How to Use an SDIRA to Invest Through an LLC
The Entrust Group
40+ years empowering investors to invest their retirement funds in real estate, startups, precious metals, and more.
[Originally published on The Entrust Group Blog]
How to invest with a self-directed IRA (SDIRA) through an LLC is one of the most popular questions we get in our offices. Since we know that this topic is an important part of many people’s retirement strategies, we wanted to share information and resources to help you understand how SDIRAs and LLCs can be used together to invest in alternative assets.
Investing with an SDIRA through an LLC
When considering investing through an LLC, one word makes all the difference.
Some investors invest in an LLC with their SDIRA. This means that they invest the funds in their SDIRA in a business that is structured as an LLC. An example of this might be investing in a local business that is structured as an LLC.
Investing with an SDIRA through an LLC is a very different scenario. When an investor invests through an LLC, they create an LLC which is owned by the SDIRA. The LLC then invests in alternative assets.
You might have heard these structures referred to as IRA LLCs or even “Checkbook Control LLCs.” In reality, both of these are simply names for an SDIRA that invests through an LLC.
People are often most familiar with investing with an SDIRA through an LLC for real estate, but this structure can work for any type of asset.
Benefits of Investing through an LLC
Investing through an LLC is an investment strategy that provides flexibility and several potential benefits for SDIRA holders.
Overview of Limited Liability Companies
A Limited Liability Company (LLC) is a US legal structure that combines the pass-through taxation of a partnership or sole proprietorship with the liability protection that comes with incorporation.
The hybrid structure of an LLC is more flexible than a corporation and there is much less recordkeeping and administration. LLCs are also subject to fewer regulations, and in some cases, they are allowed to choose how they are taxed.
LLCs are also important for their limited liability, which shields the owner from being personally liable for the company’s debts and obligations. In order to preserve the limited liability protection of an LLC, however, it is imperative that the LLC is set up properly and that the LLC and its members do not commingle funds.
Establishing an LLC
An LLC for investing purposes must be a newly formed entity. You cannot invest with your SDIRA through an LLC you have created previously for another purpose.
Since LLCs must be established and registered in a state, it is important to know the rules for establishing an LLC in your state. Different states also have different fees for registering an LLC.
Getting started with an LLC is pretty easy when you know the general procedure.
When an SDIRA invests through an LLC, the LLC must be set up so that the SDIRA owns 100% of the LLC. The SDIRA account holder cannot own the LLC. This would constitute a prohibited transaction and nullify the tax-advantaged status of the SDIRA. The SDIRA account holder is most often listed as the manager of the LLC.
Once the LLC is established, the LLC can open a checking account. This account is managed for the LLC by the SDIRA. If the SDIRA account holder is the manager of the LLC, then the SDIRA account holder is the person that manages the checking account. The ability to manage this checking account results in “checkbook control,” and allows the account holder to write checks on behalf of the SDIRA.
It is important, however, to always remember that the SDIRA is the owner of the LLC. No income made from the investments in the LLC can be paid into your personal accounts, and all the expenses paid out for the investments in the LLC must be paid for by the SDIRA.
Consulting with legal counsel that is familiar with LLC state laws and IRA rules is advisable in order to be sure that your documents are written with provisions to avoid prohibited transactions.
Tax Considerations
Investing with an SDIRA through an LLC doesn’t provide any additional tax advantages, but there are tax rules to keep in mind. Because an LLC is a pass-through or flow-through entity for taxation, the income passes through the LLC to the SDIRA. Since an SDIRA is a tax-deferred entity, there is no taxable event when the SDIRA purchases or sells an investment through the LLC.
Some investments in an LLC may also trigger unrelated business income tax (UBIT) or unrelated debt financed income (UDFI). There are several special circumstances that can result in UBIT, but it is most often triggered when an SDIRA generates ordinary income from a business. This, however, does not apply to passive income generated from the investment. UDFI can be triggered when your SDIRA’s investment is leveraged with debt, such as if a real estate property is financed with a non-recourse loan. In the event that UBIT or UDFI is required, as the owner of the LLC, your SDIRA may need to file a tax return. If you’d like to know more about UBIT, you can read more in depth on our UBIT and UDFI page.
