What's so special about the IRA LLC?

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.

Summary

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.

Reader Interactions

Comments

  1. Jeff,
    I want to establish an IRA-owned LLC to make short-term real estate loans. I’m looking for clear guidance about what I can do as both IRA owner and LLC Manager. The LLC must perform certain tasks before a loan is made, and administer the loans after they are made. If I’m perform these services (without compensation from the LLC) I want to be sure that these are not “prohibited transactions”. Can you offer some guidance here?

  2. Jeff,

    Thanks for sharing your story and this blog post. I heard of a guy that created a bank account at his local bank, set up a traditional off-the-shelf LLC that he picked up from the local bookstore and then set up a bank account in the name of his LLC. He called the account his ROTH IRA LLC account.

    Quickly, I should mention that this guy figured out how to do this after spending months researching IRA LLCs.

    When asked why he called his LLC a Roth IRA LLC account? He said in a bragadocious kind of way that the money in the account belonged to the LLC and the money in the bank account had already been taxed, so therefore, it just made sense that he had set up a Roth IRA LLC on his own.

    Clearly this is a prohibitive transaction if he does not pay taxes on the gains earned with his LLC structure.

    It is hard to imagine this might happen, but it can happen when people try to set up IRA LLCs by themselves. I liken this sort of thing to folks who watch sky diving for months and then decide to try it out for themselves without packing a parachute. They have a great take off and enjoy the exhilaration of the ride until the earth breaks their fall. I am sure we will see this individual paraded in front of the news cameras sometime down the road if he is ever blindsided by an IRS audit.

    Keep up the good work! In the end, you will keep a lot of people out of trouble with the IRS!

  3. OK, I know you can answer this question with a “NO, you can’t do that”, but, please evaluate the logic on the following.
    Scenerio 1:
    I have a self directed Roth IRA at a broker, and I trade futures. The account is traded online by me. Theoretically, I buy when I think the contracts are going up, and sell at a profit. This is not considered a PT, right?
    Scenerio 2: I have a self directed Roth IRA with an LLC. The LLC sells widgets. I can buy a widget for $1 in the name of the LLC. As a manager of the LLC, I find someone who will pay $2 for that widget. I advertise the widget in the classifieds(paying with the LLC acct), and I don’t charge any expenses to the LLC for phone or travel or business meals, etc. and I don’t receive any compensation.

    What’s the difference in managing my trading acct, and finding a product for the LLC and then finding a buyer? I’m performing the same function for both Scenerios.

  4. @Frank – call me with details. 877-903-2220.

    @Dale – In scenario 2 you are buying and selling inventory which is something that relates to operating a trade or business. Two issues… #1 you are working for the business (a PT), and #2 you may owe UBTI tax on the income of that business. It’s not an exact science, but the IRS has some logic in how they determine if something is a passive investment or a trade/business. Part of that logic is the presence of advertising. I can elaborate in a future post. Also, FYI… It may also be possible for Scenario 1 to be interpreted as a business if you spend a lot of time doing it, trade many assets, and hold the assets for short periods of time. This could bring the same UBTI & PT problems into play.

  5. Hi I want start Checkbook IRA LLC. I want to buy realestate in India for investment purposes using funds from my IRA account? What are the pros and cons of this idea. Can you he lp me to start the Checkbook IRA LLC?
    Please comment

  6. What specifically do you refer to with the caution you give (cited below) – i.e. what order is required in the formation process and what parts of the documents being filled out can create a prohibited transaction? Thanks much for your help. Sincerely, Michael Jones

    “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.”

  7. Michael,

    If structuring investments optimally could be summed up in a blog comment I would have never started this business. The mindset that you just need that one little missing piece of information is a dangerous one.

    I strongly encourage you to give my office a call at 877-903-2220.

    Any amount of effort you put into trying to set things up yourself with no help or support would be effort better spent looking for and evaluating extraordinary investment opportunities.

    – Jeff

  8. Franklin,

    Let me elaborate on my last response to your comment:

    Feel free to browse my blog archive. If you need further assistance, it is a phone call away at 877-903-2220. My business is 100% focused on helping people like you fully understand the answers to questions just like the one you posed. The answers aren’t able to be reduced into a blog comment response, so a phone call is the best way for you to get the info you’re looking for.

