LLC vs IRA LLC - what's the difference? - Posted by Penny

import · May 25, 2007, 11:20am

Posted by JOHN HASLACH, CPA, MST on June 08, 2007 at 09:27:46:

John, the UBIT sections are not easy reading. They begin at IRC Section 512. Check out this site: http://www.law.cornell.edu/uscode/26/usc_sup_01_26_10_A_20_1_30_F_40_III.html. I can’t confirm it is current (I use an online service), but the IRS Pubs are the easiest reading. If there is a mortgage on the property (which most real estate will have), the rental income is subject to the UBIT.

Flipping properties is not considered rental real estate by the IRS, but ordinary income and is subject to UBIT regardless of whether there is a mortgage.

import · May 25, 2007, 11:20am

LLC vs IRA LLC - what’s the difference? - Posted by Penny

Posted by Penny on May 25, 2007 at 11:20:31:

I am looking at using self directed IRA funds to invest in real estate by having my IRA as the sole member of an LLC and myself as manager. I know there are strict rules to follow regarding self dealing and prohibited transactions, UBIT taxes for leverage, etc. Otherwise, you risk the IRA being considered to be distributed and the subsequent tax consequences.

I have found websites that advertise an “IRA LLC” and they state that there needs to be special language when the LLC entity is set up. I have found no info on what the special language is, yet the formation fees are significantly higher than what I paid for the normal LLC that I use for real estate investing.

They refer to the Swanson v. Commissioner case ruling but this case involved a C-corp, not an LLC. So I am confused.

Can anyone tell me what the difference is between the normal LLCs we all know and love versus this “special” IRA LLC? There is a significant cost difference for the formation on the websites I’ve found to date.

thanks!

import · May 26, 2007, 1:03pm

Re: LLC vs IRA LLC - what’s the difference? - Posted by Rich-CA

Posted by Rich-CA on May 26, 2007 at 13:03:07:

You cannot manage any entity that controls your IRA funds. You must have a trustee do this for you (you direct him, he directs the LLC). If you are manager of an LLC, then any IRA funds it received will be taxable and penalties may be assigned for early withdrawal.

The whole difference is in the “arms length” treatment required for funds in a qualified retirement plan.

import · May 26, 2007, 4:05pm

LLC mgr vs. trustee - Posted by John Merchant

Posted by John Merchant on May 26, 2007 at 16:05:26:

If the LLC is owned 100% by the IRA owner and/or himself and other disqualified family members, then no, he could not personally be the LLC manager.

No “trustee” would be doing the LLC management as the trustee has a different role and is that co. charged with safekeeping and seeing that the IRA funds are used as per applicable law…Entrust, Pensco, et al… and the job of managing an LLC is designated by state statutes as “manager” or managing member.

import · May 27, 2007, 6:37pm

What about Swanson v. Commissioner? - Posted by Penny

Posted by Penny on May 27, 2007 at 18:37:47:

Please help me understand where I’ve misunderstood things. I’m not an attorney and I don’t play one on TV.

I read Swanson V. Commissioner. It basically ruled that an IRA could own a company (a C-corp in this case) with the IRA beneficiary as manager. One important distinction was that the manager could not receive any benefits (salary or other compensation), whatsoever, for services as manager in order to avoid the arms length/self dealing situations. Only the IRA benefitted in this case through the receipt of corporate dividends and was the sole shareholder upon the corporation’s formation, so how the corp was formed also seemed relevant. The IRS challenge of prohibited transactions was ruled invalid for this portion of the case.

As we all know, there are custodian/trustees out there that will allow a truly self directed IRA to invest in real estate and that IRS rules need to be followed to avoid prohibited transactions/disqualified persons involvement. The main issues that arise with using the trustee are timeliness in processing investment requests and fees for doing so.

What I have seen outlined in Diane Kennedy/Dolf de Roos book, “The Insider’s Guide to Tax-Free Real Estate Investments - Retire Rich Using Your IRA”, is the use of an IRA LLC. Your trustee is instructed to invest in the IRA LLC where the IRA is the sole member, then you as the manager have checkbook control of the invested funds to purchase allowable investments for the benefit of the IRA. It reduces trustee fees for writing checks, etc. and allows more timely action when you make offers on real estate.

This is discussed in some depth in chapters 9 and 10 of the book. It is also sometimes referred to as a checkbook IRA, checkbook control, etc. and there are various online companies that offer this with fees all over the map.

It seems that the Operational Agreement for the IRA LLC needs to have “special language” to address prohibited transactions, disqualified persons and other formation stuff, and that is my fundamental question. What is this special language needed?

