Landlording your IRA LLC's properties – Is it allowed?

A question I get all the time is “Can I personally mow the lawn, maintain, and/or repair properties owned by my IRA LLC?” My answer is “No” which usually creates the response “But another company said I could.”

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.

Reader Interactions

Comments

  1. I’m not going to address the tax issues, because (among other reasons), I’m in the UK where the tax laws are different 🙂

    However, you write:

    > If you want or need a job, you can always find
    > somebody else’s toilet to fix.

    Well, yes and no. The act of “running a toilet fixing business” is different from “fixing a toilet”.

    A toilet fixer has a whole bunch of overheads – running invoicing, and marketing the business for a start – and a set of “effective costs” – minimum call out” that you have to pay for if you employ a toilet-fixer… but just don’t get if you fix your own toilet.

    I have a bunch of rental properties – a common problem we get in some of them is a leaky tap (faucet in US English?). Most of my rental properties are within 5 minutes WALK from my house.

    A replacement washer (the part I need to fix a dripping tap) costs about £0.15. Fixing it takes about 15 minutes INCLUDING walking there and back.

    Paying a plumber to go and fix it costs about £50.

    So effectively – fixing my own dripping taps saves me £49.85 for 15 minutes work… and effective hourly rate of £199.4…. or about US400….

    $400 / hour is more than I can earn doing most things 🙂

  2. Mark,

    My point may have not been communicated clearly enough. It is this:

    You can work to make money.
    Your money can work to make more money.

    In my mind, investing is about having your money work to make more money. In this light, the “hourly rate” for investment earnings are approaching infinity over time when the investments are passive.

    As a personal preference, I don’t like spending time to save money unless it’s significant. Saving 15 minutes at a price of £50 might be worth it if the same 15 minutes can instead be spent either enjoying myself or finding another investment opportunity that will yield £50 many times over.

  3. Jef,

    Not what I wanted to hear, but your answer has convinced me that the consequences of being wrong in this area are enough to make me follow your advice. However, now a question regarding mileage to/from the property during the performance of passive duties. Can this be deductible as an investment expense at the bottom of schedule a?

  4. John – I don’t think Schedule A of your personal tax return can deduct expenses related to a property whose income is not taxed (because it is owned in a tax exempt entity [IRA LLC] whose income and expenses are separate from you personally).

  5. Can I buy properties through my IRA LLC and let my S-Corp manage them? The S-Corp would charge the normal management fee o 15% of rents.

  6. Reading this hurts!
    After thinking I could use my 401’s to purchase rental properties it looks like it will not happen.
    As a contractor and in persuit of forclosed properties in “as is” condition I was hoping that I could make the repairs only using the funds of the LLC to purchase materials. It makes it cost prohibited to do this. It is obvious that I did not understand the PT or DQP definitions!
    Back to the drawing board!
    Thanks Evan

  7. Evan,

    You can setup a Solo 401k, take a participant loan for $50k, purchase the property in your name (with a much higher LTV than would be available for an IRA non-recourse loan), perform the rehab with real estate dealing as your profession, and then take your earnings as self-employment income. Much of that self-employment income can then be contributed into the Solo 401k.

    Result: You’ve done the rehab, and much of the profits end up in a tax-favored retirement plan, and you haven’t broken PT rules.

    Jeff

    p.s. If you have more questions, call our office at 877-903-2220 🙂

  8. Hi Jeff,

    Regarding the question of providing labor without compensation as the Fiduciary of a self directed IRA to/for the property owned by the IRA, you are claiming that section 4975 (c)(1)(C) is the general rule that prohibits this in the absense of a clear specific exemption, but why couldn’t 4975 (d)(10) be regarded as just such a specific exemption:

    (10) receipt by a disqualified person of any reasonable compensation for services rendered, or for the reimbursement of expenses properly and actually incurred, in the performance of his duties with the plan, but no person so serving who already receives full-time pay from an employer or an association of employers, whose employees are participants in the plan or from an employee organization whose members are participants in such plan shall receive compensation from such fund, except for reimbursement of expenses properly and actually incurred;

    This even seems to open the door for compensation for such services, if that what you wanted to do.

    Also, regarding your comments about the Big Picture, at least for my case, the objective isn’t to own property for income, its to buy it at a distressed price, fix it up, and sell it for appreciation. So, my providing uncompensated labor enhances the return, which is very consistent with the objective. Granted, it makes it more complicated to distinguish between return on labor versus return on capital, but I don’t overly care about that as long as I can get to my account appreciate objective.

    If I wanted to argue against being able to provide no cost labor it seems like the more logical potential area of law would have something to do with providing “excess” contributions to my account, meaning the value of actual cash contributions plus the value of my labor, but I can’t find anything that mentions any limitations on that.
    Essentially by contributing my uncompensated labor I am putting in more money, and, in the case of a Roth IRA, putting in that money on a pre-tax (ar actually no tax) basis, rather than normally on an after-tax basis. This of course is the reason this idea would appeal to me.

    Your comments.

    Brian

  9. Brian,

    Reading carefully is the trick here.

    “Performances of his duties with the plan”

    As fiduciary of your plan, your duties are to direct it. Being a landscaper or repairman is not within the duties of plan fiduciary. Your grasp at the (d)(10) exemption is unsuccessful.

