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Lane
Lane, JD, CFP, MBA, CRPS
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Experience:  Providing Financial, Tax & Business advice since 1986
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Are "checkbook IRAs" legal? Advisable?

Resolved Question:

Are "checkbook IRAs" legal? Advisable?
Submitted: 1 year ago.
Category: Finance
Expert:  Lane replied 1 year ago.

NPVAdvisor :

Hi,

NPVAdvisor :

Yes, they CAN be, (1) if you're staying within what the intended use is (2) you are using an IRA custodian that stays away from the hype and lays out well (and helps you watch, going forward) what can be done without running afounl of the IRA prohibted transactions rules

NPVAdvisor :

YOu also have to weigh the pros and cons ... If you're looking at using for reals-estate rentals, for example, you'll be giving up current deductions such as depreciation and rental expenses like upkeep and maintenance ... Also, you'll lose the benefit of the lower capital gains rate (actually there won't be ANY capital gains while inside the IRA... but once you start distributing anything from the IRA during retirement, it's ALL ordinary income

Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 4167
Experience: Providing Financial, Tax & Business advice since 1986
Lane and 4 other Finance Specialists are ready to help you
Customer: replied 1 year ago.
Ok, thanks. I'm intending to buy a commercial building by setting up a IRA LLC and moving money from four existing self-directed IRA and 401k accounts to part-fund the purchase. The balance will be funded by me, ie, the building will be owned by a partnership of me and my checkbook IRA. Everything - costs, rents, etc - will be divided up prorata. All IRA matters will go through the IRA, none will go through me, and I will not benefit in any way (except as the IRA holder.)

Does that sound do-able?
Expert:  Lane replied 1 year ago.

Thanks for the accept, but generally, yes.

The only thing I'd check on is the "self-dealing" rules around IRA prohibited transactions... I'm honestly not sure about the partnership issue

See this: http://www.trustetc.com/new/rules-and-regulations/plain-english/self-dealing.html

Also, remember that some of the deductions that are normally there with real estate like depreciation, maintenance and upkeep won't be there inside an IRA.

Also, even though you will get tax DEFERRAL of any gains (on the outside you'll get that lower capital gains rate) once you finally start distributing from the IRA it's all ordinary income ...

... and of course there's the additional 10% penalty for distributions prior to age 59 and 1/2.

Thanks again,
Lane
Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 4167
Experience: Providing Financial, Tax & Business advice since 1986
Lane and 4 other Finance Specialists are ready to help you
Customer: replied 1 year ago.
Ok, all good info.

I will be ultra-careful not to self-deal at all;
I will check out partnerships in detail (I believe it can be done, it's just got to be done right;)
Yep, no depreciation deduction (makes sense as there's no tax to deduct it from - but I think maintenance and upkeep can be paid out of the IRA a/c?;)
Yep, distributions are taxable except Roth IRAs; and
Yep, I have no intention of early distributions and hopefully no need!

Thanks!
Expert:  Lane replied 1 year ago.


Sounds good then.

And, you said, "Yep, no depreciation deduction (makes sense as there's no tax to deduct it from - but I think maintenance and upkeep can be paid out of the IRA a/c?;)"

Right, just not a tax deduction now.



G'luck!

Lane
Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 4167
Experience: Providing Financial, Tax & Business advice since 1986
Lane and 4 other Finance Specialists are ready to help you
Customer: replied 1 year ago.
Not to reopen the topic, but IRS 590 says, "Fiduciary: For these purposes, a fiduciary includes anyone who does any of the following.
Exercises any discretionary authority or discretionary control in managing your IRA or exercises any authority or control in managing or disposing of its assets.

Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so.

Has any discretionary authority or discretionary responsibility in administering your IRA."

A little worrying, as it sounds like that's exactly what I would be (which is not allowed...)
Expert:  Lane replied 1 year ago.



A fiduciary IS one of the disqualified persons, but you have to go a step further and then look at the things that a disqualified person cannot do.




The kinds of thing's you'll be doing simply make it a self-directed IRA ....

Here's a list of the kinds of things that a disqualified person CAN'T do:

(If you make it through this list most likely you'll be fine)




From: http://www.irafinancialgroup.com/prohibitedtransactions.php

Direct Prohibited Transactions

Subject to the exemptions under Internal Revenue Code Section 4975(d), a “Direct Prohibited Transaction” generally involves one of the following:

4975(c)(1)(A): The direct or indirect Sale, exchange, or leasing of property between an IRA and a “disqualified person”

Example 1: Jack sells an interest in a piece of property owned by his IRA to his son.

Example 2: Judy leases real estate owned by her IRA to her father.

Example 3: Brian uses his IRA funds to purchase an LLC interest owned by his son.

4975(c)(1)(B): The direct or indirect lending of money or other extension of credit between an IRA and a “disqualified person”

Example 1: Keith lends his wife $10,000 from his IRA.

