A Self-Directed IRA LLC is a type of IRA that allows the IRA holder (you) to gain control over your retirement funds, so you have the ability to self-direct the type investments that you want to make using your retirement funds. Checkbook Control will allow the manager of the IRA LLC that ability to buy real estate or make other investments by simply writing a check. With a Self-Directed IRA LLC, a special purpose limited liability company (LLC) is established and owned by the IRA (care of the IRA custodian) and managed by you or any third-party. As manager of the IRA LLC, the you will have total control over the assets to make the investments you want and understand by simply writing a check or executing a wire transfer.
Using a Self-Directed IRA LLC with “checkbook control” to make investments involves many important tax rules and guidelines that must be adhered to on an annual basis in order for the structure and investments to be respected by the IRS and not run afoul of any federal income or state tax rules.
- Your Self-Directed IRA must remain in IRS compliance or else face taxes and penalties
- It’s imperative you understand all the rules involved with investing with the plan
- Whether it’s filing tax forms, paying UBTI tax or making sure you did not perform a prohibited transaction, IRA Financial has you covered
Below is an annual checklist for your Self-Directed IRA LLC that will help you keep your structure in IRS compliance.
Annual IRA Contributions
For 2023, total IRA contributions to a Traditional or Roth IRA cannot be more than:
- $6,500 ($7,500 if you’re age 50 or older), or
- your taxable compensation for the year if your compensation was less than this dollar limit.
Traditional and Roth IRAs must be established by the tax filing deadline for the previous taxable year (without extensions). Applications postmarked by this date will be accepted.
Contributions should be made to the IRA custodian and should not be contributed first to the IRA LLC. Once the IRA contributions have been made to the custodian, you may direct them to invest the funds in the IRA LLC.
Making annual IRA contributions is a great way to build your retirement account and generate tax-deferred or tax-free gains, in the case of a Roth IRA.
IRA LLC Annual Valuation
IRS Form 5498 gives the market value of all assets and cash held within the client account for the previous year and is used for tax reporting. IRA Financial Trust, as custodian of your Self-Directed IRA will file Form 5498 with the IRS. You will receive an email at the beginning of each year that requests you to provide the fair market value of your IRA as of December 31 of the previous year.
Every IRA administrator or custodian is required to complete and file an IRS Form 5498. One of the main purposes of the form is to give the IRS access to the annual valuation of IRA funds on a year-to-year basis. IRA valuations are also needed for in-kind distributions or Roth IRA conversions. In addition, required minimum distribution (RMD) calculations are based on year-end IRA values.
IRS Form 5498 also reports your total annual contributions to an IRA account and identifies the type of retirement account you have, such as a traditional IRA, Roth IRA, SEP IRA or SIMPLE IRA. It also lets the IRS know the amounts that you roll over or transfer from other types of retirement accounts into this IRA. The “custodian” of your IRA, typically the bank or other financial institution that manages your account, will mail a copy of this form to both you and the IRS. Form 5498 requests information pertaining to the IRA account, including the name and address of the IRA custodian, the amount of any IRA contributions or distributions taken during the year and, most specifically, the value of the IRA account as of December 31 of the prior year.
IRA custodians must distribute 5498s to participants and the IRS no later than May 31 of each calendar year — a full six weeks after the income tax filing deadline. This allows you to continue making contributions to your IRA up until April 15 and have them apply to the previous tax year.
Is Your LLC in Good Standing?
Once an LLC is established for your IRA, many states will require the LLC file an annual report (many just for informational purposes) along with a fee, in many cases.
It is very important that you keep your IRA-owned LLC in good standing with the applicable state of formation. All IRA Financial clients who are enrolled in the annual compliance service will receive the relevant information necessary to keep your LLC in good standing. All LLC annual filing costs should be paid by the LLC.
Annual LLC Tax Return Filing Requirements
An LLC owned by one IRA is treated as a disregarded entity for federal income tax purposes and no federal or state income tax return is generally required to be filed. However, an LLC owned by two or more IRAs is treated as a partnership for federal and state income tax return and an IRS Form 1065 and state partnership return is required to be filed. There would generally be no tax due since an LLC is a flow-through entity for tax purposes; however, the LLC is still required to file the partnership return. The form is due by April 15 and most state partnership returns are due on that date as well. In general, every LLC owned by two or more IRAs must file IRS Form 1065, unless the LLC received no income or took any deductions for the year.
Reviewing the IRS Prohibited Transaction Rules
The Internal Revenue Code (IRC) does not describe what an IRA can invest in, only what it cannot invest in. IRC Sections 408 & 4975 prohibits disqualified persons from engaging in certain types of transactions. The purpose of these rules is to encourage the use of IRAs for accumulation of retirement savings and to prohibit those in control of IRAs from taking advantage of the tax benefits for their personal account.
The foundation of these rules is based on the premise that investments involving IRA and related parties are handled in a way that benefits the retirement account and not the IRA owner.
Who is a “Disqualified Person?”
The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest. Learn more.
Application of the IRS Prohibited Transaction Rules
In order to determine whether a proposed transaction is a prohibited transaction and violates IRC 4975, it is important to examine all the parties engaged in the proposed transaction rather than on just the IRA owner.