    Jeff

  9. In checking your ‘preferred’ states I noted mention of a FEE to retain an agent in another state, other than your ‘home’.

    In Kansas, I found the Filing Fee (Sec of State) is $55/yr, and there’s NO tax due (Kansas Dept of Revenue) if the Net Worth is under a million – if you got more, you can AFFORD paid help!

    Wouldn’t organizing at home be cheaper for many others too?

    Just a thought ….

  10. @Bill – My records show that Kansas requires a tax of between $20 and $2500 each year. $1 per $1000 of members’ capital accounts. This could be outdated information, but this is the reason why Kansas isn’t in the spotlight of advantageous states in which to transact. The majority of other states have similar fees and/or taxes.

  11. Jeff,
    Thanks for all the info regarding self-directed IRA’s and IRA-LLC. It can be all too confusing to try to unravel, if that is not your livelihood. I’ve been to the IRA Association site and found answers to many questions I had. I myself was wondering about IRA-LLC and why they cost so much to setup. But I have gotten ahead of myself. My initial goal is to self-direct some of my current SEP-IRA towards precious metals by finding a custodian and dealer. I think the IRA-LLC may become advantageous at a later date, as I intend to hold my precious metals ira for at least 2 to 5 years, and possibly invest in a business or real estate. What I don’t understand is why would one need a faciliator to set up a self-directed IRA, if you can do that with the chosen custodian yourself. Granted .. custodians usually will have you sign agreements that eliminate them as ‘at fault’ for anything that could potentially go ‘bad’ with the self-directed IRA, but wouldn’t that be the same if done through a facilitator? Or maybe I’m confusing the roles.

  12. Sam,

    First and foremost the reason I advocate going beyond setting up a self-directed custodian IRA is a matter of wealth preservation. See more here:

    Why to directly possess your assets

    As for the higher cost, there are two reason why setting up an IRA LLC costs more:

    1) Price gouging. Most companies who sell IRA LLCs want to make as much money as possible selling them.

    2) High quality research and compliance. With my company, we obtained an exclusive license from the creator of the IRA LLC, Debra Buchanan. We continue our constant research and evolution of our documents and systems. We regularly communicate with the government to ensure proper compliance. In delivering the IRA LLC setup services we have an unparalleled system to make sure it happens quickly and smoothly. Simply put, we focus on doing things right. At the end of the day we take our costs, add on a small margin for profit and that’s how we arrive at our setup costs. Some of our competitors take the cheaper route and often buy our IRA LLC annually to copy the fruits of our R&D work.

    With most others you are paying the price of a company who wants an outrageously large profit margin. With my company, Nabers Group, you are paying the fair price for the best service. I am the only one in the entire industry who periodically visits with regulators in Washington, D.C. in-person, and Nabers Group is the only company in existence that obtained a license to use the IRA LLC system from its creator. And again, we continue this legacy of high quality work through our continued research and development to improve our processes.

    ——
    Why do you need a facilitator to setup an IRA without an LLC? I don’t know. I don’t think you should pay a facilitator to fill out forms for you, using information you gave them. But I also don’t think you should open an IRA without an LLC. Large, government-regulated financial institutions are the last party I would want possessing my assets.

    I hope this information helps 😉

    Jeff

    I hope this clears things up for you.

  13. Jeff, I understand the desire to have actual possesion of one’s assets. Nationalization sounds pretty scary. However, aren’t you required to use a custodian for investing precious metals in a self-directed IRA, whether it is owned by LLC or not? And that the assets must be stored at govt-regulated institution? Still a bit confused.

  14. Jeff, I live in Ca. can I set up an ira llc in another state to save on costs that are very expensive here and how do you choose which state on cost alone, is there much difference between states? Also if I do invest in Ca. is that ok if my llc is formed out of state?

  15. Jeff, One more question, my possible future son in law, they aren’t married yet, can he rehab a property for me as long as he isn’t related at this point, would that be an acceptable transaction transaction?

