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Is a “Checkbook Control” IRA Right for You?

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  |  By Chris Shanahan, CISP®

Working for a self-directed IRA custodian, I often field questions from clients about "checkbook IRAs" or "checkbook control IRAs". I’ve helped my clients deal with a lot of difficult and complex situations over the years – everything from sophisticated investment strategies to nuanced legal issues. Without a doubt, one of the most challenging situations I encounter is the single member LLC, which is also sometimes called a "checkbook IRA" or "checkbook control IRA."

A single member LLC is a private entity that is wholly or majority owned by an IRA. Like any other IRA investment, the LLC can invest in things like real estateprivate equity and other alternative assets that are not prohibited by the IRS.

In most cases, the IRA is the sole member of the LLC, while the underlying IRA account owner is the manager. Once a bank account is established in the name of the LLC, the account owner attains access to a business checking account allowing them to access funds in the IRA directly by investing IRA funds in their LLC -- hence the term "checkbook control IRA." The IRA account owner can then direct their own IRA funds to the LLC as many times as they wish.

Investors who choose the checkbook control IRA approach usually do so because it provides them with the protection of an LLC while also giving them a bit more freedom in terms of investing. For example, the LLC can buy and sell properties without having to go through the self-directed IRA custodian each time. It also allows them to pay only one asset maintenance fee to the custodian, versus paying maintenance fees to multiple properties. For a self-directed IRA investor who owns real estate, it lets them quickly write a check from the LLC bank account to cover unexpected maintenance or repairs (as long as the property is owned by the LLC, not by the IRA directly).

However, investors who are new to this strategy should proceed with caution (and, potentially, legal assistance). Here are some of the nuances that come into play throughout the life of the single member LLC.

Risk considerations of checkbook control IRAs
Having more investment flexibility can be attractive, but it also removes some of the protections that come with working through a self-directed IRA custodian. Custodians are on the investor’s side – we want to make sure you maintain tax-advantaged status for all of your IRA assets throughout the life of the account, which is why we do a review of each asset before purchase. Without that review, the onus is on you to ensure that you’re not investing in such a way that could leave you open to IRS penalties or worse.

Forming the single member LLC
Most custodians will require that an attorney draw up the necessary paperwork to form an LLC, and with good reason. For one thing, the requirements for the language that must be used in the operating agreement are usually not known by the IRA account owner. For example, specific language regarding prohibited transactions and the application of IRS Code 4975 must be present in the documents, as well other language regarding UBTI (Unrelated Business Taxable Income) and capital contributions to the LLC. In addition, having an attorney draw up the documents associated with forming the LLC gives the client peace of mind that a professional is overseeing the development of the entity and that the process is being followed correctly.

Maintaining the single member LLC
Many IRA custodians, including PENSCO, require that the account owner hire an attorney to act as a “special advisor” to the single member LLC. This requires signing an agreement that states they will oversee the transactions of the entity, in the process ensuring that there are no prohibited transactions being committed and no UBTI being generated (and, if there is, ensuring that the tax is paid from the IRA account associated with the LLC). The attorney must also agree to provide the IRA custodian with an accurate valuation of the LLC’s holdings at least once per year.

At PENSCO, we’re very familiar with single member LLC IRAs, and we know they can carry big benefits for some investors. But for those who aren’t very familiar with the logistics of a checkbook control IRA, it pays to have a respected attorney in place in order to draw up legal documents and oversee transactions. After all, it's still an IRA and all of the IRS rules and regulations still apply.

Editor’s Note: This is an updated version of a post we originally published in July 2014. We welcome new comments and questions below.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.

PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.