Category Archives: Self-Directed Traditional IRAs

I have heard that you can set up an self-directed IRA LLC than can invest in your own business. Is this true?

Question: Hello, I am in Austin and hoping to set up my own online business through my IRA.  I will be the sole owner.  Is this possible?  Do I need to form an LLC?  And lastly, if the business becomes profitable, would I be able to pay back the IRA and then run it as a regular business from which I can make personal use of the profits?

Answer: Thank you for your inquiry.  First let me start by reiterating what it says below, which is that we do not provide tax, legal, accounting, investment or other professional advice.  Anything I say is merely educational in nature and you should absolutely consult your own advisors.

I have been asked similar questions many times.  First, let me answer your last question.  No, if your IRA owns the business, you would not be able to pay back the IRA and then run it as a regular business from which you can make personal use of the profits, unless of course you took the LLC as a distribution from your IRA and paid taxes and, if you’re under age 59 1/2, penalties on it.  To the extent your IRA has money in it you can always take a distribution of cash, provided you are willing to pay taxes and/or penalties.

Do you need an LLC to own a business in your IRA? It depends on the business, but under most circumstances an LLC would be a good idea, simply because of all the issues that an active business has to deal with, especially if you have any employees.

Is it possible to set up an online business through your IRA where your IRA (not you) would be the sole owner?  Well, that’s the $64,000 question, as they say, isn’t it?  There are several issues with doing this.  First of all, unless the business is set up to be owned by a taxable entity such as a C corporation or an LLC which elects to be treated as a C corporation, the profits from the business would be considered Unrelated Business Income (UBI) to the IRA and as a result the IRA would owe Unrelated Business Income Tax (UBIT) on its profits.  This may take away some of the advantages you hoped to achieve by starting the business in your IRA.  You may want to review IRS Publication 598, which describes UBI in more detail.  Note that if the business pays its own income taxes (because it is a C corporation or other taxable entity), then the UBI would not pass through to the IRA.  The fact that a particular investment may cause your IRA to owe UBIT does not necessarily mean that you should not make that investment, but it certainly is a factor you will want to be very familiar with prior to entering into such an investment.

Another issue with your plan is that the IRS may consider your services to the IRA owned business to be an excess contribution to your IRA under Internal Revenue Code Section 4973, or worse, a prohibited transaction under Internal Revenue Code Section 4975.  Your question reminds me of the facts of Chief Counsel Advice No.  200917030, which may be summarized as follows:

Chief Counsel Advice (CCA) 200917030 involved a couple who formed a Roth IRA owned corporation into which they directed payments for consulting, accounting and bookkeeping services they provided to other individuals and businesses.  This was found to be a listed transaction similar to the one described in Notice 2008-4, which should have been reported by the taxpayers on Form 8886, Reportable Transaction Disclosure Statement.  The CCA said in this case, like the transaction in Notice 2004-8, the structure of the transaction purportedly allows a taxpayer or multiple related taxpayers to create a Roth IRA investment that avoids the contribution limits by transferring value to the Roth IRA Corporation comparable to a contribution to the Roth IRA, thereby yielding tax benefits that are not contemplated by a reasonable interpretation of the language and purpose of Code Sec. 408A (the Code section authorizing Roth IRAs). In this case, the value of the services provided was shifted from Taxpayers or their business to the Roth IRA Corporation when the Taxpayers provided services through the Roth IRA Corporation as employees of the Roth IRA Corporation. Furthermore, the total value of services provided by Taxpayers to clients of the Roth IRA Corporation was not received by Taxpayers in the form of salary or other compensation from the Roth IRA Corporation. As in the Notice 2004-8 transaction, Taxpayers shifted the value of income or property from Taxpayers or a business of Taxpayers to the Roth IRA Corporation, thereby purportedly avoiding the contribution limitations applicable to Roth IRAs. Taxpayers or their business engaged in transactions with the Roth IRA Corporation by providing services to clients through the Roth IRA Corporation. Value was transferred from Taxpayers or their business to the Roth IRA Corporation comparable to a contribution to the Roth IRA whenever the Roth IRA Corporation received payment from clients as a result of the services provided by Taxpayers.

