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Is the Self-Directed IRA LLC Legal?

The Self-Directed IRA Structure has been in use for some 35 years, however, the concept of using an entity owned by an IRA to make an investment was first reviewed by the Tax Court in Swanson V. Commissioner 106 T.C. 76 (1996). In Swanson, the Tax Court, in ruling against the IRS, held that the funding of a new entity by a retirement account, such as an IRA for self-directing assets was a permitted transaction and not prohibited pursuant to Code Section 4975. The Swanson Case was later affirmed by the IRS in Field Service Advice Memorandum (FSA) 200128011. In FSA 200128011, the IRS, in providing guidance to IRS agents for purposes of conducting audits, confirmed the Tax Court’s holding in Swanson and held that a newly established entity owned by an IRA and managed by the IRA owner may make investments using IRA funds without violating the prohibited transaction rules under Internal Revenue Code Section 4975.

In addition to the Tax Court confirming the validity of using retirement funds to invest in a wholly owned entity and managed by the IRA holder to make investments, the IRS in IRS Field Service Advice (FSA) Memorandum 200128011 confirmed the ruling of Swanson that held that the funding of a new entity by an IRA for self-directing assets was not a prohibited transaction pursuant to Code Section 4975.

An FSA is issued by the IRS to IRS field agents to guide them in the conduct of tax audits.

The significance of FSA 200128011 is that the IRS confirmed the Tax Court’s ruling in Swanson, which ruled against the IRS. Like Swanson, the FSA advised IRS agents conducting audits that the creation and ownership of a new entity by an IRA for investment purposes would not be considered a prohibited transaction under Code Section 4975. Furthermore, the IRS established that the payments of dividends by an IRA owned entity to an IRA would not constitute a prohibited transaction. Like the Tax Court in Swanson, the IRS concluded that an investment into a newly established entity to make IRA investments would not be a prohibited transaction pursuant to Internal Revenue Code Section 4975. The IRS, in confirming the Tax Court’s ruling in Swanson, seemed to suggest that the focus on whether a transaction is prohibited pursuant to IRS rules should be examined based on how IRA funds are invested not on the structure used to effect the investment. In other words, the type of investment made with IRA funds once contributed to the newly formed entity will determine whether the transaction is prohibited under Internal Revenue Code Section 4975, not the vehicle that was used to make the investment.

Conclusion

In light of Swanson and IRS FSA 200128011, the formation and funding of a new entity by an IRA for purposes of making investments in it should not be considered a prohibited transaction under Internal Revenue Code Section 4975.  There are close to hundred thousand self-directed IRA LLC structures in existence.  The IRS is well aware of the popularity of the Self-Directed IRA LLC structure and after conceding the fact the an IRA can use a wholly owned entity to make investments as it did in the Swanson case, it later confirmed and validated the structure in FSA 200128011.  Accordingly, since 1993, the IRS has never argued the validity of the self-directed IRA LLC structure and in fact instructed its IRS agents on its validity in 2001.

To learn more about the advantages of using a self-directed IRA LLC to make investments, please contact a tax professional at 800-472-0646.

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Posted in Self-Directed IRA