Or where am I wrong with this?

Thanks for your help and patience, as I do not want to foul up my IRA.

import · May 26, 2007, 4:29pm

Re: LLC mgr vs. trustee - Posted by Rich-CA

Posted by Rich-CA on May 26, 2007 at 16:29:24:

I think his question was if the LLC was owned by the IRA, then could he be the manager in a manager managed LLC. The answer is no, because he is a disqualified person because he owns the IRA.

import · May 27, 2007, 8:20pm

Swanson v. Commissioner etc. - Posted by John Merchant

Posted by John Merchant on May 27, 2007 at 20:20:24:

It seems you have a pretty good grasp of the SDIRA/LLC raisons d’etre including “check book control”, etc. and I can’t fault your logic or conclusions.

As to your basic question as to “special language” required in SDIRA owned LLC, I’m going to duck that one.

Since this calls for personal legal advice, pertaining to a particular legal situation and LLC, I feel it’s inappropriate for me to even begin to render or get into that legal advice on any one person’s IRA and LLC.

I could recommend some lawyers around the country whose legal advice I’d trust.

import · May 26, 2007, 8:18pm

You are right - Posted by John Merchant

Posted by John Merchant on May 26, 2007 at 20:18:20:

I did misread your reply and what you said was accurate.

The more complete answer to his question would probably be that he couldn’t be the Mgr if he and his lineal family owned that LLC 100%…but if he and they owned 95% or less and an outsider or two owned the remaining portion than yes he might legally be the mgr of same.

And as you correctly said, he could never be his own Trustee, and not Mgr either of that LLC since he said he and his lineal family owned the whole IRA.

This caught my eye because just earlier today I was briefing this issue of when might a SDIRA owner be his own Mgr…and satisfied myself that he could IF he and his family didn’t own the whole thing.

import · May 27, 2007, 10:44pm

Re: Swanson v. Commissioner etc. - Posted by Penny

Posted by Penny on May 27, 2007 at 22:44:26:

I would greatly appreciate the referrals, as my regular business attorney was unfamiliar with this and unable to provide a referral.

Thank you!

import · June 7, 2007, 10:14am

RE Investing w IRA money may be subject to TAX! - Posted by JOHN HASLACH, CPA, MST

Posted by JOHN HASLACH, CPA, MST on June 07, 2007 at 10:14:39:

If you are flipping with IRA money, the income/gain is definitely subject to tax. If you own and rent, and there is a mortgage, it is subject to tax. See IRS Pub 598. http://www.irs.gov/pub/irs-pdf/p598.pdf

import · June 7, 2007, 6:08pm

Re: RE Investing w IRA money subject to TAX! - Posted by Penny

Posted by Penny on June 07, 2007 at 18:08:32:

Thanks - I found that, as well. Oh, the joys of reading IRS publications ;-). In addition, the taxable income appears to be taxed at the higher trust rates, not corporate rates, as well.

Definitely something to factor into investment returns on this type of deal.

import · June 7, 2007, 10:35am

UBIT - Posted by John Merchant

Posted by John Merchant on June 07, 2007 at 10:35:38:

Yes, as John H says, an IRA that has a mtg on a property is subject to some tax on internal gains as per UBIT rules and regs.

import · June 8, 2007, 5:43am

Re: RE Investing w IRA money subject to TAX! - Posted by JOHN HASLACH, CPA, MST

Posted by JOHN HASLACH, CPA, MST on June 08, 2007 at 05:43:12:

I find who sell the idea of investing in Real Estate with IRA money don’t tell you that part.

import · June 7, 2007, 11:40am

Re: UBIT - Posted by JOHN HASLACH, CPA, MST

Posted by JOHN HASLACH, CPA, MST on June 07, 2007 at 11:40:33:

John, I also know of investors who are using IRA money to flip properties. Flipping properties is ordinary income and it is all subject to UBIT.

import · June 8, 2007, 9:09am

Re: UBIT - Posted by John Merchant

Posted by John Merchant on June 08, 2007 at 09:09:53:

John I had trouble linking to the IRS Pub. you mention.

So would you please give us the cites, either IRS Laws or Regs (or DOL, since it’s the rule maker now on IRAs) on what such a taxable “flip” would be, time-wise?

How long does a property have to be held in order to legally avoid UBIT?

It’s entirely logical of course that if an IRA is running a business of any kind, including quick flipping properties, it would be subject to UBIT…but the mere making of a profit or gain within an IRA would not be subject to UBIT without further considerations such as taking a mortgage or running a business.