The bottom line is that the IRS naturally wants to collect taxes on services you provide.  And an IRA is intended to be used for arms-length investments, not to derive a current benefit.  To the extent you change either of those basic premises you may get into trouble with the IRS if they review the transaction.

Having said this, does it mean that you cannot own a business in your IRA?  No, it does not mean that at all.  It means that you cannot provide personal services to that IRA-owned business.  In other words, the business must be an investment only.  You may of course invest in a business which you know someone else is starting, assuming the person starting the business is not otherwise a disqualified person.  Also, as mentioned above, you will want to investigate the tax structure of the business to see if it will subject your IRA to UBIT, and if it does, whether the after-tax profits you expect your IRA to receive are higher than other investments your IRA might make.

If your need is for current income, some people consider doing what the IRS refers to as a ROBS arrangement (Rollover for Business Startups).  The IRS has concerns about this set up, and you may find tons of information on the internet about these types of arrangements.  This typically involves 1) setting up a brand new C corporation, 2) appointing yourself as director and President of that corporation, 3) adopting a 401(k) plan for the corporation with you as trustee of the plan, 4) rolling your IRA into the 401(k) plan, and 5) as trustee of the 401(k) plan investing in all the shares of the corporate as employer securities.  The set up is fairly expensive, but there are many firms who offer to set up a ROBS arrangement on your behalf who swear by its legitimacy.  If you decide to go that route then by all means make sure whoever you go to for the plan is aware of the IRS’ concern and satisfy yourself that they have met those concerns.

I am aware that this information probably conflicts with a lot of the information out there on the world wide web, where anything is possible and you can avoid all these pesky prohibited transaction rules by simply starting an IRA-owned LLC, or what is sometimes referred to as a “checkbook control IRA.”  Unfortunately, the prohibited transaction rules still apply in almost all cases, and so if you cannot do it directly in your IRA then you cannot do it simply by imposing an LLC in between the IRA and the transaction.

I hope that somewhat answers your question, although I realize that such a response often creates more questions than it does give answers.  Good luck with your investments, and if you need assistance with a self-directed IRA (emphasis on the self-directed part) please feel free to let us know.

Follow Up Question: Thanks so much for your informative and thorough reply.  After researching some more, and since I don’t need that much capital, I think the best option for me is to take an annuity distribution from my IRA which apparently is not subject to the 10% penalty.

Follow Up Answer: Correct. As long as you maintain the payments for the LONGER of 5 years or until you are 59 1/2 there is no 10% premature distribution penalty. Note
that there are 3 different methods of calculating the amount of the distributions, but it’s fairly easy to find calculators online.  The key thing to know is that you cannot vary the annuity plan during the 5 years or you will have to go back and pick up the 10% penalty amount. If you can live with these restrictions, an annuity payment, or series of Substantially Equal Periodic Payments as it’s more formally known, is a great alternative.  Best of luck with your business venture.

Testimonial: Thanks again.  Your generosity in sharing your expertise amounts to altruism!

Can I invest my IRA into International Real Estate? More specifically a 300 acre orchard in Belize?

Question: Thank you for your article on IRA myths: http://www.eldr.com/blogs/its-your-ira/top-10-self-directed-ira-myths-debunked

I have a 300k self directed IRA at Schwab, but I am intrigued by a non-stock market investment alternative.

I’m aware of a 300 acre orchard for sale in Belize for 400k.  Your article mentioned that debt can be used in the IRA and then tax must be paid on the portion of the investment funded by debt.  I presume it would be prudent to borrow around 200k to fund the business with working capital.  Do you have a suggestion on the legal entity best suited for this scenario, the order in which transactions should occur, etc.  Is there a book that spells out doing this?

Answer: Thank you for your question.  I do not know of a book spelling out how to do a debt-financed transaction in a foreign country, though there are certainly books on international investing.  Typically what we see at Quest IRA is a local corporation or other entity formed to hold the investment, and the IRA owns the shares of the entity.  Of course this implies that you have someone down in Belize to manage the entity for you.

