Can a Self-Directed IRA LLC be created in a Series LLC Cell?

17 Replies

Hi. This is my first post here on BiggerPockets and I hope someone can shed some light on a question of mine.

I am going to create a self-directed IRA (SDIRA) LLC (aka a checkbook IRA), and I have spoken with several firms in that area, e.g., uDirect, IRA Financial Group. I can't get an answer to this question: rather than paying their charge of $1,400-2,200 to create a Traditional IRA LLC plus another $1,400-2,200 to create a Roth IRA LLC, I want to create two new cell/series in a Texas Series LLC to save myself the bulk of the setup and ongoing LLC costs.

Can anyone confirm this is ok? How do I go about doing so? Are there any issues associated with using series LLC cell for this purpose that would be unique to an IRA LLC?

Thanks! P.

Why not create one single member LLC and have both of your IRAs invest in it? It sounds like the companies you are speaking to are facilitators, not IRA custodians. Their forte is setting up these LLCs and charging for their services.

You can probably set up the LLC more cost effectively yourself, using your own attorney if needed. You'd instruct your IRA custodian to invest the funds of both of your IRAs into this one LLC, they'd each hold a percentage share of ownership based on initial investment. You, as non-member manager, would control the checkbook of the LLC. Most IRA custodians who accept single member LLCs as IRA investments will require that you appoint some kind of special advisor (licensed CPA or attorney) who will review all the transactions of the LLC to make sure there are not any prohibited transactions happening.

@Doreen Chaisson

I'm sorry, but that is simply not good advice.  I hate to call another poster out, but felt I really had to here.

A partnership LLC comes with all kinds of restrictions including prohibitions on future funding and the necessity for partnership tax returns. This is something that a tax attorney who specializes in ERISA law and has specific knowledge of self directed IRA LLC structures will be aware of and able to advise a client on. A typical corporate or real estate attorney will not have that kind of knowledge and could lead a client into potential trouble.

@Patrick Plummer is not, of course, required to work with one of the specialty firms that offer checkbook IRA plans, and could work with an independent tax attorney familiar with these concepts. Often times that can end up being more expensive, however, based on the hourly rate of the attorney and how much assistance the client may require.

As to Mr. Plumber's question about a series LLC, I'm going to punt on that one. Our tax attorney is not a fan of the series LLC since it is a concept that has yet to be fully tested in the courts. It seems good in theory, but will it really stand? As such, this is not an area we have delved into at the level of detail required to answer the question at hand.

I would add that a Texas series LLC would only be beneficial if the investments were to take place in Texas. I noticed Mr. Plumber is in Pennsylvania and would not recommend a Texas LLC for real estate investments in Pennsylvania.

@Brian Eastman

are there any IRS documents you could point out that talk about prohibition on future funding in Partnership SDIRA LLCs? I was doing some research on this myself the last few days. I didn't find any information from the IRS, but found articles from several 3rd parties (custodians) that said it should be allowed. Their rational was that the only person benefiting from a further contribution were the beneficiaries of the IRA and that it should not create a prohibited transaction. That explanation doesn't necessarily make sense though, so it would be great if you know of official IRS documents on that subject.

I also contacted the company that did the paperwork for my self directed IRA LLC, MySolo401k, who can recommended by my custodian Ira Services. They said that it was OK to do future funding, as long as we would update the operating agreement to change the ownership ratio between the 2 IRA accounts if the 2 contributions were not in the same ratio as the original funding and ownership. Is this in your opinion not proper advice?

I am also a fan of using cells in my NV Series LLC for everything, and I'm not happy when banks tell me I need a stand alone LLC to get a loan from them, but for my SDIRA I also created a separate stand alone LLC, just in case, because there are no IRS rules on the subject.

Jean

Thanks for the feedback. I'm pretty sure I have the "real" answer: you CANNOT create a new cell in a Series LLC for the IRA because the owner of any cell is still the parent LLC's members (albeit with different, definable percentages based on the cell operating agreement), and that means it "touches" the owner, i.e., me.

Further, here's what uDirect answered: "You are not able to use an existing LLC. Your IRA cannot interact with any thing that you have any personal ownership of. That is why a new LLC has to be created where the IRA is the original and only owner."

Thanks again! I hope this helps someone else in the future! 

Merry Christmas to all! P.

@Jean G.

