outlawing self prepared tax returns.
So, get the facts and make your own choice. If you still think it’s best to transact at the custodial level, then that’s fine. Hey, millions of people still think it’s best to invest mostly in mutual funds and the world still turns.
Don’t get too tripped up on account structuring. Get the facts, make your decision and move on to the fun part: finding and making the investments.
Hey Jeff, I want to buy an office condo to rent out. If I rollover money out of my IRA into a self-directed IRA LLC, form the LLC to own the office condo and have the LLC purchase the condo, can I then rent the condo at market rates to an S-corp that I own?
David T.,
I would not recommend personally renting a condo that your IRA LLC owns.
The government doesn’t say “it has to be a fair deal when transacting with a conflict of interest.” Instead it says “a conflict of interest is prohibited.”
If the rent were truly “market rate,” then as IRA LLC manager, why not rent the unit to someone else at the same rate?
If the rent were truly “market rate,” then as an office condo tenant, why not rent another similar office for the same rate?
I’m not suggesting that you aren’t really aiming to do the deal at the market rate, but the above questions are the way the government would probably look at it. And when it comes to answering those questions, there’s not a strong answer.
So if you are really in need of an office condo, I suggest renting one as a standalone deal. And same thing with the IRA LLCs need to find an investment. Keep them separate and sleep well at night.
This can also ensure that you find the best investment rather than let an ulterior motive steer you into a mediocre investment.
I hope this helps
Jeff
Ed,
No, that’s not okay.
Any time there is a conflict of interest, it’s a prohibited transaction. In that scenario your LLC is indirectly loaning money to you.
Think more about investing your IRA LLC into a good investment rather than steering your thoughts over to investing in yourself.
Oh, also, you may want to consider converting your IRA LLC to a Solo 401k and taking a $50,000 participant loan.
http://www.solo401k.com/2009/03/02/how-to-borrow-money-from-your-solo-401k/
– Jeff
Jeff,
Thank you, however I was speaking more to the fact that a DP is “Any business entity i.e., LLC, Corp, Trust or Partnership in which any of the disqualified persons mentioned above has a 50% or greater interest”. Thus, if the IRA loans money to an entity where I hold less than 50% ownership, and the transaction is at arms length (fair rate of interest paid to the IRA), that would be OK. Thoughts?
Hi Jeff,
This is a very helpful site. Thank you.
I am confused about this provision: IRC 4975(c)(1)(E) prohibits any direct or indirect act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account.
My questions:
1. If I’m the account holder and have a one person LLC that I manage in my IRA wouldn’t I be the fiduciary and every time I buy or sell real estate in the LLC it would be for my own interests so therefore it would be a prohibited transaction?
2. If I post ebay ads for this property and/or put a for sale sign out at the property would this be a prohibited transaction since doing these items would be providing a ‘service’ to the plan and be in my own interests?
Thank you.
I have a self directed IRA with a custodial account in Ohio. I recently created an LLC to conduct business in the state of Ohio as well, but it is not the same type of business that my 401k custodial account was created for. Currently, I would be interested in using some of the funds in the custodial account for the newly created business and wish to also have checkbook control over the transactions for both businesses. Is there anything that you would suggest me to do at this point to make this happen?
Wonderful site.
Can I set up a self-directed solo 401K or IRA LLC that invests 80% in a property, with the other 20% invested by me at time of purchase/LLC formation, with the 20% carved out to provide named dates and times during which it is available to me for personal use? The 80% would be purely for rental income.
If I set up some form of an intermediate time-share company would it help?
Thanks
Guy
@Ed – It’s a common misconception that it’s okay to loan IRA money to an entity where a DQP owns less than 50%. The Department of Labor has addressed this directly in an Advisory Opinion, and it’s a prohibited transaction if the DQP ownership is “significant,” the definition of which is not set at any specific numeric threshold. At a minimum, any entity in which a DQP owns 20% of more, in my mind, should definitely avoid doing any business with the plan. This is due to IRC 4975 (c)(1)(D) and (E). The “D and E” rules trump everything and they say that no matter the numbers, if the transaction is in the interest of the fiduciary, it’s prohibited. That casts a wide net that I think you should stay away from.