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LLC Investment Options
Just like SDIRAs, LLCs are allowed to invest in any alternative investment allowed by the IRS. Alternative investment options are practically endless and include everything from real estate to precious metals, private equity, and even food trucks and horses. The only restricted investments per the IRS rules are collectibles, life insurance, and S Corporations.
Rules For Investing Through an LLC
The rules for investing with your SDIRA through an LLC are the same as the rules for investing with an SDIRA. In order to preserve the tax-advantaged status of your SDIRA, it is imperative that you avoid prohibited transactions and dealings with disqualified persons.
Disqualified persons include the SDIRA owner, any fiduciaries or family members of the SDIRA owner, as well as some business or business partners. The disqualified person list is determined by the IRS, and it is important to pay close attention to the details of the list when transacting with your SDIRA.
Prohibited transactions are transactions between an IRA and a disqualified person that benefits the disqualified person. These transactions can include selling or leasing a property, providing credit or a loan, providing goods or services, or any other interaction or transfer of assets that benefits a disqualified person.
Understanding prohibited transactions and making sure your LLC and SDIRA avoid dealings with a disqualified person is an important part of self-directing your accounts. In the event that these rules are not followed, SDIRA owners jeopardize the tax-advantaged status of the SDIRA and may be subject to paying both taxes and penalties. Consequently, it’s important to learn the ins and outs of the rules and be sure to consult with your legal and financial advisors.
Investing with Your SDIRA through an LLC at Entrust
You can begin investing with your SDIRA through an LLC as soon as you have established and funded all the necessary accounts.
Entrust exists to make investing with self-directed accounts accessible so that you can plan the retirement of your dreams. The IRS requires that self-directed accounts be administered by a custodian to ensure that all the recordkeeping for the accounts meets the IRS guidelines, and for over 40 years, we have been administering self-directed accounts for investors who invest in alternative investments.
Although we do not establish LLCs and we cannot give advice about investments, we are here to serve as the administrator of your SDIRA. While we always advise that you consult with your financial advisors and legal counsel when investing, it is particularly important when setting up and investing through an LLC to be sure that everything is done properly. If you are looking for someone to help you get started, check out this list of providers some of our clients have used in the past.
SDIRA and LLC FAQs:
1. What is a self-directed IRA LLC?
Investing with a self-directed IRA (SDIRA) though an LLC is an investment strategy that allows SDIRA holders to invest in alternative assets via a pass-through entity, the LLC,owned by the SDIRA. Often SDIRA investors will use this structure to purchase real estate or potentially reduce fees when holding multiple assets. This structure gives an SDIRA holder checkbook control which allows the account holder to complete faster transactions by writing checks for the SDIRA rather than waiting on the SDIRA provider to issue a check.
2. What is checkbook control?
"Checkbook Control" is the term used when a self-directed IRA owner has complete signing authority over an account that gives access to his/her retirement funds. This strategy is achieved through the establishment of an LLC owned by the SDIRA.
3. What can my SDIRA invest in through an LLC?
The LLC can hold any alternative investment allowed by the IRS. The options for alternative investments are almost unlimited, but the IRS prohibits collectibles, life insurance, and S corporations.
4. Can Entrust establish my LLC?
No. We do not establish LLCs for our clients. You may want to consult with financial and legal professionals that are familiar with LLC state laws and IRA rules when creating an LLC to be sure that your documents are written with provisions to avoid prohibited transactions. If you need help getting started, you can consult this list of providers that has been used by Entrust clients.
5. How do you invest through an LLC with an SDIRA?
In short, you need to establish a new LLC owned 100% by your SDIRA. As the SDIRA account holder, you can be listed as the manager of the LLC. The LLC then opens a checking account. Once Entrust has received your LLC’s operating agreement and your SDIRA is funded, we can issue a check from the SDIRA to the LLC’s checking account. When the LLC checking account is funded, the LLC can begin investing.