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.