Pursuant to Internal Revenue Code Section 4975, a self-directed IRA is prohibited from engaging in certain types of transactions. The types of prohibited transactions can be best understood by dividing them into three categories: Direct Prohibited Transactions, Self-Dealing Prohibited Transactions, and Conflict of Interest Prohibited Transactions. To learn how those work, check out this article.
Life Insurance and Certain Collectibles
In addition to the above, pursuant to IRC Section 408(m), a Self-Directed IRA cannot Invest in life insurance contracts or collectibles defined below:
- Any work of art
- Any metal or gem
- Any alcoholic beverage
- Any rug or antique
- Any stamp
- Most coins
However, the IRS has carved out a set of exceptions to the disqualified transaction rules under IRC 408(m) for certain precious metals and coins. The following types of precious metals and coins are allowed to be purchased with a Self-Directed IRA:
- one, one-half, one-quarter or one-tenth ounce U.S. gold coins (American Gold Eagle coins are the only gold coins specifically approved for IRAs. Other gold coins, to be eligible as IRA investments, must be at least .995 fine (99.5% pure);
- one ounce silver coins minted by the Treasury Department;
- any coin issued under the laws of any state;
- a platinum coin described in 31 USCS 5112(k) ; and
- gold, silver, platinum or palladium bullion (other than bullion that is made into a coin) of a certain fineness that is in the physical possession of a trustee that meets the requirements for IRA trustees under Code Sec. 408(a).
All IRS-approved precious metals and coins should be held in the physical possession of a United Stated bank or depository and not held personally.
S Corporation Stock
Because of the shareholder restrictions imposed on “S” Corporations, an IRA cannot own stock in an S Corporation.
Overall, when looking at a potential investment with your IRA, it is important to verify that no disqualified person will be involved in the transaction or receive any benefit from such. In addition, if purchasing precious metals or coins, make sure they are IRS-approved and satisfy the requirements under IRC 408(m).
Triggering an IRS prohibited transaction can have steep tax consequences as the individual’s IRA would lose its tax exempt status and the entire fair market value of the IRA would be treated as taxable distribution, subject to ordinary income tax and penalties.
The Application of the UBTI Rules
Most people believe that when they use their retirement funds to make investments such as stocks, mutual funds, and real estate, the income and gains generated will be tax free. In most situations, they are correct. This is because an IRA is exempt from tax pursuant to IRC 408 and 512 which exempt most passive forms of income generated by an IRA from taxation. Some examples of exempt types of passive income include: interest from loans, dividends, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate.
However, in a number of instances, the Unrelated Business Taxable Income (UBTI) tax could be triggered when a retirement account engages in certain types of transactions which could turn a potential tax-free investment into a very tax-inefficient one.
The UBTI tax is triggered in three types of investment categories involving retirement accounts:
- Using margin to buy stocks or securities
- Using a nonrecourse loan to buy real estate (there is an exemption for 401(k) plans under certain conditions)
- Investing in an active trade or business operated through an LLC or pass-through entity, such as a partnership.
For 2023, the maximum tax rate of 37% is triggered at just $12,300. However, the UBTI tax rules are not triggered if less than $1,000 of income is generated by the investment at issue. For retirement accounts, the UBTI income is reported on IRS Form 990-T and the tax is due by April 15. The tax would be paid by the Self-Directed IRA.
Thinking of a Roth IRA Conversion?
For many people, the decision on whether to make a Roth IRA conversion is a difficult one. The primary advantages of making a Roth IRA conversion is that Roth IRA distributions are tax-free so long as the IRA holder is over the age of 59 1/2 and the Roth IRA has been open and funded at least five years. The downside for making the conversion is that the tax must be paid on the fair market value of the IRA account at the time of conversion.
The following is a number of items that one should consider before electing to make a Roth IRA conversion:
- Do you have the ability to pay income taxes on the money you convert from your pretax IRA?
- Based on your income tax bracket, does it make sense to pay the entire tax due in 2023? If you expect your income tax rate to go up, converting may be for you. If you think it will go down, then the opposite holds true.
- Do you anticipate withdrawing Roth IRA funds for personal use within five years of conversion? If so, you may face taxes and penalties.
- How confident are that your Roth IRA investments will be successful?
Read more: When to do a Roth Conversion – Advice from a Tax Attorney
Self-Directed IRA Custodian Fees Matter
Fees do matter! Like any services you pay for, whether personal or otherwise, you want to make sure you have a full understanding. Most custodians have a flat annual fee for administering your IRA. However, some also charge an asset valuation fee based on the value of your IRA. The more your account is worth, the more you end up paying each year.
Moreover, some custodian also impose fees per transaction, such as transfers, distributions, investments, conversions, and even for account termination. IRA Financial clients know better. Our Self-Directed IRA fee schedule is quite clear. Pay one annual fee, and that’s it.
Staying in IRS Compliance
It is vital that your Self-Directed IRA LLC structure remains up to date and in full IRS compliance in order for the structure to be respected by the IRS. To ensure that your IRA remains IRS compliant, IRA Financial is proud to offer all its clients an optional annual compliance service that gives them access to tax professionals and extensive tax filing services. Of course, this is something you can do on your own, or hire another professional.
Using a Self-Directed IRA LLC is a powerful vehicle to take greater control over your retirement future. Operating the plan is not over complex, however, it is important that every investor has a good understanding of the topics outlined above. However, since most investors are more focused on making investments and less interested in navigating the IRS rules, it’s important you work with your plan administrator or financial advisor so you can stay on track.