@Guy B.- See this post here —-> http://www.jeffnabers.com/2008/07/24/coinvesting-with-your-plan-partnering-with-disqualified-persons/
– Jeff
Jeff – Great, informative site.
Let me preface this by saying I have run this by a lawyer and two different CPAs and gotten three different answers. I called the IRS Taxpayer Helpline and talked to the Personal, Business and Tax Exempt centers and got absolutely NO answers.
I already have a SIDRA that owns and funded an LLC. I am the LLC Manager with “checkbook” control.
I do not want to fall afoul of any IRS rules regarding self-directed IRAs nor do I want to trigger any tax obligations other than what would normally result from withdrawing money from the IRA eventually. I am currently withdrawing money from the IRA under the 72T provision of the IRS code. I get SEP payments on a monthly basis; these continue until May 2011. After that time I can withdraw without penalty as I will be over the age of 59 1/2, with any withdrawals subject to my normal income tax.
What I want to do is have my LLC purchase houses in somewhat dilapidated condition through a realtor that is in no way related to myself or my wife. Thus we are avoiding the disqualified person problem in the actual purchase. The intent of the purchase would be for the LLC to own a rental property for a minimum of two years and to have the property produce income for the LLC. Because these properties are in a less desirable area, I would expect little to no appreciation during the time we would hold them. We may hold them quite a bit longer than two years.
Acting as Manager of the LLC, after purchase I would have any necessary repairs or improvements made to make the house a rentable property. I would contract with companies and or individuals to have this work done, keeping records of invoices, lien releases and payments made by the LLC. Again, I would avoid any involvement with a disqualified person. I would act only as Project Manager, making sure all work was done on time and up to required standards. I would take no form of remuneration for this work; there would be no personal gain or benefit.
Once the house was rehabilitated and fit for occupancy, acting as Manager of the LLC, I would advertise it, find a tenant and accomplish all necessary occupancy paperwork to complete the leasing transaction. Again, I would take no remuneration or benefit from this work.
During the lease, I would act as Manager for the property, collecting rent for the LLC, contracting out for any necessary repairs and dealing with whatever problems present themselves. There would be no personal gain, benefit or remuneration for managing the property in this fashion.
I do not want the purchase of these rental houses to generate any tax changes for the SDIRA LLC. I specifically want to avoid Unrelated Business Income Tax. If by improving these dilapidated properties to make them suitable to rent the LLC becomes subject to UBIT or might require a Form 990-T to be filed, please let me know as I do not want that to happen.
I have been told that I CANNOT do this. That I have to buy fully renovated houses through a separate, independent, non-disqualified transaction and then rent them out.
So, my question for you is, is there really a significant tax difference/problem if the LLC buys the house from an intermediary after said intermediary repairs/renovates the house versus the LLC buying the house, me as Manager contracting for repairs and passively managing it as rental for 2+ years in both cases?
In closing…I wish I had found your site before I had Guidant set up my SIDRA/LLC!
JGN,
Firstly, congrats on taking action to get your wealth under your own control
Secondly, might want to read this:
http://www.jeffnabers.com/2008/05/30/landlording-your-ira-llcs-properties-is-it-allowed/
Thirdly, I don’t think the government will claim UBIT occurred unless you either leverage the property with debt or unless you personally have so much involvement that the activity looks more like a business than an investment transaction. Absent of both of those should mean absent of UBIT.
– Jeff
(Oh yeah, don’t forget to opt in to my email list to be kept in the loop with inside information and access to special products and services) –> http://www.nabers.com/services/asset-safety/
Jeff,
Thanks for the reply.
I did read the landlording article and I have held that opinion; passive landlording is the safest route vis-a-vis IRS penalties.
In fact, given all the conflicting advice I have received from 3 different CPAs and two different lawyers, I’ve decided to just hire a Property Management firm to stay clear of the IRS.
