I have created an LLC with myself, a partner (non-relative), and my two self-directed IRA accounts (one ROTH, other SEP). The partner is the only Voting member. Profits are distributed equally based on capital contribution, liabilities only to Voting partners. the LLC interests were purchased by the IRAs out of a custodian. The LLC then purchased some land that is not yielding income, just modest expenses, and is now participating in other investment yielding short-term interest gains question 1: should the LLC return my capital contribution so as not to be a participant in this entity (currently I am a Nonvoting 14.13% participant, from a capital standpoint). We will be making short-term gains that will need distributing, and, as it stands, I would receive 14.13% on my K-1 question 2: any issues with appointing me as President with no compensation for this role so that I am able to direct the investments?
Hi and welcome to Just Answer!That is a very sensitive issue. If you don't follow the rules set forth by the Internal Revenue Service, you can jeopardize tax-deferred status of your account. This could lead to the disqualification of the IRA and severe tax consequences.Self-directed IRA accounts are allowed to invest into private limited partnerships (formed as an LLC) as long as there is no prohibited transactions. See here - http://www.law.cornell.edu/uscode/text/26/4975(c) Prohibited transaction(1) General ruleFor purposes of this section, the term “prohibited transaction” means any direct or indirect—(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;(B) lending of money or other extension of credit between a plan and a disqualified person;(C) furnishing of goods, services, or facilities between a plan and a disqualified person;(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account; or(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.
So far - yourself is a disqualified person for these purposes - so when your personal assets are combined with assets from the IRA - that might be classified as the use of plan assets for the benefit of, a disqualified person - and as such could be classified as a prohibited transaction.
got it. read all that. and that's what I've tried to do. but is there any issue with me as an individual person also being a member of the same LLC so long as not majority owner (I am not) and taking the net profit distributions (first question) or should I exit (withdraw my capital contribution from the LLC so it is cleaner) question 2. and I see the chat above, it's cleaner just not to be involved (exit) so long as I am not personally profiting and these are arms-length transactions with other parties, it is ok that I be appointed as President by the Voting Member, correct?
I see your answer on first question. I don't think I'm doing anything wrong, but now that there would be significant profits, I think it might be better to exit. waiting on your second answer.
just to be clear: self-directed IRAs are self-directing, here the Managing Member appoints me as President and I am making the decisions about investments, but there are no transactions with people I know - they are with external entities
but is there any issue with me as an individual person also being a member of the same LLC so long as not majority owner (I am not) and taking the net profit distributions (first question) or should I exit (withdraw my capital contribution from the LLC so it is cleaner) question Because you are a disqualified person - and your own interest in the form of a partnership interest should NOT be combined with the partnership interest owned by the IRA. Such situation might be classified as a prohibited transaction according to the section 4975 as stated above.2. and I see the chat above, it's cleaner just not to be involved (exit) so long as I am not personally profiting and these are arms-length transactions with other parties, it is ok that I be appointed as President by the Voting Member, correct?Yes - you may be appointed as President - that is not an issue - as long as there is no any prohibited transactions.
what is the best way to exit at this point. simply a change to Operating Agreement I suppose. Do I need to have the land assessed to understand the basis before withdrawing my capital contribution? By the way the custodian had told me this structure was ok (they reviewed the LLC Operating Agreement for each purchase), but I have still been concerned.
A disqualified person as defined by the IRC 4975(e) (2)) includes following:(A) a fiduciary;(B) a person providing services to the plan;(C) an employer any of whose employees are covered by the plan;(D) an employee organization any of whose members are covered by the plan;(E) an owner, direct or indirect, of 50 percent or more of—(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation,(ii) the capital interest or the profits interest of a partnership, or(iii) the beneficial interest of a trust or unincorporated enterprise,which is an employer or an employee organization described in subparagraph (C) or (D);(F) a member of the family (as defined in paragraph (6)) of any individual described in subparagraph (A), (B), (C), or (E);(G) a corporation, partnership, or trust or estate of which (or in which) 50 percent or more of—(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,(ii) the capital interest or profits interest of such partnership, or(iii) the beneficial interest of such trust or estate,is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C), (D), or (E);(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G); or(I) a 10 percent or more (in capital or profits) partner or joint venturer of a person described in subparagraph (C), (D), (E), or (G). So far - you as an individual is disqualified person.
yes, I see this part: (ii) the capital interest or profits interest of such partnership
looking forward to your answer on best way to exit at this point. there haven't been any profits so far.
the deal is I am not over 50% owner in the LLC, so theoretically, it is not supposed to be a problem
(E) an owner, direct or indirect, of 50 percent or more of—(ii) the capital interest or the profits interest of a partnership
looking forward to your answer on best way to exit at this point. there haven't been any profits so far.Your concern has a very valid point. If you want "quietly" correct the situation without notifying the IRS - you may change the operation agreement and sell your interest to another partner.Another option should be if the IRA sells their interest in the partnership - and exits the LLC.The issue is that based on your information - the IRA already involved into prohibited transaction - and in case of audit - tax consequences might be severe...I would suggest to have a local tax attorney reviewing your case and providing some path forward.the deal is I am not over 50% owner in the LLC, so theoretically, it is not supposed to be a problemWhat is important - that you are a disqualified person as an owner of the IRA - regardless of your ownership in the LLC. So the percentage of your ownership is irrelevant for that determination.
thanks I have tried. this is such a grey area because the IRS doesn't much focus on clarifying this area, just does this "prohibited transaction" list no one really knows for sure or wants to deal with it. hence looking for an answer here. I think I will just play it safe and exit LLC. the one thing that bothers me is if my partner dies and the interests need to be sold, I mean, botXXXXX XXXXXne, this is just a vehicle for investing, so I have to rely on some finding someone as third-party that understands what the vehicle is intended for.
only way I see it can work is rewriting the Operating Agreement so that the role of President is in perpetuity for the life of the organization.
I don't think the IRAs transacted with me as a minority and non-voting member of the LLC though, as a passive participant, the problem becomes as I am starting to direct the decisions. thanks and let me know if you have any parting thoughts on the "perpetual President" approach
Yes - that is very complex area. You generally may do a "quiet" exit - hoping that you would not be audited.However - you may step forward - disclose your circumstances and ask the IRS to issue a ruling - there is a risk that the IRS will classify the combination of your own funds with IRA funds as a prohibited transaction.In this case - you may sue the custodian for damages.But before doing anything - I strongly suggest to consult with a local tax attorney. As we already noted - that is a very complex area and a very gray area.