When it comes to investing in options, with a Self-Directed IRA LLC, the IRS generally does not tell you what you can invest in, only what you cannot invest in. These rules are generally known as the “Prohibited Transaction” rules.
Understanding UBTI Tax Rules
In addition to the Prohibited Transaction rules, the IRS imposes a levy or tax on certain transactions involving IRA funds. Let’s say that you use an IRA fund to invest in an active business, such as a restaurant or store. This active business operates through a pass through entity (a business structure that reduces double taxation). Therefor, a percentage of net profits or income you generate by that activity may be subject to a tax. This tax is often referred to as Unrelated Business Taxable Income (UBIT or UBTI).
If you care to do more research, the UBTI rules are generally in the Internal Revenue Code Sections 512-514.
However, there is a reason that the UBTI tax rules do not impact most retirement investors. The Internal Revenue Code Section 512(b) provides a general exemption for the following categories of income by retirement account:
- Rental income
- Capital gain type transaction
Retirement investors often purchase publicly traded company stock. This gets an exempt from the UBTI tax rules.
Investing in Options through Self-Directed IRA LLC
When it comes to investing in options with a Self-Directed IRA LLC, the question then becomes whether it will trigger the UBTI rules. An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset. This is occurs at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It is a binding contract that strictly defines terms and properties.
Exclusions include gains from the lapse or termination of options to buy or sell securities from irrelevant business taxable income. However, the exclusion is not available if the organization currently engages in the business/trade of writing options. It is also not available if the options are held by the organization as inventory or for sale to customers in the course of a trade or business. So, if option trading is not operating as an active trade or business, then a Self-Directed IRA LLC for investing in options should not trigger the UBTI tax rules.