Which brings me back to these two questions on the initial purchase and renovation of the property. As I said, I have conflicting and very scary advice from these CPAs and lawyers, so allow me to ask specifically if I can do the following with my IRA “checkbook” LLC.
As Manager of the LLC can I purchase a rental property through a realtor, paying in full with a check from the LLC?
Can I then, as Manager of the LLC, contract directly with companies to renovate/repair the property to make it suitable for use as a rental/occupancy and pay these contractors in full with a check from the LLC?
I have been advised that my personal involvement as Manager in these two tasks would put me at risk of IRS penalties.
Can you address that aspect?
Thanks,
JGN
Jeff,
In the article that starts this comment session you say about disqualified persons:
” Also include anyone who provides services to your retirement plan.”
Do you mean anyone dealing with the actual IRA management aspect, for example the custodian?
Or would it include a company or person working on one of the LLC’s rental properties as in a plumber installing a water heater? Is he providing a service to the IRA?
Thanks,
JGN
JGN,
Yes, the custodian is a DQP as well. It includes those providing ongoing services to the plan. A plumber providing a one time service to the plan’s property isn’t considered a DQP according to a DOL advisory opinion.
As far as what you can do as LLC manager, it’s “ministerial” duties.
There’s no hard and fast guide. If it seems like you are running a business, you may have problems. If it seems like you are administering an investment, you should be fine.
Jeff,
Like others I have been looking into SDIRA’s for two years now and have been afraid to do it, however your site has got me going, it’s just great.
? 1. I have Roth, my Husband has Roth. We want to buy land, hold on to it until we retire. ? Do we need two LLc’s or will one work.
? 1. Can other family with IRA LLC’s buy with us.
Thanks Wee
Wee,
I’m actually wrapping up a new post on this topic right now. Make sure you are subscribed to RSS, and you’ll see the post early next week
Jeff
Very informative site!
I’m considering setting up a checkbook IRA to make a real estate loan at an IRS-approved market rate secured by a standard deed of trust. The loan would allow a 501(c)(3) nonprofit corporation to purchase a building from a 3rd party. So far so good.
The twist is that I am a director of the 501(c)(3) that would be the borrower. I get some personal satisfaction from the good that is done by the nonprofit, but I receive no monetary benefit–no salary, fees, expenses, or anything else of tangible value. Does my role as director of the nonprofit make the nonprofit itself a DQP?
Thank you, David.
And bravo for your honesty.
Now, looking at your situation, that personal satisfaction actually does create a prohibited transaction per IRC 4975(c)(1)(D) and/or (E). That personal satisfaction makes the transaction partly in your personal interest, and the rules say your transactions must be in the sole interest of the retirement plan.
It’s not that the nonprofit corporation is necessarily a disqualified person. The problem is that at the point at which you would make the decision, you would understand and expect that side benefit, even though it isn’t monetary.
Now that you poked your head into the Self-Directed IRA/401k word, keep going and pursue control of your wealth, but look for transactions that don’t have this type of possible conflict of interest you described.
Good luck!
Jeff
Thanks for your quick and thoughtful answer.
However, it seems to me that your logic would seem to apply equally to the CHIRA which has been specifically allowed in an IRS private letter. The CHIRA clearly and by design serves the IRA owner’s general, intangible benefit in terms of personal satisfaction, etc. The personal satisfaction and the desire to help a charity were apparently not of major concern to the IRS in that case.
David K,
I understand that the CHIRA seems incongruent, and there’s more behind that…
I don’t pay much attention to the IRS’s interpretation of this area of law. Not only do they not make the law, but they also haven’t had the authority to interpret it (at least not the section that relates to retirement accounts) ever since the Presidential Reorganization Act of 1978. In that Act, the authority to interpret the retirement account laws (IRC 4975) was taken from the IRS and given to the DOL. The Department of Labor.