I am not sure what the banking situation is down there and whether or not you could borrow money with a 50% down payment, so that is one thing you would need to investigate.  The tax situation is another factor.  You will want to understand the local tax implications of any investment.  As far as the IRA being taxable, that does apply when either the IRA owns a business which is  non-taxed at the business owner level (i.e. either it is directly owned by the IRA or the IRA invests in a non-taxed entity such as a partnership or an LLC), or when the IRA rents personal property (rents from real property are exempt), or when the IRA owns debt-financed property either directly or through a non-taxed entity.  Depending on how you structured the transaction, it may be possible to avoid the Unrelated Business Income Tax (UBIT) if the IRA invests in a taxable entity.  More information on this topic may be found in IRS Publication 598, which is freely available at www.irs.gov, or by reviewing Internal Revenue Code Sections 511-514.  I have also attached some information for you to this email.  Of particular interest to you may be the following paragraph in the AICPA Planning article attached: (Found on www.QuestIRA.com)

Exempt organizations can also avoid the debt-financed property rules by investing in such property through a foreign corporation. In PLR 9952086, an exempt organization held 100% of the stock in a foreign corporation that invested in a foreign corporation that invested in a U.S. partnership holding debt- finance securities. The Service held that the dividends paid by the foreign corporation to the exempt organization were excluded from UBTI as dividends under Section 512(b)(2) and were not debt-financed income because the exempt organization had not incurred debt to acquire its interest in the foreign corporation.

In a series of three recent private letter rulings, the Service has again concluded that dividends received from a foreign corporation is tax-free dividend income even if the foreign corporation borrows to invest in securities. See, e.g., PLR 200251016 (Sept. 23, 2002); PLR 200251017 (Sept. 23, 2002); PLR 200251018 (Sept. 23, 2002); PLR 199952086 (Sept. 30, 1999).

Good luck with your investments, and have a great day!

Can I sell private shares of a company I invested in to my Roth IRA?

Question: I am trying to use my Roth IRA to start a llc that will purchase shares of an income producing business. This is a great investment that I currently hold in a taxable account. My plan is to sell the shares back to the business and repurchase them through the llc that my IRA owns. The returns historically average between 30-45% per year. My problem is that I only have $34,000 in the Roth and I can shift from $33,000 to $250,000 worth of shares to the Roth owned llc. I’m just wondering what is the best way to finance this and if you have any recommendations on lenders. My brother is willing to lend a non recourse loan but that seems a little risky although my interpretation is that he is not a disqualified person. I appreciate any input that you have.

Answer: Unfortunately, there are a number of problems with what you propose.  First of all, it is a violation of the prohibited transaction rules to, either directly or indirectly, sell or exchange the shares that you own in a taxable account to your Roth IRA.  Just based on the brief description in your email, it seems almost certain that your plan would violate Internal Revenue Code Section 4975(c)(1)(A), which prohibits the direct or indirect “sale or exchange, or leasing, of any property between a plan and a disqualified person.”  You will certainly want to get competent legal assistance from an attorney who is intimately familiar with the prohibited transaction rules to guide you.

As far as lenders go, the ones that I am familiar with loan against real estate assets, not shares of an LLC, so unfortunately I don’t have any lender recommendation for you.  As you know, all loans must be non-recourse to any disqualified person and to the IRA itself as well.  You are correct that your brother is not a disqualified person solely because of his status as your brother, but you are also correct in assuming that having your brother loan your IRA or your IRA owned LLC money is risky.  The problem is that all IRA transactions are supposed to be on an arms-length basis.  If the person you are dealing with is someone in whom you have an interest in which would affect your best judgment as a fiduciary for your IRA, then the transaction may still be considered to be prohibited because a benefit to that person may be deemed to be an indirect benefit to you.  This area of the law is a bit tricky, so hopefully your legal counsel will be knowledgeable enough to guide you on this issue as well.

