Self-Directed IRA LLC Investments
A Self-Directed IRA LLC offers one the ability to use his or her retirement funds to make almost any type of investment on their own without requiring the consent of any custodian or person. The IRS and Department of Labor only describe the types of investments that are prohibited, which are very few.
The foundation of the prohibited transaction rules are 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. The rules prohibit transactions between the IRA and certain individuals known as “disqualified persons”. The outline for these rules can be found in Internal Revenue Code Section 4975. In general, 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.
The following are some examples of types of investments that can be made with your Self-Directed IRA LLC
- Residential or commercial real estate
- Domestic of foreign real estate
- Raw land
- Foreclosure property
- Mortgages
- Mortgage pools
- Deeds
- Private loans
- Tax liens
- Private businesses
- Limited Liability Companies
- Limited Liability Partnerships
- Private placements
- Precious metals and certain coins
- Stocks, bonds, mutual funds
- Foreign currencies
Real Estate
The IRS permits using a Self-Directed IRA LLC to purchase real estate or raw land. Since you are the manager of the Self-Directed IRA LLC, making a real estate investment is as simple as writing a check from your Self-Directed IRA bank account. The advantage of purchasing real estate with your Self-Directed IRA LLC is that all gains are tax-deferred until a distribution is taken (pre-tax 401(k) distributions are not required until the IRA holder turns 70 1/2). In the case of a Roth Self-Directed IRA, all gains are tax-free.
For example, if you purchased a piece of property with your Self-Directed IRA LLC for $100,000 and you later sold the property for $300,000, the $200,000 of gain appreciation would generally be tax-deferred. Whereas, if you purchased the property using personal funds (non-retirement funds), the gain would be subject to federal income tax and in most cases state income tax.
Self-Directed IRA Tips:
- The deposit and purchase price for the real estate property should be paid using Self-Directed IRA LLC funds or funds from a non-disqualified third-party
- No personal funds or funds from a “disqualified person” should be used
- All expenses, repairs, taxes incurred in connection with the Self-Directed IRA real estate investment should be paid using retirement funds – no personal funds should be used
- If additional funds are required for improvements or other matters involving the real estate investments, all funds should come from the Self-Directed IRA or from a non “disqualified person”
- If financing is needed for a real estate transaction, only non-recourse financing should be used. A non-recourse loan is a loan that is not personally guaranteed and whereby the lender’s only recourse is against the property and not against the borrower.
- With a Self-Directed IRA the use of a non-recourse loan would be subject to tax pursuant to Internal Revenue Code Section 514, which would not be the case with a Solo 401(k) Plan. This provides a very exciting investment opportunity for a self-employed individual or small business owner who is eligible for a Solo 401(k) Plan.
- No services should be performed by the IRA holder or “disqualified person” in connection with the real estate investment. In general, other then typical trustee type of services (necessary and required tasks in connection with the maintenance of the plan), no active services should be performed by the plan participant or a “disqualified person” with respect to the real estate transaction.
- Title of the real estate purchased should be in the name of the Self-Directed IRA LLC. For example, if Joe Smith established a Self-Directed IRA LLC and named the LLC XYZ, LLC, title to real estate purchased by Joe’s Self-Directed IRA LLC would be as follows: XYZ LLC
- Keep good records of income and expenses generated by the real estate investment
- All income, gains or losses from the Self-Directed IRA LLC real estate investment should be allocated to the IRA
- Make sure you perform adequate diligence on the property you will be purchasing especially if it is in a state you do not live in
- Make sure you will not be engaging in any self-dealing real estate transaction which would involve buying or selling real estate that will personally benefit you or a “disqualified person”
Tax Liens
The IRS permits the purchase of tax liens and tax deeds with a Self-Directed IRA. By using a Self-Directed IRA to purchase tax-liens or tax deeds, your profits are tax-deferred back into your retirement account until a distribution is taken (pre-tax IRA distributions are not required until the Plan Participant turns 70 1/2). In the case of a Roth Self-Directed IRA, all gains are tax-free.
