We have seen some unbelievable things over the past few years… especially the past few months. The only thing certain is that there is a lot of uncertainty ahead. If you haven’t already done so, right now I strongly suggest you watch the 30 minute condensed version of the film I.O.U.S.A. This film features David Walker, the former U.S. Comptroller General… aka the chief accountant of the government. He tried to fix the government’s financial problems, but Dick Cheney and others told him he needed to stop because they didn’t need solving. So he stepped down from his position and decided to prove to the world just how bad of shape our government really is in.

Today some people, including congressmen, are promoting some very extreme ideas. Some of these ideas involve the government “nationalizing” (or “confiscating” for those of us who speak directly) the assets of the people. Some plans even call for confiscation of retirement account assets specifically. In one scheme called the “Guaranteed Retirement Account” all retirement assets would be liquidated and handed over the Social Security Administration for investment management in a program that would provide a guaranteed return of 3% per year. This kind of silliness doesn’t need to be gratified by anything more than a brief response:

1. We’ve already seen how well the Social Security Administration manages money. It simply doesn’t. There is no money. There is no account. It just hands its income straight over to the general spending account of the government, and (not surprisingly) it gets spent!
2. Liquidating $16 trillion is impossible. It would crash the securities market entirely, and $16 trillion would not be withdrawn. If you started liquidating people’s retirement accounts alphabetically by name, those with names that start with letters n through z would receive little to nothing because of the price free fall created by the first half of the mass sell off.
3. The real world cost of living increases do not jive with published CPI figures, and there is often a discrepancy of much more than a few percent. A 3% return on investment would likely be a steady loss of principal when accurately indexing for inflation.

While we may not see that particular scheme enacted into law, it can’t be ignored that this type of solution is being considered. This government theft approach isn’t unheard of. In fact, Argentina just did it! Don’t forget that our government “confiscated” personal gold holdings in 1933… at least sort of. It was really more of a “government request” than a confiscation. An executive order was announced that requested that citizens show up to a Federal Reserve Branch within a month to sell their gold for $20 per ounce. The notable fact here is that not all the gold was turned in. According to author John Rubino, only 22% of the gold in circulation was actually turned in. Shortly thereafter, the gold price was set to $35 per ounce, thus devaluing the dollar by 41%.

It is not beyond possibility for our government to aim to take our wealth to pay for its financial problems. The difference between the gold confiscation of the 1930s and the threat of retirement account confiscation today is this: In the 1930s it was effectively voluntary to surrender your gold, while today over 99.9% of retirement assets are in the hands of custodians who are regulated by the federal government. While the 1933 confiscation was only 22% effective, a confiscation today would be 99.9% effective because of our unfounded trust in the financial services industry.

If a wealth “nationalization” plan were pursued, the outlook is grim for the overall population, but you can protect your wealth by simply taking direct possession of it. With an IRA LLC or a self-directed, self-trustee Solo 401k plan, you can legally hold your retirement account assets yourself directly. If an order were placed for you to surrender your retirement account assets, you could simply distribute them to yourself before the order deadline. In such a case you might have to give up around 40% of your assets to taxation, but that is much better than losing 100%.

Again, I don’t like to come off as spreading “doom and gloom”, but unbelievable economic events are occurring left and right. The acts of the Fed (in concert with Fannie Mae and Freddie Mac) may have already devastated your first pillar of wealth – home equity. Don’t let further acts of foolishness destroy your retirement account.

Spend your time looking at the lighter side of things – investments that perform well; investments that you can understand and have predictable results. Just make sure that you are protected from losing your assets due to lack of optimal structuring. Whether you use a Self Directed IRA or Solo 401k to invest in a variety of alternative assets, make sure you set yourself up for direct possession of your assets.

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First, let’s summarize that the accountholder/participant of a retirement plan generally can’t have a transaction between themselves and their retirement plan. This includes the furnishing of services, sale of property, lending of money, and extension of credit between a plan and disqualified person (such as the accountholder). Next, let’s establish that active landlording means mowing the lawn, repairing, and fixing up properties, while passive landlording means collecting rent, paying mortgages/taxes/insurance, and contracting out the more active tasks to non-disqualified-persons. So is active landlording allowed? No, and I’ll provide two answers – the technical and the layman’s.

The Technical Answer

The argument for why active landlording for your IRA LLC’s property is not a prohibited transaction goes something like this…

As a general rule, the Internal Revenue Code provides that a fiduciary is prohibited from furnishing services to the plan or its assets. IRC § 4975(c)(1)(C). However, there is a statutory exemption for services necessary for the . . . operation of the plan if no more than reasonable compensation is paid. IRC § 4975(d)(2). The regulations provide additional “gloss” to this statutory exemption:

If a fiduciary provides services to a plan without the receipt of compensation or other consideration . . . , the provision of such services does not, in and of itself constitute an act described in section 4975(c)(1)(E) or (F). The allowance of a deduction to an employer under section 162 or 212 for the expense incurred in furnishing office space or services to a plan established or maintained by such employer does not constitute compensation or other consideration.