Finally, I assume that your goal is to avoid taxes on this wonderful investment you have found.  Unfortunately, the method you have selected will not accomplish this goal, although it certainly may have other benefits.  There are 3 circumstances when an IRA, which normally enjoys tax free treatment of its gains, must pay taxes.  First of all, if the IRA owns or operates a business, either directly or through a non-taxed entity (the tax is avoided if the entity invested in is taxable).  Second, if the IRA receives rents from personal property.  And third, if the IRA owns debt-financed property.  Your proposed solution may cause taxes to be due under the first and third scenarios, depending on how you structure the transaction.  You may find out more about the topic of Unrelated Business Taxable Income (UBTI) in IRS Publication 598, or by referring directly to the Internal Revenue Code Sections 511-514.  Also, I have written a few articles on the topic which may be found on our website at www.QuestIRA.com.  If the profit from the venture is as high as you say it is, then the after tax returns should still make for a fantastic return for your Roth IRA, assuming you can overcome the other obstacles to the investment.  Good luck!

Just would like your opinion on the WSJ & SEC article about Lawsuits & Fraud over Self Directed IRA’s

Concerned Investor: Just would like your opinion on the WSJ article about Lawsuits over Self Directed IRA’s: (Read WSJ Article Here)

Is the article of immediate concern?  Is this just scam artists at work?

Also, read the article from the Securities Exchange Commission (SEC) on fraud within self-directed IRAs (Read SEC Article Here)

Question: Thoughts on question Above?  This lawsuit has scared some people for sure. Notice this article is directed at SDIRA’s and not specifically to Equity and Entrust, that could be a perception to people who do not understand. I think I should tell him to go to Quest and not worry about it, but would I love to give a little substance to relieve his concern.  Thoughts?

Answer: Regarding the article and the lawsuit, it basically is a fundamental misunderstanding of what roles the custodian and administrator play versus what role the client plays in making their own decisions.  There is no doubt that scam artists use self-directed IRAs as tools to get money.  But the question is whose role is it to police the investments that the clients choose, the client or the custodian?  The correct answer is that it is the client’s responsibility to do their due diligence on the investment and the people they are investing with.  This is very clearly spelled out in numerous places in the documents signed by every client.  And that’s why the product is called a ‘SELF-DIRECTED IRA.’

Having said this, the industry as a whole is doing as much as we can to help educate our clients and potential clients on how to avoid fraud, and of course we are setting up our own internal auditing processes as well to assess whether it is administratively feasible to handle certain investments.  However, we do not do due diligence for the clients and we do not recommend any investment or service provider.  Clearly a self-directed IRA is not for everyone, and here at Quest at least we do not pretend that it is.  We merely educate people as to what the possibilities are and then it is up to the client to decide if they want to pursue a self-directed IRA, and if they do open an account to find their own investments and do their own due diligence.

The Texas State Securities Board has come out with an explanation of self-directed IRAs which we agree with completely (the SEC issued a similar statement as well).  I have attached a copy.  At first blush you might read it to be against the use of self-directed IRAs, but really what it is saying is that you have to be careful of investment providers who may use self-directed IRAs to take your money.

Let me know if you have any further questions.  Have  a great day!

Quest IRA, Inc. Develops New Interactive Website & Social Media Campaign

Today Quest IRA, Inc., a leading provider of self-directed IRAs, released their new website improvements. Not only is there email notification for clients and online access to their IRA account, but there is a whole new section on the website called “Investment Options’ totally dedicated to understanding the process of purchasing alternative investments in your self-directed IRA.

Those interested in learning more about self directed IRAs and Quest IRA, Inc. can visit http://www.QuestIRA.com. Anyone interested in Quest’s free educational classes, webinars and networking events can call 800.320.5950 for more information.

Does the IRS look at same sex marriage the same way in determining a Prohibited Transaction?

Question: Hello Quincy, I am in a same sex marriage in California. Both I and my husband have Roth IRA’S. I want to use Quest to set up a self directed IRA and do some real estate investing.

My question is can my husband buy a HUD property and then sell me an option on it with me using my self directed IRA to pay for the option and then in turn I assign my option to an end buyer for profit without the IRS considering the transaction doing business with a disqualified person?

I see that the IRS defines a disqualified person as a spouse but the federal government does not recognize same sex marriage at this point. I understand that you may not be able to offer legal advice, but I would be interested to see your opinion on this issue.

Thank you very much for taking the time to answer.