More importantly, with a Self-Directed IRA, you, as manager of the Self-Directed IRA LLC, will have “checkbook control” over your retirement funds allowing you to make purchases on the spot without custodian consent. In other words, purchasing a tax-lien or tax deed is as easy as writing a check!
Self-Directed IRA Tips:
- The deposit and purchase price for the tax lien should be paid using Self-Directed IRA funds or funds from a non-disqualified third-party
- No personal funds or funds from a “disqualified person” should be used
- A check from the Self-Directed IRA account should be taking to auction or used for the tax lien purchase – no personal check or cash should be used
- No credit card should be applied for in the name of the Self-Directed IRA as that would violate the IRS prohibited transaction rules. A pure debit card is allowable
- All income, gains or losses from tax lien investments should be allocated to the Solo 401(K) Plan
Choosing The Right Self-Directed IRA Depends On What You Want To Own
Loans & Notes
The IRS permits using IRA funds to make loans or purchase notes from third parties. By using a Self-Directed IRA to make loans or purchase notes from third-parties, all interest payments received would be tax-deferred until a distribution is taken (pre-tax IRA) distributions are not required until the Plan Participant turns 70 1/2). In the case of a Roth Self-Directed IRA, all gains are tax-free.
For example, if you used a Self-Directed IRA to loan money to a friend, all interest received would flow back into your Self-Directed IRA tax-free. Whereas, if you lent your friend money from personal funds (non-retirement funds), the interest received would be subject to federal and in most cases state income tax.
Self-Directed IRA Tips:
- The loan or note amount should be paid using Self-Directed IRA funds or funds from a non-disqualified third-party
- No personal funds or funds from a “disqualified person” should be used in the loan transaction
- The loan or note should not involve a “disqualified person” directly or indirectly
- The loan or note should have a stated interest rate of at least Prime as per the Wall Street Journal, which is 5.50% as of August 30, 2022
- All interest and principal associated with the loan or note should be allocated to the Self-Directed IRA
- It is good practice to have the loan terms documented in a promissory note or loan agreement
- If you will be acting as the lender, consider securing the loan with an interest or lien in an asset owned by the borrower
- Make sure you will not be engaging in any self-dealing loan transaction which would involve a loan or note that will personally benefit you or a “disqualified person”
Private Businesses
With a Self-Directed IRA you are permitted to purchase an interest in a privately held business. The business to be purchased can be any entity other than an S Corporation (i.e. limited liability company, C Corporation, partnership, etc.). When investing in a private business using 401(k) funds, it is important to keep in mind the “Disqualified Person” and “Prohibited Transaction” rules under IRC 4975 and the Unrelated Business Taxable Income rules under IRC 512.
Self-Directed IRA Tips:
- The deposit and purchase price for the business should be paid using Self-Directed IRA or funds from a non-disqualified third-party
- No personal funds or funds from a “disqualified person” should be used to purchase the business
- The purchase of the stock or assets of the business should not directly or indirectly benefit the plan participant personally or any “disqualified person”
- The purchase of a business operated via an LLC or partnership will potentially trigger the Unrelated Business Taxable Income rules under IRC 512 and a corresponding tax of approximately 40% for 2018 would be applied
- Stock of an S Corporation should not be purchased with retirement funds as the S corporation rules only allow individuals to be S Corporation shareholders
- The purchase of stock of a C Corporation would not trigger the application of the Unrelated Business Taxable Income rules under IRC 512
- All income, gains or losses from the purchased business should be allocated to the Self-Directed IRA
- The plan participant or any “disqualified person” should not have any ownership in the business being purchased and should not directly or indirectly personally benefit from the acquisition
- Make sure to perform adequate diligence on the business you will be purchasing or investing in especially if you will be buying the stock/interests and not the assets
- Make sure you will not be engaging in any business acquisition transaction which would involve buying or selling a business that will personally benefit you or a “disqualified person”
Precious Metals & Coins
The Self-Directed IRA structure allows for investments into precious metals and certain coins. The advantage of using a Self-Directed IRA to purchase precious metals and/or coins is that their values generally keep up with, or exceed, inflation rates better than other investments. In addition, IRS approved metals or coins, as defined under Internal Revenue Code Section 408(m) should be held an an approved depository or U.S. Bank.