So, certain DOL Opinion Letters set a precedent that exclude the CHIRA concept. So, basically the DOL’s opinion clashes with the IRS, and in a legal authority sense, the DOL’s opinion matters and the IRS’s opinion doesn’t matter.
The twist is that the IRS does most of the enforcement for retirement account laws.
Now zoom out all the way and take a look at this picture.
The IRS (or the whole government for that matter) does not have a history of acting logically or compassionately.
The literal and technical application of the laws and regulation here are very clear. The IRS enforces all that, and they think the CHIRA is fine today. And a reasonable and compassionate organization would never give people one signal and then enforce a real law to the contrary.
But again, most government agencies aren’t always reasonable or compassionate. Even when they have good people working there with good intentions, the fact that government activity is a non-competing/monopolistic one tends to allow any kinds of mundane or extreme actions.
In other words, stranger things have happened than the IRS changing its mind on something. And changing its mind to agree with the actual law isn’t far fetched at all.
I’m not saying the IRS is going to seek and destroy CHIRA accountholders. They could, but they probably won’t. I am saying that an IRS letter that makes some attorneys comfortable to do the CHIRA doesn’t mean the real, actual, clear law won’t be applied in most or all other circumstances.
I hope this helps
Jeff
I just paid $1,299 for a firm to set up a self directed Roth Solo 401k for me, complete with EIN. Basically, they sent me the completed plan documents and had me sign them. They are attorneys and siad they will provide ongoing legal advice as needed. I am attempting to set up a trust a/c, and neither Bank of America or Wells Fargo seem to know what I am talking about and trying to do, even though I provideded them a copy of EIN paperwork from the IRS in the name of John Doe 401k Plan Trust and the Adoption Agreement. They seem to be confused that I am the trustee and will be making the investment decisions. They seem to think that because I am opening a trust a/c at their bank, they must put me into an IRA a/c which is limited to their investment choices. Am I being charged too much and why am I having so much trouble with the banks in getting an a/c opened?
Hi
My understanding is that the IRA is protected from outside fources.
But since my SDIRA LLC will be buying rentals, and they come with a lot of liabilites, I would like to separate the rentals into different “baskets” or LLC’s so that if someone slips and falls at one property, it will not risk my entire IRA if everything is owned by one single entity.
Is it ok to set up several LLC’s that you then direct the custodian to invest in? (capitalize)
Ideally there would be a “master-LLC” that would be the sole member of several subsidiary LLC’s and thus one could avoid moving the money back to custodian every time I would want to move money from one subsidiary LLC to another.
Thoughts?
And thanks so much for your time
@Jim H,
Your experience is pretty typical of our competitors. We/Nabers Group (www.nabers.com) have the most experience with self-trustee 401k plans and IRA LLCs.
Even though you aren’t our client (tsk tsk) head over to our community where you can probably find a little bit of info on explaining things to your banker >>> http://community.nabers.com.
– Jeff
P.S. If you want to see what the process could have been like with us, check out http://www.unlimited401k.com/tutorials to see how the bank account is automatically setup with our system
S,
What you described is do-able. I wrote about it here:
http://iraaa.org/learnmore/viewarticle.aspx?aid=17
– Jeff
I am considering setting up a checkbook IRA to buy tax liens in Florida. Based on my age, I receive minmum disrtibutions based on the value of the IRA as of 12/31 the previous year. Would I determine the value based on amount paid for the certificates plus the accurred interest as of 12/31? Who would issue the check for the distribution? Would I report to the IRS the total value of the IRA each year?
If it were property, how do you determine the market value of the property each Dec? Property values are rather subjective. The IRS could challenge the value I assume saying you are trying reduce your min distribution by too low a valuation of the property.
Thanks.
HI Jeff,
Would you be interested in being a guest on one of our weekly educational real estate webinars discussing the use of a self directed IRA to buy real estate? As you know this is a hot topic and looking for experts to discuss with us and our clients.
Thanks,
Steve Saunders
Silver Stream Advisors
http://www.slvrstream.com
801-352-4052