Example 2: Amy personally guarantees a bank loan to her IRA.

Example 3: Peter uses IRA funds to lend an entity owned and controlled by his mother $60,000.

4975(c)(1)(C): The direct or indirect furnishing of goods, services, or facilities between an IRA and a “disqualified person”

Example 1: Eric buys a piece of property with his IRA funds and hires his father to work on the property.

Example 2: Marilyn buys a home with her IRA funds and personally fixes it up.

Example 3: Sara owns an apartment building with her IRA and hires her father to manage the property.

4975(c)(1)(D): The direct or indirect transfer to a “disqualified person” of income or assets of an IRA

Example 1: Dan is in a financial jam and takes $12,000 from his IRA to pay his mortgage and credit card bill.

Example 2: Steve uses his IRA to purchase a rental property and hires his friend to manage the property. The friend then enters into a contract with Steve and transfers those funds back to Steve.

Example 3: Victoria invests her IRA funds in a real estate fund and then receives a salary for managing the fund.

Self-Dealing Prohibited Transactions

Subject to the exemptions under Internal Revenue Code Section 4975(d), a “Self-Dealing Prohibited Transaction” generally involves one of the following:

4975(c)(1)(E): The direct or indirect act by a “Disqualified Person” who is a fiduciary whereby he/she deals with income or assets of the IRA in his/her own interest or for his/her own account

Example 1: Jessica who is a real estate agent uses her IRA funds to buy a home and earns a commission from the sale.

Example 2: James wants to buy a piece of property for $110,000 and would like to own the property personally but does not have sufficient funds. As a result, James uses $90,000 from in his IRA and $20,000 personally to make the investment.

Example 3: Dana uses her IRA to funds to invest in a real estate fund managed by her Son. Dana’s son receives a bonus for securing Dana’s investment.

Conflict of Interest Prohibited Transactions

Subject to the exemptions under Internal Revenue Code Section 4975(d), a “Conflict of Interest Prohibited Transaction” generally involves one of the following:

4975(c)(i)(F): Receipt of any consideration by a “Disqualified Person” who is a fiduciary for his/her own account from any party dealing with the IRA in connection with a transaction involving income or assets of the IRA

Example 1: Joe uses his IRA funds to loan money to a company in which he manages and controls but owns a small ownership interest in.

Example 2: Michelle uses her IRA to lend money to a business that she works for in order to secure a promotion.

Example 3: Brandon uses his IRA funds to invest in a hedge fund that he manages and where his management fee is based on the total value of the fund’s assets.

Statutory Exemptions

Under Internal Revenue Code Section 4975(d), Congress created certain statutory exemptions from the prohibited transaction rules outlined under Internal Revenue Code Section 4975(c). For these certain transaction, Congress believed there is a legitimate reason to permit them. For these transactions, Congress has issued a blanket statutory exemptions permitting these transactions assuming that certain requirements specified are satisfied. Below is a list of some of the statutory exemptions found in Internal Revenue Code Section 4975(d) that apply to IRAs:

  • Any contract with a disqualified person for office space, legal, accounting or other services necessary for the operation of the IRA as long as reasonable compensation is paid.Note – this exemption does not apply to an IRA fiduciary (the IRA holder) as per Treasury Regulation Section 54.4975-6(a)(5).
  • The provision of ancillary services to an IRA by a bank trustee
  • Receipt by a disqualified person of any benefit to which he may be entitled as a participant or beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries;

Life Insurance and Certain Collectibles

In general, a Self-Directed IRA LLC cannot Invest in life insurance contracts or collectibles defined below:

  • Any work of art
  • Any metal or gem
  • Any alcoholic beverage
  • Any rug or antique
  • Any stamp
  • Most coins

Types of Collectibles That may be Purchased Using IRA Funds

  • one, one-half, one-quarter or one-tenth ounce U.S. gold coins (American Gold Eagle coins are the only gold coins specifically approved for IRAs. Other gold coins, to be eligible as IRA investments, must be at least .995 fine (99.5% pure);
  • one ounce silver coins minted by the Treasury Department;
  • any coin issued under the laws of any state;
  • a platinum coin described in 31 USCS 5112(k) ; and
  • gold, silver, platinum or palladium bullion (other than bullion that is made into a coin) of a certain fineness that is in the physical possession of a trustee that meets the requirements for IRA trustees under Code Sec. 408(a).

S Corporation Stock

Because of the shareholder restrictions imposed on “S” Corporations, an IRA cannot own stock in an S Corporation. Note – an IRA can own stock in a “C” Corporation.

Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 4167
Experience: Providing Financial, Tax & Business advice since 1986
Lane and 4 other Finance Specialists are ready to help you
Expert:  Lane replied 1 year ago.

Thanks again, Julian!


If you'd like to work with ME again just say "For Lane only," at the beginning of your next question.

Thanks again,
Lane

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