Self-Directed IRA Tips:
- Only IRS approved metals or coins (bullion) may be purchases as per Internal Revenue Code Section 408(m)
- The IRS approved precious metals or coins being purchased by the plan should be paid using Self-Directed IRA funds or funds from a non-disqualified third-party
- With respect to IRS approved precious metals or coins(bullion), the metals or coins should not be held in the personal possession of any individual
- With respect to the IRS approved precious metals or coins outlined in Internal Revenue Code Section 408(m), the bullion must be held in the “physical possession” of a U.S. depository or at a U.S. bank
- An affidavit signed by the trustee of the plan confirming that the IRS approved precious metals or coins are being purchased and being held in the sole interest of the retirement account is good practice
- All income, gains or losses from the purchased precious metals or coins should be allocated to the Self-Directed IRA
- IRS approved precious metals or coins should not be held at a bank outside the United States
- Perform adequate diligence on the dealer with which you will be transacting with for the purchase of IRS approved metals or coins
Foreign Currencies
The IRS does not prevent the use of IRA funds to purchase foreign currencies, including Iraqi Dinars. In fact, the Self-Directed IRA Plan structure permits the purchase of foreign currencies. Many believe that foreign currency investments offer liquidity advantages to the stock market as well as significant investment opportunities.
By using a Self-Directed IRA to purchase foreign currencies, such as the Iraqi Dinar, all foreign currency gains generated would be tax-deferred until a distribution is taken (pre-tax IRA distributions are not required until the Plan Participant turns 70 1/2). In the case of a Roth Self-Directed IRA, all gains are tax-free.
Self-Directed IRA Tips:
- Make sure you have a solid background in trading currencies – high volatile and significant risk
- If you will be investing with a third-party, perform adequate diligence on the individual and make sure the individual has the knowledge to trade foreign currencies and all his/her securities licenses are in good standing.
- Beware of leverage – it is allowable but it would trigger the application of the Unrelated Business Taxable Income rules under IRC 512 and thereby a corresponding tax
- No personal guarantee of any leverage or loan obligation is permitted
- All income, gains or losses from the foreign currency transactions should be allocated to the Self-Directed IRA
Stocks, Bonds, Mutual Funds, CDs
In addition to non-traditional investments such as real estate, a Self-Directed IRA may purchase stock, bonds, mutual funds, and CDs. The advantage of using a self-directed IRA is that you are not limited to just making these types of investments. With a Self-Directed IRA with “checkbook control” you can open a stock trading account with any financial institution as well as purchase real estate, buy tax liens, or lend money to a third-party. Your investment opportunities are endless! When purchasing stocks or securities with a Self-Directed IRA, all income and gains, including dividends, would flow back to the plan without tax. With a Roth Self-Directed, all gains are tax-free. Whereas, if you purchased stocks with personal funds, all income and gains would be subject to federal and in most cases state income tax would be subject to federal and in most cases state income tax.
Self-Directed IRA Tips:
- If you will be investing with a third-party, perform adequate diligence on the individual and make sure the individual has the knowledge to trade stocks or securities and all his/her securities licenses are in good standing.
- Beware of promoters who are promising high returns and that do not work at reputable financial institutions – high likelihood of fraud
- Beware of leverage – it is allowable but it would trigger the application of the Unrelated Business Taxable Income rules under IRC 512 and thereby a corresponding tax
- No personal guarantee of any leverage or loan obligation is permitted
- Open up a brokerage account in the name of the Self-Directed IRA – not a personal account
- All income, gains or losses from the stock investments should be allocated to the Self-Directed IRA