Treas. Reg. § 54.4975-6(a)(5)(iii)(“Services without compensation”). This is the authority upon which we based the position we took in the article. It is not 100% on point but nevertheless gives a strong indication that services provided to IRA-owned property by the taxpayer without compensation are not likely to trigger a prohibited transaction. If the taxpayer further refrains from making any improvement that requires capitalization of the improved asset under the IRC, then the already low risk of a problem is reduced even further.

I think this argument is flawed. To make it easier to follow the logic, first understand that there are 6 general prohibited transaction rules (A, B, C, D, E, & F) and 16 prohibited transactions exemptions (1-16). For further clarification it is sometimes appropriate to cross-reference DOL Advisory Opinions, IRS Treasury Regulations, and court cases.

In the above argument, there are two possible loopholes for why active landlording might not be a prohibited transaction. Loophole #1 contends that exemption 2 applies to mowing the lawn and repairs. Exemption 2 applies to services that are necessary for plan operation such as furnishing of office space, or legal, accounting, or other services. Yes, active landlording is “other services”, but I don’t think it’s necessary for the operation of a plan. If tax returns need to be filed for the plan, or amendments or restatements of plan documents are required for the plan to maintain its qualified status, then those services are necessary for the operation of the plan. On the other hand, if the plan owns a house with tall grass and a leaky roof, the plan is still in operation. One of its assets (the property) has some problems that could be solved, but those problems are not detrimental to the operation of the plan. Therefore, I think Loophole #1 is not legitimate, and to my knowledge there is no other official interpretation or guidance to suggest otherwise.

Loophole #2 contends that a treasury regulation says a disqualified person can provide services to their plan if they receive no compensation. This reg specifically says that such services do not violate Prohibited Transaction rules E or F. Unfortunately, the general rule prohibiting such services is PT rule C, which is not addressed by this reg.

So, all in all, there is a general rule that says you can’t provide services to your retirement plan. There is an exemption for other rules (but not the “services” general rule) and there is an exemption for “necessary services” which probably don’t encompass lawn mowing or roof repair. It is entirely possible that a new interpretation of this specific idea (whether active landlording is okay for an IRA LLC) could come out in a DOL Advisory Opinion, Treasury Regulation, or tax court case that would provide an exemption that would apply. Until then, the general rule applies.

The Layman’s Answer

No. Seriously, man, don’t do it or you could have to pay a lot of taxes, penalties, and interest.

The Bigger Picture

Why would you want to provide labor for your investment? If a property’s income, net of contract labor fees, does not provide a desirable return on investment… then the solution isn’t to do the labor yourself; the solution is to find a better investment.

Owning an asset and making decisions relating to that asset is part of investing. Fixing a toilet is labor and/or a job. If you want or need a job, you can always find somebody else’s toilet to fix. Mixing a job and an investment makes the waters of investment planning and performance assessment pretty murky. Being unable to tell that a bad investment is a bad investment because of this sleight of labor may make you feel better, but you can’t take that feeling to the bank.

I believe that any time and effort you could possibly spend repairing an investment property could be better spent finding and evaluating new investments.

Solo 401(k) retirement plans can grant direct checkbook control without the use of an LLC or custodian.

The concept of custodian comes from Internal Revenue Code Section 408(a)(2) and is defined in Section 408(n). This entire IRC section 408 is devoted to Individual Retirement Accounts, or IRAs. The code basically explains that an IRA is normally a trust, and the trustee must be a bank. It then defines bank as a bank, trust company, or any company specifically approved by the IRS. This capacity of trustee to an IRA is known as “custodian”. This trustee role is simply that of investing the plan as directed by the accountholder.

A Solo 401(k) plan is a type of 401(k) that is designed for self employed individuals whose businesses have no full time employees. All 401(k) plans are qualified plans, and qualified plans do not have any special restrictions on who can serve as trustee.

So the significant difference is that with a Solo 401(k), the participant can actually be the trustee and handle the investment transactions themselves. This can serve to simplify operating the plan because no third party is introduced. Such simplification can also serve to minimize third party fees.

Titling of Assets

If you’ve been researching or operating a self directed IRA, you may be familiar with how IRA assets must be titled. If Jeremy Smith had an IRA with Sunwest Trust, his IRA’s assets would be titled as:

Sunwest Trust, Inc. F/B/O Jeremy Smith IRA

“F/B/O” means “for benefit of”. To experience the benefits of checkbook control, some self directed IRA accountholders choose to create a special purpose LLC to be owned by their IRA but managed by them. So the membership units of the LLC would be titled as:

Sunwest Trust, Inc. F/B/O Jeremy Smith IRA

…and Jeremy (as manager of that LLC) would further invest the new LLC funds to purchase assets that would be titled in the name of the LLC.

To own and directly control retirement assets in a Solo 401(k) plan can be much simpler. Jeremy would simply have his plan setup to name himself as trustee. He would then direct the plan to purchase assets to be titled to:

Jeremy Smith Solo 401k Trust

…or whatever Jeremy chooses to name the trust that exists for the sole purpose of managing the assets for his Solo 401(k) plan. In this case, there is absolutely no need to setup an LLC for the purpose of gaining checkbook control.