  16. @Rod – Certain activities, such as buying real estate, create “nexus” in that state (where the RE is located) for the LLC. “Nexus” is business activity that requires registration in that state. This can be in the form of creating the LLC in that state… or by creating the LLC in another state and then registering it as a foreign (“foreign” meaning from another state) LLC in each state where nexus is created. Either way, investing in RE in CA is going to require you to deal with the franchise tax they charge. You have two choices:

    1) Create the LLC in CA and pay the tax
    2) Create the LLC in another state and register it for the authority to do business in CA and pay the CA tax
    3) Don’t do business in CA (don’t invest in CA real estate)

    Personally, I would lean toward #3 unless you are a very seasoned investor who knows that CA markets so well that your profits will be huge enough to dwarf the tax. If you are dipping your toes in or are an intermediate investor, I would look elsewhere. To me, it seems dangerous to do any kind of business in a state that is teetering on bankruptcy even after having a history of taxing its citizens higher than any other state. Taxes could go up higher and higher and if there’s any state that will pass extraordinarily ridiculous laws making certain transactions impossible or unprofitable, CA will definitely be the first.

    That last paragraph is my personal two cents, so you don’t have to like it or value it if you don’t want to 🙂

    Jeff

    p.s. If your future son-in-law did rehab on a property owned by your retirement plan, it wouldn’t be a prohibited transaction as long as your only objective in directing the plan is to generate profit from the plan. Also, the moment he becomes your son-in-law, he must have no involvement in your plan transactions.

  17. Jeff,

    Is a father-in-law or mother-in-law a “disqualified person”? If so, can you reference the IRS regulation that specifically mentions “in-laws”?

    If I set up an IRA-LLC and invest in rental property is everything held in the name of the LLC (i.e. utilties, phone, cable tv, etc.) or in the name of the tenant?

  18. A son-in-law and a daughter-in-law are considered disqualified persons, but a mother-in-law and father-in-law are not.

    If your IRA LLC buys a rental property, it is the owner. The decision of which utilities are in the name of the owner/landlord vs. the tenant is up to you and there are no guidelines unique to IRAs or IRA LLCs.

    I hope this helps 🙂

    – Jeff

    p.s. There’s a lot of information out there and many decisions you will need to consider, as I’m sure can see. If you haven’t already done so, call my office to find out how you can have our knowledgeable staff on your team. 877-903-2220

  19. Jeff,

    If I am not looking at CA RE but rather want to invest in Missouri, can I set up my IRA LLC where I live in Washington and invest in Missouri RE with out any nexus problems?

  20. I have two 401k accounts,one being held by Prudential from a former employer with $40000 value.
    I am interested in investing in a friends business in the UK-would a IRA LLC be the best way to go about this as compared to just cashing in this account and paying the taxes and penalties?

  21. Jeff,

    I have retired and my retirement funds a currently in a 401A. I’m contemplating a rollover into a self-directed IRA with American Estate & Trust, who will then create a LLC for me. I want to purchase a rented condo as an investment property. My question is how can verify that the company(ies) I am considering do business are legitimate. I have checked the BBB and they have an excellent rating, but doesn’t that just mean the no has reported them, yet? I want to verify that their credentials are valid and they are doing business correctly. Also, I am not 59 1/2 yet, would putting money in an LLC at this age constitute a transaction that would initiate the 10% penalty by IRS?

    Thanks Pat

  22. Jeff,
    I am thinking about setting up an IRA LLC for real estate investments. I raise capital through friends and family to purchase foreclosed condos/homes then rehab and rent. Usually I put a little of my own money into each deal, then my brokerage company manages the property for a fee. My brokerage company also gets paid a commission on the purchase, and a commission on the sale of each asset.

    Can I use a checkbook IRA for these investments? I am thinking no because of the management and brokerage fees that my company gets paid (my company is a single member LLC).

    Tom

  23. Hi Jeff,

    Can a IRA LLC own a Foreign LLC?

    The reason is that Foreign investment providers will not accept an application from a USA domestic LLC but will from a Foreign LLC owned by a USA person

  24. Hello all!

    Business has really picked up, so if you need help please call my office at 877-903-2220 🙂

    Jeff

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