IRS Rules for the IRA LLC
IRS Rules for the IRA LLC
An IRA LLC is similar to any retirement plan in that it’s created as tax-advantaged investing. If you’re familiar with the IRS rules for standard retirement accounts, those apply to a Self Directed IRA LLC as well. Let’s start by recapping the basics and then we’ll take a look at some of the other rules which an IRA LLC will frequently encounter.
- An IRA LLC is required to adhere to all standard retirement regulations.
- As opposed to a brokerage IRA, an IRA LLC has to be wary of interacting with Disqualified Persons.
- The IRA LLC account holder must be cognizant of sweat equity and not perform any services for the IRA LLC that are deemed prohibited.
Contributions to an IRA LLC
Contributions limits for an IRA LLC in 2021 are capped at $6,000, and at $7,000 if you’re 50 or older. This contribution is fully tax deductible. (However, that may change if you are also covered by a retirement plan in your workplace). Remember when making a contribution that you have to make it to your IRA account held with the Custodian, and not as a deposit into the IRA LLCs checking account.
Rollovers into an IRA LLC
Almost any retirement account can be rolled over into an IRA LLC. As long as the rollover occurs within 60 days, the account will not be charged with any tax penalties. If you’re rolling over from an existing IRA, the process starts with opening an account with a Self Directed Custodian. Then, your new Custodian should be able to walk you through the rest of the setup, including opening a checking account for your IRA LLC.
Self Directed IRA Custodian
The IRS mandates that every retirement account be held by a qualified Custodian. This could be a bank, trust company, or non-bank custodian. For an IRA LLC, you’ll need to choose a Custodian that specializes in self-directed assets. Then once you set up your Custodian account, you can proceed with creating a specialized IRA LLC and opening a checking account in its name. Once that happens, the Custodian will legally be holding your retirement account, but you’ll be able to perform transactions on your own without having to go through the Custodian.
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Legislation for all retirement accounts was crafted in such a way as to encourage saving. One of the ways in which the legislation accomplished this was by enacting the principle of Prohibited Transactions. In essence this principle prohibits you or somebody close to you from receiving benefit from the IRA before the account holder is ready to retire. This can be a very practical issue for an IRA LLC due to the fact the account holder is personally managing the IRA assets.
This is a corollary of Prohibited Transactions. A financial transaction becomes prohibited when it takes place between the IRA LLC and a Disqualified Person. Disqualified Persons include the account holder, as well as close relatives and those with a strong fiduciary interest.
Sweat Equity in an IRA LLC Asset
Obviously, in a Self Directed IRA LLC, you will be directing the investment. However, the IRS limits the kind of activities that you may perform for your retirement account. Sweat equity refers to prohibited involvement which comes via providing financially worthwhile activities for the assets owned by the IRA LLC. As a general rule, activities that fall under the category of desk management and direction would be permitted, but more physical activities like property upkeep would be forbidden. To have these activities performed, one would have to use the IRA LLC’s assets to pay a third party to do them.
UBIT in an IRA LLC
You opened a Self Directed IRA LLC so that your investments could get those great tax deferred benefits. However, there is a case where you’ll have to pay taxes now. That’s called UBIT – Unrelated Business Income Tax. This tax is applied when your IRA LLC is running an active business like a restaurant. (As opposed to a passive investment like a mutual fund). Congress enacted UBIT because they found that certain organizations were taking advantage of their tax deferred status and were using it to compete against other companies. In an effort to level the playing field, these tax advantaged organizations were made to pay similar taxes.
The assets in your IRA LLC get full tax deferral as long as the funds used to purchase them were retirement funds. However, if the asset was purchased with a mix of IRA funds and non-IRA funds, then only the portion that can be attributed to the retirement funds is entitled to the tax benefits. The non-retirement related part of the asset still has to pay regular taxes. This tax is called UDFI – Unrelated Debt Financed Income. In simple language, the percentage of the asset that was paid for with regular funds still has to pay regular taxes.
Like all retirement accounts, an IRA LLC is subject to RMDs – Required Minimum Distributions. A RMD is required to make sure that the money you saved for retirement is indeed accessible to you in your retirement years. It also allows the government a chance to collect the deferred tax bill. RMDs start when you turn 72, with the amount varying based on a number of factors. There are a number of RMD calculators online, although it’s usually easier just to ask your accountant. Sometimes RMDs can pose a challenge in a Self Directed IRA LLC as your assets may be physical and need to be liquidated.
If you’re looking to buy a larger asset with your IRA LLC, you may find that your retirement funds don’t cover the cost of the asset. In that case you’ll have to apply for a loan to cover the difference. However, it can’t just be any loan. Rather, you need to apply for a non-recourse loan. This means that you won’t be giving any personal guarantees on the loan; instead the entire responsibility of the loan will fall on the asset itself. These types of loans are not as common as a standard mortgage and often possess different terms.