The opinion of our attorney and many others in the field is that there is a risk of creating a disqualified party transaction in altering the LLC. The two separate IRA accounts are disqualified parties to each other. The act of joint venturing the two IRA's into the LLC initially is OK, but then that LLC becomes a disqualified party to each of the underlying IRA's. Future transactions other than proportional distributions of equity in the LLC then become problematic.

It could be argued that future funding in the exact proportions as the initial funding is OK, but there is still the risk that the LLC itself is viewed as disqualified to the IRAs. Any shift in the equity balance of the LLC creates a transaction between the IRA accounts and carries significantly more risk.

There is no specific code to reference other than IRC 4975 outlining disqualified parties. This kind of interpretation comes from a depth of knowledge of the tax code and years of experience working with IRA plans and related court cases, and piecing together all the variables and interrelated components that impact such structures.

This is, arguably, a conservative interpretation. With IRA funds, the risk of being wrong is severe, so a conservative approach such as this is best.

Brian, are you saying that if my wife and I create a multi-member SDIRA LLC that pools both of our traditional IRAs into one LLC, that any subsequent contributions would need to be made at the exact same proportion? In other words, for illustration, if her initial contribution to the IRA LLC was $2,000 and mine was $1,000 (for a total of $3,000 at start), any future year's IRA contributions would need to be at the same 2:1 ratio and that we both couldn't contribute $2,000 each without risk of becoming disqualified?

Thanks for your expertise and insight here. P.

@Patrick 

We actually would not recommend the partnership LLC at all. Some others will, but we feel there is enough complication and risk that the perceived simplicity and cost savings is not realized.

It is arguable that even if you added capital in the same proportions as the initial funding, this is still a transaction between the IRA and a disqualified party (the LLC that - once formed - has equity and control interests of the other, disqualified IRA).

To fund the LLC in a disproportionate manner would much more clearly create issues. Even if the LLC operating agreement is altered, there is clearly a shift of value from one IRA to the other. If the LLC were in all cash, this may not create an issue, but with difficult to value assets in the LLC, what exactly is the shifted equity in the LLC worth?

A partnership LLC is also required to file federal and state partnership tax returns, which a single-member LLC is not. The feds recognize the underlying IRA owners as exempt, but several states would tax the partnership income. The cost of such filings diminishes the benefit of combining the IRA's into a single LLC.

Brian, great insight. 

IRA Financial argues that a Solo 401K has all the benefits of a SDIRA, assuming a person has self-employment income in order to establish it. See: http://www.irafinancialgroup.com/solo401k.php

According to their site: "A Solo 401k plan is perfect for any sole proprietor, consultant, or independent contractor. A Solo 401k plan offers the same abilities as a Self-Directed IRA LLC, but without having to hire a custodian or create an LLC. With the IRS approved Solo 401(k) Plan, roll over your existing IRA or 401(k) plan funds tax-free into a new Solo 401(k) Plan and use those funds to make tax-deferred investments, such as real estate, while also gaining the ability to borrow up to $50,000 as well as make annual plan contributions up to $59,000 – almost 10 times the amount of an IRA."

Based on this, it sounds as though this is an attraction option for my wife and I that have a part-time small business as well. We can just roll our existing funds into that and have the same checkbook control that we desire from a SDIRA...

Thoughts? Thanks! P.

@Patrick Plummer

It sounds as if you may qualify for the Solo 401k and yes, it would greatly simplify your situation.

Unlike an IRA which is an individual arrangement, a 401k is an employer sponsored retirement plan. As such, you can within the 401k have multiple individual participant accounts - one for you and one for your wife - assuming your wife is a documented employee of the business.

You could not roll a Roth IRA into such a 401k, but I think you mentioned that your funds were in a traditional IRA.

With the 401k, there are still proscribed methods for documenting and bookkeeping so as to independently value your account and that of your wife, but the ability to combine the funds for investments is much easier than in the IRA realm.

@Patrick Plummer in a former life I practiced in US Tax court, I strongly suggest if you qualify for the solo 401k go that route, and roll your ira into the solo 401k it is much more flexible in real estate transactions, and the compliance cost and reporting requirements are much less.  The SDIRA is a dinosaur compared to the solo401k.  The SDIRA have just been around longer giving them more popularity.  Go to mysolo401k.net they have lots of good info, also try 401kadm.com. Even if you currently don't qualify they can help you set up the structure of your business correctly to qualify next year.

