Is it possible for a Self-Directed IRA to be a Multi-Member LLC? A Self-Directed IRA is not an IRS term you will find anywhere in the Internal Revenue Code; it is essentially an IRA account that is permitted to be invested in alternative assets, such as real estate, private equity, and precious metals. In other words, a Self-Directed IRA is an IRA that allows for alternative asset investments not permitted by a brokerage firm or traditional financial institution.
- The use of an LLC is popular among Self-Directed IRA investors
- A Self-Directed IRA can be a multiple-member LLC, but a partnership return must be filed annually
- Although it is permitted, most investors choose to go the single-member LLC route to eliminate the need to file the partnership return.
The Self-Directed IRA LLC
A Self-Directed IRA that uses an LLC to make investments is known as a Self-Directed IRA LLC or a Checkbook Control IRA. The use of an entity wholly owned by an IRA and controlled by the IRA owner was affirmed in the Tax Court case Swanson v. Commissioner, 106 T.C. 76 (1996), and further confirmed by the IRS in Field Service Advisory (FSA) 200128011 (April 6, 2001).
The Self-Directed IRA LLC with “checkbook control” has quickly become the most popular vehicle for investors looking to make alternative assets investments, such as rental real estate, which require a high frequency of transactions. Under the Checkbook IRA format, a limited liability company (LLC) is created, funded, and managed by the IRA holder. The Checkbook IRA allows one to eliminate certain costs and delays often associated with using a full-service IRA custodian. The structure allows the investor to act quickly when the right investment opportunity presents itself cost-effectively and without delay. In addition, using an LLC provides the IRA owner with limited liability protection as well as a higher degree of anonymity.
An LLC is essentially a hybrid entity in that it can be structured to resemble a corporation for owner liability purposes and a partnership for federal income tax purposes. An LLC offers the limited liability benefit of a corporation and the single level of taxation of a partnership.
An LLC owned by one party is known as a single-member LLC and is treated as a disregarded entity for federal income tax purposes. Whereas an LLC with two or more owners is known as a multiple-member LLC.
Members of a Multi-Member LLC will benefit from the limited liability associated with an LLC as well as the benefit of a single level of tax and the flow-through of business losses.
For tax purposes, a Multiple-Member LLC is treated as a partnership and is required to file a U.S. partnership tax return (Form 1065). If an LLC is characterized as a partnership for federal income tax purposes, the LLC’s earnings would not be subject to an entity-level tax; instead, they would “flow-through” to the members. Thus, earnings are taxed only once. In addition, LLC losses would “flow through” to the members and the members could deduct their ratable share of the losses generated. However, in the case of a Self-Directed IRA LLC, the owner of the LLC is a tax-exempt trust and, thus, does not pay income tax or have the ability to take advantage of losses.
All states require a Multiple-Member LLC to file a respective state partnership return. Just like a single-member LLC, all Multiple-Member LLC income and gains flow through to the members pro rata tax-free. In other words, the LLC is not subject to income tax and all income and gains pass through to the members for tax purposes.
Self-Directed IRA LLC – Multiple-Member
Any time an IRA invests in an LLC that has two or more owners, the LLC is treated as a Multiple-Member LLC and taxed as a partnership. It is quite common for an IRA to invest in an investment fund, real estate fund, joint venture with a third party, or even another IRA. In such cases, a partnership return IRS Form 1065 must be filed along with the respective state tax return. Since the IRA is tax-exempt and an LLC is not subject to tax, in general, all income or gains generated by an IRA from a Multiple-Member LLC would be tax-exempt. Nevertheless, the LLC must still file a partnership tax return even though no federal income is due. This is one reason many Self-Directed IRA investors would prefer to make investments using a single-member LLC as it is not required to file a federal income tax return. Of course, it is not always possible to structure a Self-Directed IRA investment as a sole investment into a single-member LLC. For example, some investors will use a separate LLC for a traditional and Roth IRA to keep both as single-member LLCs and not be required to file a partnership return.
Filing a partnership income tax return (Form 1065) is not complex and tax is not due. In fact, IRA Financial has tax professionals who can assist with this. Nevertheless, some IRA investors would prefer structuring a Self-Directed IRA investment that does not require the filing of a partnership return. The good news is that the Self-Directed IRA tax experts at IRA Financial have helped tens of thousands of IRA investors structure tax-efficient Self-Directed IRA investments.