IRA/LLCs – IRA Ownership of LLCs

An IRA/LLC is an investment structure whereby an IRA invests capital into a newly created limited liability company (“LLC”). The IRA owns the LLC units just like your IRA can own Coca-Cola corporation stock. This IRA/LLC structure has been popular amongst real estate investors and other investors who regularly invest in alternative assets with their retirement account. A common IRA/LLC structure is one where the IRA invests a designated amount of cash into the LLC in exchange for 100% of the membership units of the LLC. The LLC then in turn acquires the intended investment asset. For example, a rental property. An IRA/LLC can also be formed with numerous IRAs owning the LLC with the ownership allocated between the different IRAs based on the dollars invested.

Self-directed IRA investors prefer the IRA/LLC structure as it allows them to have signing control for the LLC to enter into contracts as well as access and signing authority on an LLC business checking account to more easily fund transactions and asset expenses. IRA/LLCs are particularly popular amongst real estate investors. When an IRA owns real estate directly, the income and payments as well as contracts and documents flow through the IRA custodian. Many IRA owners don’t like the back and forth of instructions and authorizations for expenses or contracts with their custodian on the property and instead choose to use the IRA/LLC structure whereby their IRA owns the LLC and the LLC in turn owns the real estate and operates the investments. In this instance the IRA owner can serve as manager of the LLC. As manager of the LLC, the IRA owner can have signing authority for the LLC for contracts and can use an LLC business checking account. 

To establish an IRA/LLC, an investor must have a self-directed IRA account and a properly structured and restricted LLC. To ensure compliance, the IRA owner needs to operate the LLC in accordance with the laws affecting IRAs. 

Step One – Self-Directed IRA

The first step in establishing an IRA/LLC is having a self-directed IRA. A self-directed IRA is an IRA that can invest in any asset allowed by law. The common investments owned by self-directed IRAs are real estate, LLC and LP interests, notes, private company stock, and VC/PE funds. There are around 30 banks or trust companies who offer self-directed IRAs, including Directed Trust Company. With $13.9 trillion in IRAs and growing interest in alternative assets these accounts are becoming more and more common. A self-directed IRA can be a traditional IRA, Roth IRA, or SEP IRA. The “self-directed” label simply means it can invest in assets off the public markets at the direction of the account owner. Most self-directed IRA accounts are funded by a transfer from an existing IRA at a brokerage to the new self-directed IRA account. Once that self-directed IRA account is established and funded with a transfer of cash from another retirement account, it is ready to invest into an alternative asset1.

Step Two – Properly Structured & Restricted LLC

The second step in establishing an IRA/LLC is a properly structured and drafted LLC. An IRA/LLC must be established as a manager-managed LLC and the manager may be the IRA owner so long as the operating agreement restricts certain actions. You cannot establish an IRA/LLC as member managed as the IRA is the member and that would mean the IRA custodian would manage the LLC. IRA custodians will reject an LLC if the IRA custodian is required to manage the LLC. The LLC will need articles of organization and a tailored operating agreement that restricts actions that would violate the rules applicable to IRAs.

The federal tax code has significant restrictions on IRAs that limit who an IRA can transact with2. These rules are known as the prohibited transaction rules and in the case of an IRA/LLC the rules will restrict the IRA owner from receiving compensation from the LLC and will restrict the LLC from transacting with the IRA owner or persons disqualified to the IRA owner3. 

Operating the IRA/LLC Properly

There are numerous case examples of people who have used the IRA/LLC structure incorrectly. Most recently, in McNulty v. Commissioner, an IRA owned an LLC 100% and the IRA owner was the manager4. The IRA/LLC acquired precious metals which the IRA owner stored at their home. Precious metals can be owned by an IRA, however, the federal tax code requires that the metals be stored with a bank5. The Tax Court ruled that the IRA owner violated the rules by storing the precious metals at their home and the tax court deemed the precious metals distributed.

In Ellis v. Commissioner, an IRA owned substantially all the ownership of an LLC and the IRA owner was the manager and took a salary for their services as manager. The Tax Court ruled that the salary to the IRA owner was a prohibited transaction and distributed the IRA. Most practitioners have always restricted salaries in IRA/LLCs when the salary or compensation would be paid to the IRA owner or anyone else who is a disqualified person to the IRA and the IRA/LLC operating agreement should specify such restriction.

Conclusion

IRA/LLCs are a popular and advantageous tool for self-directed IRA investors who need greater control in their investments. Real estate investors can benefit from an IRA/LLC by having easier transaction processes with the LLC and by having singing authority on an LLC business checking account. Practitioners should ensure that the proper self-directed IRA is established with a custodian who allows for IRA/LLCs and should also ensure that the LLC documents are properly drafted and restrictive. Practitioners also need to advise their IRA/LLC clients of the rules affecting IRAs and should advise the IRA owner against taking a salary or compensation and should provide advice regarding the prohibited transaction rules that may affect the IRA/LLCs investments.

Footnotes:

1. IRAs must hold investment assets and cannot acquire assets for personal use. IRC § 4975. Assets restricted to IRAs are collectibles IRC § 408(m), life insurance IRC § 408(a)(3), and s-corporation stock IRC § 1362 (b)(1)(B).

2. IRC 4975 (c)(1)(d). IRS Chief Counsel Advice Number (CCA) 200952049 (12/24/2009).

3. IRC 4975 (e). Ellis V. Commissioner, No. 14-1310 (8th Cir 2015).

4. McNulty v. Commissioner, 157 T.C. No. 10 (2021).

5. IRC § 408(m)(3).

This e-bulletin was prepared by Mat Sorensen Esq., CEO of Directed IRA | Directed Trust Company, Partner at Kyler Kohler Ostermiller & Sorensen, LLP, mat@kkoslawyers.com.