Answer: You ask a very interesting question, but I would argue that the answer is no regardless of whether or not the federal government recognizes your marriage.  The problem is IRA transactions are intended to be on an arms length basis, and clearly a transaction with your husband would not be an arms length transaction.  He is a person in whom you have an interest which would affect your best judgment as a fiduciary for your IRA.  I presume he may also be the beneficiary of your IRA in the event of your death. You most likely have joint bank accounts and other assets.  Remember, that the prohibited transaction rules cover any direct or indirect transaction between your IRA and a disqualified person.  Either your husband is a disqualified person because your marriage is valid under state law (but I agree that there may be a problem with the IRS trying to argue that they don’t recognize your marriage for most federal purposes but want to recognize it for IRA prohibited transaction purposes) or even if he isn’t directly a disqualified person the benefits of the transaction indirectly affect and involve you, and you are a disqualified person to your IRA.  I would say the same thing to a male/female couple who lived together but were not married.  Certainly the better part of caution dictates that your IRA should not enter into transaction with your husband.  Sorry, but that’s my opinion.

Quest IRA, Inc. Names Nathan Long as CEO

As much as it pains me, LOL, today Quest IRA, Inc., a leading provider of self-directed IRAs, announced that Nathan Long has been named Chief Executive Officer (CEO) and will be relinquishing his Executive Vice President title. Nathan Long has been with Quest for the past five years and is the brother of President/Owner of Quest IRA, Inc. H. Quincy Long.

Click the image below to read the Press Release on PRWeb

How do I strucuture a multi-family real estate investment for my IRA?

Question: Hello Quincy, hope all is well with you. I need some guidance in putting a small 20 unit apartment complex deal together at around $600K. On August 1, 2012, I will be given my $105,000 401K funds that I will be transferring over to you because my company is being bought out. Is there any way for me to use these funds towards purchasing this apartment complex? I have a private investor with a 100k self -directed IRA available to me, but the bank is not going to allow a second on the property and they are going to require that the 30% come from me. I am sure that in all your daily dealings you probably see this kind of scenario pop up and that is why I need your advise in structuring this deal? I will more then likely need around 30% ($180,000) to put this deal together which I have available if I include the 401K funds. This property will be held in a LP which is already established, please let me know if there is any other information that you need.

Answer: Regarding the transfer of your 401(k), I assume you will be choosing to do a direct rollover into your IRA.  If you take the funds as a distribution and then roll them over they are required to withhold 20% and send it to the government.  If you wish to rollover the entire amount, then you would be required to pull the 20% out of your pocket and get credit on your next tax return.  Not a good idea.  With a direct rollover the check is made out directly to Quest IRA, Inc. FBO Client Name IRA #[Acccount #].  If you need help with that part, let our new accounts department know and they will be happy to guide you.

As far as the structure of the deal, mixing your personally with your IRA is going to be difficult if not impossible to do without violating the rules.  The reason for this is that you cannot benefit personally from your IRA’s investments (except of course when you take distributions from your IRA).  Also, you cannot personally guarantee any indebtedness of your IRA. This means, for example, that you cannot purchase the property in an LP owned partly by your 401(k) and partly by yourself personally, since the bank would require a personal guarantee from you for the entire loan amount.

Also, even if you found a way to get the deal done with a loan from the bank which was non-recourse (is this possible?), the investment would generate unrelated business income and your IRA may be subject to taxation.  This may be okay if the investment is profitable enough, but you do have to take the taxation into account when deciding whether or not to do the deal.  I have a couple of investments that cause my 401(k) plan to file a tax return and sometimes to pay taxes, but they are such good deals that I find the after-tax returns to be well worth it.>>

You can call me or Nathan Long anytime you like if you need more information, although Quest IRA, Inc. cannot give you tax, legal or investment advice. Have a great day & hope that helps!

Follow Up Question: Thanks for the information, I was not sure how I should do the roll over to Questira. If my final goal is to turn this 401k into a Roth Ira to grow tax free, I roll it over to Quest Ira as a distribution minus 20% to government and I am done? Then this should not effect my income taxes for 2012 since I left the 20% distribution fee behind, is this correct? I know you cannot give tax or legal advise, but I just want to know the possible consequences depending on what I decide to do with the money.

