BUSINESS PRACTICES & STRUCTURE
CHECKBOOK IRAS
WITH GREAT POWER COMES GREAT RESPONSIBILITY
I f you’re getting the sense that an IRA-LLC allows you to do anything you want at any time you want with the money in your IRA without having to get any- one’s approval, you’re right. The power this strategy gives you can be intoxicat- ing. However, do not jump into an IRA-LLC blindly. That power is not right or necessary for everyone. When you use an IRA-LLC, it’s very easy to bend or break the rules. There’s no custodian to approve your transaction or to give you basic com- pliance reviews. There’s no one to remind you about unexpected tax con- sequences. You have full authority to make your own decisions, but you’re wholly on your own. That’s a dangerous place to be with IRAs because it’s shockingly simple to break the rules. The IRS calls this a “prohibited transaction,” and commit- ting one will nearly always cost you a minimum of 40-60 percent of the value of your IRA. The stakes are very high indeed. Remember: Every single rule that applies to IRAs still applies to every single action you take within your IRA-LLC. Your IRA-LLC is simply an extension of your IRA. Every use of your IRA’s capital must be to the benefit of your IRA alone.
Solving a Nightmare Scenario For IRA-Based Real Estate Investing THE IRA LLC CAN EXPEDITE YOUR DEALS WHILE PROTECTING YOUR PROFITS.
ed back in 1974. When Mike presented the offer to purchase that property, he was unable to sign that offer himself. Instead, he had to wait for his custodian to sign the agreement. Even more trouble- some, Mike was unable to make a good-faith deposit with the owner to reserve the property because the mon- ey had to come from his IRA via his IRA custodian. The IRS doesn’t always issue clear rules, but this is one place where there is no ambiguity: The funds for the deposit and all of the money associated with the deal must come en- tirely and directly from the IRA itself. Even though Mike had found a great deal, he didn’t have the ability to get the property under contract. By the time he returned with a contract signed by his custodian, another investor had already swooped in and taken the deal away. That’s when Mike did what he should have done long ago, and established an IRA-LLC (aka “Checkbook IRA”).
4 Mike’s IRA company received ownership documents for MIF LLC from Mike’s attorney. When this transaction was complete, Mike found himself proudly in control of MIF LLC, which currently boasts a bank account with $250,000, all of which Mike is free to invest as he pleases. In turn, the value of MIF LLC and all of its profits are the property of Mike’s IRA. Additionally, Mike can sign documents, including purchase and sale agreements, on behalf of MIF LLC. When he sees great opportunities, he can now take action and seize the deal on the spot. •
THE IRA-LLC SOLUTION An IRA-LLC is a clever structure that provides an end-run around the obliga- tion to involve your custodian in every aspect of every transaction. It provides the one thing that IRAs fundamentally lack: instant access to both capital and signa- tory authority. In effect, the IRA-LLC is a way to establish a private investment fund using your IRA capital, over which you maintain absolute control. The process Mike followed to set up his IRA-LLC was simple: 1 Mike’s attorney set up Mike’s Invest- ment Fund LLC (MIF LLC). 2 Mike was designated as the Presi- dent of MIF LLC. 3 Mike’s IRA purchased 100 percent ownership of MIF LLC by wir- ing $250,000 to MIF LLC’s bank account.
by Bryan Ellis
hen Mike (not his real name) found a “needle-in-the-haystack” type of real estate deal, he knew he’d hit the jackpot. He could get the property so inexpensively that there was a built-in profit of more than $50,000. Mike was lucky he got there first. This deal was the kind that wouldn’t wait around for the unprepared. Mike was fortunate in terms of preparation as well: He had plenty of capital to fund the deal inside of his self-directed individual retirement account (IRA). But Mike lost that profit of $50,000 W
A FUNDAMENTAL PROBLEM WITH IRA TRANSACTIONS For all their wonderful tax advantages, IRAs have a fundamental structural disad- vantage that causes a big problem with one key component of deal-making: speed. Unfortunately, the added step of receiv- ing funding and approval from your IRA custodian can be the death knell of any time-sensitive transaction. Please note, this isn’t a criticism of IRA custodians. Rather, it’s a problem with the fundamental structure of IRAs as designed by the U.S. Congress when IRAs were creat-
even though he found it first, and even though he had all the capital he needed in his IRA. Somebody else beat him to it.
WHAT HAPPENED? As Mike discovered too late, own- ing a self-directed IRA – even a well-funded one – doesn’t mean you get to make on-the-spot decisions about what you’ll purchase using those funds. Every transaction – without exception – must be fun- neled through your IRA custodian.
Bryan Ellis is the founder of Self-Directed Investor Society, and his goal is to assist in your ongoing effort to understand the rules governing your IRA, just like Mike! Learn more about prohibited
transactions, self-directed investing, and real estate investing in your IRA at https://SelfDirected.org.
34 | think realty magazine :: january 2018
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