Ahhh… the single most mis-answered question in the self directed IRA world:
Customer: I’ve noticed it costs more to setup an IRA LLC than it does a general purpose LLC. What’s so special about the IRA LLC?
LLC Facilitator: The Operating Agreement has special language. Putting together an IRA LLC without this magical language will result in a prohibited transaction and hefty taxes.
This is untrue. While it’s advisable to include special language in a special purpose LLC (one that is intended to be owned by an IRA and managed by the IRA accountholder), the absence of such language will not create a prohibited transaction in itself. Believe it or not…
Any newly created LLC can be used with an IRA!
…without necessarily creating a prohibited transaction. The sales pitch that you need the special purpose operating agreement is bogus.
That said, it is still advisable to have an IRA LLC established for you by a company experienced and competent in such facilitation. Not because you have to, but because you should want to. Why?
You want things to look good in the event of an IRS audit
This is probably the main reason why you should have an IRA LLC formed for you by a specialist instead of doing it yourself. If you get audited, the IRS is going to have a first impression about your IRA LLC structure. If it looks like you did everything compliantly and your documents pro-actively address most compliance issues, the IRS’s first impression may be friendly. If it looks like you just threw the LLC together with little regard for compliance, this may negatively affect the IRS decision of how long and excruciating the whole ordeal will turn out to be. This is an important issue. Notice I said “looks like”. Regardless of how compliant you are, the IRS can still make your life a living hell for a couple years. I’ve never heard of an IRA LLC triggering an audit, but once one starts you should want to make them happy. Having a nice neat record book (as provided by an IRA LLC facilitator, with documents that explain exactly what you did and why it was compliant) will probably make the IRS happier than an incomplete record book or one that contains mistakes.
I spoke with a gentleman earlier today who was forming his IRA LLC himself based on research he did on the internet for 6 months. He called me because he was trying to find someone to pay a small fee to for signing some of his LLC documents as organizer. In the event of an audit this guy’s situation may very well induce the full wrath of the IRS. Imagine the field agent reviewing all of his financial information:
IRS Agent: What’s this?
Guy: It’s my IRA LLC.
IRS Agent: Looks like a prohibited transaction. We’re gonna look into this.
[to “Organizer” listed on documents]
IRS Agent: So I understand you organized Guy’s LLC.
Organizer: No, I just signed as organizer for a fee. He did everything himself.
[IRS agent begins to transform like the Incredible Hulk]
Immediately, the IRS could feel that Guy is trying to deceive them. The strange part is that I don’t even understand why he wants to do it this way. He doesn’t have to have somebody else form his IRA LLC. If he’s organizing it, I think he should sign as organizer. If someone else is, they should sign as organizer. Anything else may be deceptive and will probably only serve as a means to appear like someone who is not being up front and honest to the IRS.
I can’t help but to think how much more profitable Guy’s investments would be if he spent less of that 6 months’ time learning how to form an IRA LLC himself and more of the time finding, researching and evaluating investment opportunities.
You can form an IRA LLC yourself. It doesn’t require a special document to be compliant with laws and regulations. The formation process does, however, need to be followed in a particular way. If formation tasks are done in the wrong order or if certain parts of documents are filled out incorrectly, it can create a prohibited transaction. Or, also undesirable, it can create a nasty IRS audit. Therefore, I don’t think it’s worth saving a few bucks to form it yourself. Currently, most IRA LLC facilitators charge $2,500 to $3,000 to setup an IRA LLC. This is similar to the amount of money you would pay in taxes in the event of an accidental distribution (resulting from a prohibited transaction) for an IRA worth about $9,000. Add zeros as necessary to project your tax incentive for having your IRA LLC formed for you.
Coming up… How to choose an IRA LLC Facilitator.