This convenience is little known because conventionally 401(k) plans have served as an investment vehicle for large corporations with many participants. Solo 401(k) plans are much easier and less expensive to operate. In fact, Jeremy can serve the roles of employer, employee, plan participant, plan administrator, and plan trustee. Serving the role of employer and employee allows him to contribute up to $46,000 per year to his account (or $51,000 if he’s over age 50). If Jeremy’s wife works in his business, she can participate as well and contribute up to another $46k each year.

The Downside of Checkbook Control

You may hear about potential problems of checkbook control, such as recordkeeping and legal compliance. Firstly, the only reporting required for a Solo 401(k) is annual filing of Form 5500-EZ, and it is only required once plan assets exceed $250,000 in value. There are plenty of companies who will prepare this form for about $300.

The issue of checkbook control legal compliance is quite simple. All self directed accountholders and participants must avoid prohibited transactions. This requirement and responsibility rests solely on you as accountholder/participant regardless of whether you have checkbook control and regardless of whether you are using and IRA or Solo 401(k). See an elaborate explanation here.

The facts are that when using a self directed, self administered, self trusteed Solo 401(k):

• meeting the reporting requirements is simple, and it’s inexpensive to have Form 5500-EZ prepared for you
• there is no special or unique risk of legal noncompliance that would otherwise be eliminated by using a custodian

Conclusion

In my opinion, a Solo 401(k) where the same person serves all roles involved is the simplest, most effective and direct way for that person to self direct their retirement plan investments. It opens doors to the most flexible options possible. This allows for investment into foreign assets, investment clubs, tax liens, precious metals, and many other investments that some custodians optionally refuse.

So if you’re self employed (through your own Corporation, LLC, or even Sole Proprietorship) and you have no full time employees, the rules are bent in your favor with a Solo 401(k) – arranging and utilizing checkbook control is easier.

• Enron
• WorldCom
• Tyco
• Subprime mortgage crisis
• Mutual fund mortgage overexposure and misreporting
• Fannie Mae & Freddie Mac accounting scandals
• Insolvency of Investment Bank Bear Stearns

…most Americans are running low on trust when it comes to financial service companies. Who can you trust?

This is an especially important question in light of my recent post about misinformation in the self directed IRA community. My answer: yourself. That is what self directed investing is all about. You have control of your assets.

With the checkbook control provided by an IRA LLC, there is no potential for fraud unless your IRA rollover is handled by someone other than a bank or trust company (aka custodian). With a Solo 401(k) you don’t even have to transfer your assets through a custodian in the first place.

Q: What should I be concerned about?

A: Prohibited transactions and tax compliance, although it is simple to address both concerns. You can search Google for “self directed IRA prohibited transactions” and “IRA UBIT tax” to learn about the basics of both topics. If a service provider claims something that doesn’t jive with your basic understanding of these core topics, that should throw up a red flag. Claims such as “your IRA can loan money to you or your company” and “your IRA can own a company that does business with you or your company” should clearly create some concerns for compliance with self dealing rules.

Good questions to ask a service provider include:

1. Are your plan documents IRS Prototypes? If yes, this means that their plan documents (for qualified plans such as a 401k) are essentially determined to meet the requirements of being a qualified plan as detailed in a blanket IRS determination letter that can be provided to you. If their answer is “no” and their plans are also not “mass submitter” documents, then there may be reason for concern.
2. Are your entity documents attorney drafted and supported? Entity documents, such as the Operating Agreement of a Special Purpose LLC, need to be regularly updated by an attorney to reflect the evolving viewpoint of the IRS and DOL. Many IRA LLC facilitators are simply reusing (without authorization) documents they purchased, but are unable to afford the legal support required to keep their services as compliant as possible. This type of intellectual property infringement can either decrease the price of the service or increase the profit margin (depending on how the unscrupulous service provider looks at it), but neither are a good deal for the individual investor who would pay the consequences in the case of legal or tax noncompliance.

Finding a company that answers the above questions favorably means that your checkbook control structure should be legitimate and compliant. This direct control eliminates potential fraud or mishandling of funds because you aren’t going to defraud yourself. This scenario may actually be able to improve your overall investment strategy. For example, my company does not accept or handle deposits or assets of any kind. For this reason, we don’t have to pass banking regulatory costs on to our customers. If it were reasonable to say that chartering a bank or trust company costs $2 million, we are excited to say that our first $2 million of reinvestable revenue can be directed towards the development of tools to help the investor rather than to protect the investor from us mishandling their funds. If maintaining a bank or trust company costs $500,000 per year in regulatory fees, that’s $500,000 of further reinvestment into tools & new services… or savings for us to pass on to our customers through lower fees.

Because the risk of prohibited transactions and fiduciaries issues are the same with or without checkbook control, the peace of mind that checkbook control offers is certainly worth a premium. The fact that it offers that peace of mind and savings (instead of a premium) is what I believe will turn this investment strategy into something that is feasible for average people.

Taking direct control of your wealth is an exciting alternative to riding the economic roller coaster, and it removes the need for you to become comfortable placing your assets into the hands of yet another smiling guy in a suit. Trust yourself.