Hope this helps, good luck  

@Brian Eastman

I am in a similar boat as @Patrick Plummer with regard to a multi-member LLC funded by two SDIRAs (one traditional, one ROTH). In my case, both SDIRAs belong to my wife, if that makes any difference. We have also been told that if we needed more money in the LLC, we could make additional contributions to the SDIRAs in the proportion of the LLC ownership of each SDIRA. I had seen this thread previously, so I asked the attorney specifically about this and he said that according to IRC 4975(d)(9), and because there is no actual financial benefit to either IRA (or the IRA owner), that this is perfectly acceptable, and that he has set up many LLCs in this manner. Do you disagree that 4975(d)(9) exempts the IRAs from being a DP to the LLC? Is there any code that outlines the true rule in this case, or are we dealing with one of those situations where it simply hasn't been ruled on yet? This is fascinating to me, especially because two educated people seem to have such strong opinions on each side.

On another note (and as an explanation as to why I want to set up my LLC this way), please look at my plan below. Please feel free to let me know if you see any pitfalls, or areas where I could/should do something differently:

Here's my plan (at a high level):

1)Open a self-directed IRA (funded by means of a traditional pre-tax IRA rollover)

2)Open a self-directed ROTH IRA (funded by after-tax cash contributions)

3)Open an LLC

i)Using a single LLC means I will not have to change the title of the property as ownership of the LLC shifts from the traditional to ROTH SDIRA (more on that below).

     ii)If I bought the property with two single member LLCs, the percentage of ownership would have to be listed on the title. The percentages will change as I move the investment into the ROTH

4)Direct the IRA custodian to invest the SDIRA and ROTH SDIRA into the LLC

i)Custodian of both SDIRAs will write checks to the LLC

ii)I will take the checks and deposit into a checking account in the name of the LLC

5)Identify/purchase a piece of property by writing a check from the LLC bank account

i)Property will be owned by, and titled in the name of, the LLC

     ii)At this point, I cannot personally benefit from the property because it is owned by an entity that is funded by my SDIRAs. To benefit in any way from this property at this point would be considered a "prohibited transaction"

6)Over the next 5 (or so) years, I will transfer the SDIRA into the ROTH SDIRA

     i)Each year, I will have to pay taxes on the amount of SDIRA I convert into ROTH SDIRA

     ii)This allows us to spread the tax burden over a several year span as opposed to getting hit with a big tax bill all at once.

7)Once the SDIRA is fully converted to ROTH SDIRA (and wife is at least 59.5 years old), she can take the property as a distribution from the ROTH IRA without any tax consequence.

I know this was a bit long. I really appreciate your opinion as I am trying to find a consensus among the many opinions I have been getting.

@Eric Tomlin

If you want to use the property personally, just buy the property with non-IRA funds. If that means taking smaller distributions of cash over a period of years rather than a lump sum, great.

What you have proposed is complex, expensive, and does have some risk associated with it. It is possible, but you would want to be working hand-in-hand with a skilled ERISA/Tax attorney all the way through the process. This is not a "setup an IRA LLC and just go invest" type of project.

There are folks who are comfortable with adding funds to a partnership LLC so long as it is done proportionally. There have not been any clear rulings on this topic and we take a conservative approach.

@Brian Eastman

If I had the funds laying around to buy the land outright, I would. But since I don't - and I don't want to take out a loan to buy the property - I figured why not use a portion of my retirement portfolio to buy it?

1) The purchase is first and foremost an investment. I intend to buy and hold the land, and do nothing to it for at least 5 to 7 years. At that point, I will re-evaluate what I do with it (as one would do with any investment).

2) I have no intention of building on or improving the land while the LLC is owned by the SDIRA. So there is no risk of prohibited transactions.

3) Once the LLC is fully owned by the ROTH IRA, if I decide that I want to build/live on the land, I can take the land as a distribution tax free. Then it is mine to do with as I wish.

4) Other than minor expenses of setting up the LLC, I don't see how this is "expensive". Can you elaborate? Is there some cost aspect that I am simply missing out on?

Thanks! I love getting input from many sources (as opposed to someone who just "yes-es" me to make me happy.

@Eric Tomlin

Each fractional Roth conversion will require appraisals.  As noted, you would want a CPA or attorney guiding you through the process and they do not work for free.

Find yourself a qualified tax attorney to discuss your plan with.  My guess is they will try to talk you out of it.