Follow Up Answer: It doesn’t quite work that way.  The amount you convert to a Roth IRA is simply added to your taxable income for the year.  For example, if you have $100,000 in taxable income in 2012 and convert $100,000, now you have to pay taxes as if you made $200,000 of taxable income.  So obviously the higher your marginal tax bracket the higher your taxes will be on the conversion.  The 20% withholding for a distribution from your 401(k) is just like a down payment on your taxes.  Ironically you are both taxed and penalized on that money that is sent to the government!  You are always better off doing a direct rollover and then next year, if you absolutely have to, you can remove some money from the Roth IRA to pay taxes on the conversion.  In this case you would still have to pay the 10% premature distribution penalty next year unless you had a Roth IRA previously and were removing your contributions and/or previous Roth conversion money that had been in the account for at least 5 years. 

Follow Up to the Follow Up: Wow!! I do not see how u keep up with this stuff, but I am glad u are able to explain it in plain English for my comprehension. I will just rollover my 401k to you and figure out what I might want to do later. Thank you so much for spending the time.

Prohibited Transaction Exemption 80-26

Question: Quincy – Just did an IRA Class in Orange County, CA with Pete.  Had 80 paid attendees which was pretty good.

Had a lady with a house owned by her IRA approached me about making a loan for her IRA.  The attached exemption says a non-recourse loan can be made by her to the IRA if she doesn’t charge interest.  But as I read it, the loan can only be for 3 days.  Do you have any experience of insight on this exemption?

Answer: Yes, I am familiar with it, at least tangentially.  You are not looking at the most current version, which I have attached.  You will note that it says:

“On December 15, 2004, the Department proposed to remove the three-day duration limit that applied to loans engaged in under PTE 80-26 for a purpose incidental to the ordinary operation of a plan. The Department recognizes that broadening the scope of the exemption in this manner would greatly benefit plans facing liquidity problems. The Department believes that plans will be adequately protected regarding such loans, i.e., loans for a purpose incidental to the ordinary operation of a plan where such loans have durations that exceed three days, to the extent the conditions of the class exemption, as amended herein, have been met. Accordingly, the Department has determined that the effective date of the amendment will be December 15, 2004; the date the proposed amendment was published in the Federal Register.”

“Section IV. Prospective General Exemption

Effective as of December 15, 2004, the restrictions of section 406(a)(1)(B) and (D) and section 406(b)(2) of the Act, and the taxes imposed by section 4975(a) and (b) of the Code, by reason of section 4975(c)(1)(B) and (D) of the Code, shall not apply to the lending of money or other extension of credit from a party in interest or disqualified person to an employee benefit plan, nor to the repayment of such loan or other extension of credit in accordance with its terms or written modifications thereof, if:
(a) No interest or other fee is charged to the plan, and no discount for payment in cash is relinquished by the plan, in connection with the loan or extension of credit;
(b) The proceeds of the loan or extension of credit are used only–
(1) for the payment of ordinary operating expenses of the plan, including the payment of benefits in accordance with the terms of the plan and periodic premiums under an insurance or annuity contract, or
(2) for a purpose incidental to the ordinary operation of the plan;
(c) The loan or extension of credit is unsecured;
(d) The loan or extension of credit is not directly or indirectly made by an employee benefit plan;
(e) The loan is not described in section 408(b)(3) of ERISA and the regulations promulgated thereunder (29 CFR 2550.408b-3) or section 4975(d)(3) of the Code and the regulations promulgated thereunder (26 CFR 54.4975-7(b)); and
(f)(1) Any loan described in section IV(b)(1) that is entered into on or after April 7, 2006 and that has a term of 60 days or longer must be made pursuant to a written loan agreement that contains all of the material terms of such loan.
(2) Any loan described in (b)(2) of this paragraph that is entered into for a term of 60 days or longer must be made pursuant to a written loan agreement that contains all of the material terms of such loan. “

I would be concerned about your lady’s proposed transaction on more than one front.  First of all, would the IRA she proposes to make a loan to be considered an “employee benefit plan?”  Secondly, could such a loan be considered to be “for a purpose incidental to the ordinary operation of the plan?” I think it’s highly likely that the answers to both of those questions would be no, and therefore the exemption would not apply.  If you read the totality of the exemption it seems clear that this is not meant to apply to an IRA borrowing funds from the IRA owner for the purchase of real estate or whatever.