The Self-Directed IRA LLC
A self-directed IRA (SDIRA) is an individual retirement account, as you may now know from Self-Directed IRA LLC, How Can I Benefit. Some people consider it the “Do it yourself” retirement account. In other words, self-directing puts you, the IRA holder, in complete control. However, this is if you go with the self-directed IRA with checkbook control. The second type of self-directed IRA is without checkbook control, or the custodian-consent checkbook IRA. Both IRAs allow you to invest in both traditional and alternative investments – but there are different rules.
Custodian Controlled Self-Directed IRA
You can find many financial institutions that will allow you to make nontraditional investments (invest in alternative assets). This is in contrast to This is in contrast to traditional financial institutions, like Fidelity, Vanguard and Chase to name a few, which primarily make commissions and fees from stocks, mutual funds, bonds, etc. With a custodian controlled self-directed setup, the custodian generates its profits through annual valuation fees and transaction fees. So if you wondered if they charge annual fees, the answer is yes.
Another factor with this self-directed setup is that you need custodian consent before you can make a transaction. With this comes long delays as you wait for custodian consent. In some cases, you may not receive consent on your desired transaction. There are also the high custodian fees to consider for each of these transactions. Finally, it’s important to note that the IRA will be in the name of the custodian. As a result, you receive no limited liability protection.
This is a more appealing option for people who make fewer investments.
Self-Directed IRA LLC with Checkbook Control
In the case of a true self-directed IRA, the IRA holder has full control of his/her investments. This is the self-directed IRA LLC with checkbook control. In this structure, you can make direct investments without custodian consent. An LLC (limited liability company) is established, which the IRA account owns. However, the IRA account holder (you!) manages. Your funds will be transferred by a passive custodian to the LLC’s bank account.
Once your funds are transferred by the passive custodian to the LLC bank account, this provides the IRA holder (again, you) with checkbook control over your IRA accounts. Now you can make all investment decisions.
Self-Directed IRA Custodian – “Passive Custodian”
The passive custodian provides no advice or recommendations regarding investments. They execute investment decisions by the IRA owner and perform custodial and administrative duties to maintain the tax-deferred status of an IRA. Also known as a directed IRA custodian, a passive custodian provides no advice or recommendations regarding investments. A passive custodian simply establishes and maintains IRAs. They’re in attendance to satisfy IRS regulations.
Tax Free Investing
Self-Directed IRA LLC’s are extremely tax-efficient. The main advantage to using a self-directed IRA is that the income and gains from your investment is not subject to tax. Therefore, you don’t pay tax on your investments until you reach retirement age.
Self-Directed IRA Rules
When you make self-directed investments, you must abide by the IRS rules. At IRA Financial, our expert IRA specialists provide ongoing advice to ensure you always operate according to these rules. They predominantly involve prohibited transactions, disqualified persons and allowable investments.
Prohibited Transaction Rules
There are certain transactions that a retirement account cannot engage in. You can find more on this in IRC Section 4975. However, you can best understand prohibited transactions by breaking them down into three basic categories:
- Direct or indirect prohibited transactions
- Self-dealing prohibited transactions
- Conflict-of-interest prohibited transactions
Direct or indirect prohibited transactions
This is a transaction between the disqualified person (Plan participant) and the retirement account that either directly or indirectly benefits the participant Any type of retirement account you establish must on a personal level. The IRS-prohibited transaction rules are primarily in place for this reason.
However, if you want to use your retirement funds for personal gains and are under 59 ½, you must pay tax and a penalty.
To clarify the difference between the two:
Direct prohibited transaction: Transactions that deal with the disqualified person and retirement account directly. These are very obviously situations, such as using your self-directed IRA to pay off your credit card bill.
Indirect prohibited transaction: Transactions that don’t appear to benefit the disqualified person directly but do so indirectly. Less obvious situations, such as investing in a business of which you are 10%-part owner.
Self-dealing prohibited transactions
A type of indirect prohibited transaction, self-dealing is a situation where you use your income or assets to further your own interests.
Let’s take a look at two examples from Self-Directed IRA in A Nutshell, a helpful IRA book that helps IRA holders self-direct their accounts easily.
- Debra, a real estate agent, uses her retirement funds to buy a piece of property. She earns a commission from the sale. This is prohibited.
- Brett uses his retirement funds to invest in a partnership with himself. He and his family will own more than 50% of the partnership. This is prohibited.
Why are these acts prohibited? In both cases, the Plan participants use their retirement income for personal interests, an act that is prohibited.
According to the IRS, a disqualified person is anyone who can exercise substantial influence over the affairs of the tax-exempt organization. When the IRS refers to a disqualified person, they mean the IRA holder. That’s right: you are a disqualified person, as well as your lineal descendants.
Disqualified Persons include:
- IRA holder (you)
- A trustee or custodian (anyone who provides services to the IRA)
- A family member (your spouse, parents, grandparents, children and grandchildren. Also, their spouses. This does not include brothers, sisters, aunts, uncles or cousins).
Conflict of Interest Prohibited Transactions
Another prohibited transaction is when a disqualified person has a connection with a transaction and uses the income or assets within his/her retirement funds to profit. An example is if you use your retirement funds to loan money to a company that you manage, control and have a small ownership in.
Always keep in mind that the prohibited transaction rules serve a dual purpose. The first is to encourage you to accumulate your retirement funds, but it also prevents individuals from taking advantage of tax benefits for personal investments.
A self-directed IRA provides unlimited investment opportunities. However, if you don’t follow the rules, this may lead to severe taxation or the disqualification of the IRA.
Excluded Investments & Allowable Investments
The IRS doesn’t tell you what you can invest in – only what you can’t invest in. Rather than looking at self-directed IRA allowable investments, it’s much easier to go over the excluded investments
in a self-directed IRA account. A helpful tip is to figure out what you want to invest in, and then consult with a tax-attorney or certified public accountant (CPA) to determine if they fall under the excluded investments. These include:
- Any work of art
- Any metal or gem
- Alcoholic beverages
- Rugs or antiques
- Most coins
These excluded investments fall under IRC Section 4975. IRC Section 408 goes into more detail on types of metals and coins that are permitted transactions. As does Adam Bergman’s Self-Directed IRA In A Nutshell.
Roth IRA vs Traditional IRA
A Roth IRA and a Traditional IRA are virtually the same in that they are subject to the same rules. Tax reporting requirements are also the same. A Roth IRA, however, is post-tax. In other words, you pay your taxes now. Therefore, all the money you make on your profits are tax-free.
A Traditional IRA is pre-tax. You pay your taxes later. This also means that your profits will be taxed.
Meet with an IRA specialist at IRA Financial Group today. We’ll help you set up your Self-Directed IRA with Checkbook Control.
Self-Directed IRA Services
For more information on self-directed IRA services provided by IRA Financial, join thousands who took the time to watch our short, yet informational self-directed IRA video on our services page.
Did you know?
You can generate tax-deferred income from your Self-Directed IRA LLC.