    As for YOUR big picture. It sounds like you want to operate a business within your plan. That would trigger the most aggressive tax there is – UBIT – a trust tax that ramps up to 35% very quickly.

    I’d recommend you contact my office for assistance on putting together a plan to accomplish your goals without running afoul of the rules and without triggering large taxes accidentally.

    Jeff

  10. Jeff,

    I keep reading that unlike a 401(k), one cannot borrow money from an IRA. In the case of a self-directed IRA LLC, is it not possible for the LLC to make a loan to a dq person under the exemption in irc 4875(d)(1)?

    Thanks.

  11. James,

    That IRC text describes a loan to a DQP who is a participant or a beneficiary. IRAs don’t have participants, they have “accountholders” or “account owners.” Most likely in this text they don’t consider the IRA accountholder to be a “participant.” That leaves “beneficiary.”

    So it appears it could be possible to an IRA to loan money to its beneficiary, but I wouldn’t be surprised if some cross referencing led to the conclusion that it would still be a prohibited transaction.

    Plus, if you lent money to your IRA beneficiary and then you ultimately were benefited (because they lent it back to you, improved the house you live in, etc) then it would almost certainly be a PT.

    I wouldn’t go into the territory of lending IRA $ to any DQP. If I were you, I’d immediately take this time and energy and put it toward protecting and building your wealth.

    Jeff

  12. Hello, question 7 and 8 is my question as a contractor wanting to do my own work. Do I understand the answer. Create a solo IRA i.e conventional IRA you can borrow from. Then take the loan from this IRA to buy rental property. Make the improvements and treat this asset seperatly from your LLC so you don’t have the DQP issues?
    Problem is you have to pay the loan back. what am I missing in this approach?

  13. Hi, Paul. I’m not sure what you’re missing.

    You can setup a Solo 401k and borrow from it and pay the loan back, yes.

  14. Regarding providing services to an asset owned by the solo 401k…I own my own real estate brokerage company. Would I have to list my 401k owned properties for sale with a different real estate brokerage to avoid a PT? Could I just list it for sale through my brokerage but only pay a commission to the selling broker(who would be from a different brokerage)? Or would this fall into the same line of thinking of mowing the lawn or fixing a toilet without pay?

  15. Al,

    Because brokerage activities should easily fall under “ministerial” services (aka “administrative”) you should be in the clear. Just don’t accept any commission.

  16. First off let me say THANK YOU for an amazing site and very thorough answers! 🙂
    Regarding the Brokerage question.
    My broker has a $ 399 fee on any transaction that I do with them. So if I buy and Sell any Real Estate with the SDIRA LLC and do not take a commission “except” for the $ 399 transaction fee (which never enters my pocket, but goes immediately to the broker)
    Do you think this would still be a PT since the $399 had to be paid somehow?
    The $399 does shows up when they 1099 me at the end of the year, although it is a wash since that “income” goes directly back to them.

    Thank you in advance 🙂

  17. S,

    If you aren’t getting anything, then you should be okay. But I would suggest you find a way to not have the $399 reported on your 1099. Consider having another unrelated agent be on record for the transaction so that their 1099 shows the phantom $399.

    – Jeff

  18. can I deduct the mileage from my home to the investment proeprty that I have purchased with my self-directed IRA funds?

  19. If i buy a rentaL property, and it needs fixing up, can i go to a place like the habitat for humanity ‘restore’ and buy, for example, used kitchen cabinets? and then ask my contractor to pick them up? at the moment i can’t do that because it would take too long for my custodians to send a check (by which time the cabinets would be sold to someone else), but i thought that, perhaps with a checkbook IRA, that would be possible.

  20. Hello all!

    Business has really picked up, so if you’re really serious about getting help with your self-directed investing please call my office at 877-903-2220 🙂

    Jeff

  21. Hi Jeff. I love your site. I was planning on setting up a solo 401k, buying fix-it-up properties, do some repairs myself or hire son-in-laws or subs to do the repairs, then flip the properties for a profit. Now you have me worried about conflicts. How can I legally build my retirement funds flipping property?

  22. Seems like maintenance of property would be considered a preservation of assets, a fiduciary responsibility and therefore necessary for plan operations.

  23. Congrats on such an informative website. I am seeking your opinion on the situation below.

    I have a SDIRA LLC with checkbook control. I bought 1 condo unit in a building that consists of a total of only 5 units. Every unit owner automatically becomes a member of the HOA. However; the other unit owners are asking me to become an “uncompensated” Officer of the HOA/Board, such as President, Secretary, or Treasurer. Am I allowed to serve as an Officer in the name of my LLC ? As an Officer of the HOA, I would only provide ministerial/clerical duties such as bookkeeping, paying bills, banking deposits, writing checks for the HOA, rule making, voting on amendments, preparing reports, organizing HOA meetings,accounting, and hiring or contractors, legal counsel, or other professional services, etc. What is your opinion Jeff ?

    I also would like to clarify the Landlord duties. Do I have to hire a Property Manager to market the condo for rent, screen tenants, collect security deposits and rents, etc. ? or can I do it for my SDIRA Checkbook Control LLC as long as I do not receive compensation?

    Thanks Jeff

  24. i am considering investing in a vacation rental property (home rents out by the night or week.) What types of services can I provide (without compensation) that are not prohibited transactions, and which would I need to have handled by a rental management firm? If purchased, could DP rent the room for a night from the management firm without being a PT?

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