Why Setup an LLC for Investing in an IRA?

why setup an llc for investing

The one investment type that has remained popular over the years is LLC investments. An LLC is a legal organization that provides the tax advantages of a partnership. LLCs limit the legal liability of the individual partners involved. This works in the same way that a corporation does. LLCs are sometimes considered securities and may have to meet the standards of securities offerings. So, why setup an LLC for investing?

The majority of our clients do not form an LLC when investing their IRA funds. 90% of the transactions that Midland handles are direct purchases from the IRA. That is to say that the IRA account purchases the asset in the name of the administrator.

Why Setup an LLC for Investing?

LLCs can be a great choice for control in an IRA. This is especially true when there are multiple business partners. We will discuss the advantages and disadvantages below.

As stated before, most of our assets are purchased directly in the name of the administrator. This is usually the case for split ownership among close family or friends. For example, we have closed properties in the following two manners many times.

1. Midland Trust FBO John Smith, IRA #12345 as an undivided 75% interest and Midland Trust FBO Linda Smith, IRA #7654321 as an undivided 25% interest

  • In this example, John’s IRA and his spouse’s IRA purchased a piece of real estate as “tenants-in-common”. In other words, there are two owners to the property on the deed. John’s IRA and Linda’s IRA. All income or expenses for the property split 75/25.

2. Midland Trust, LLC FBO John Smith, IRA #1234567 as an undivided 50% interest and John and Linda Smith as an undivided 50% interest.

  • In this example, John’s IRA is buying half the property while John and his wife are buying the other half. All income and expenses split 50/50. The IRA gains (i.e. rent/sale income) are not subject to taxation.

Setting Up an LLC for Private Placement Investments

Many times, we have clients that want to invest their IRA in private placements. These are investments where their money is pooled with other investors. For example, ten investors pool their funds for a real estate investment project. When the project is complete, they plan on leasing the units to future tenants. Let’s say this asset was a “tenants-in-common” as the examples above. Is the group comfortable having ten tenants write ten different rental checks to ten different owners? Absolutely not! In this case, an LLC is a good idea. The LLC can operate its business and then pay off each investor (some of which could be Midland accounts).

Common LLC Setup Methods

  1. The IRA accounts and other individuals are listed as members (owners) of the LLC. There is an operating agreement that dictates the managing member of the LLC. It also indicates who is a financial member. Please contact Midland if you want to be the managing member of your IRA-owned LLC. There are some rules you should be aware of. The role of the managing member is to act on behalf of the LLC. The managing member pays any gains to each member of the LLC on behalf of the LLC.
  2. Equity position. In this case, the LLC is already set up with members on the operating agreement. Instead of altering membership when a new investor onboards, the LLC offers private stock in the company. For example, the shares are $50,000 each. The investor fills out a subscription agreement where they subscribe to a certain number of shares. As the company runs its business, profits return to the subscribers (shareholders). Some of the subscribers may be Midland accounts. Again, IRA gains are non-taxable.

Considerations for Using an IRA to Invest in an LLC

  1. Generally speaking, the IRA holder and his/her lineal descendants cannot be the managing member of the Corporation. This is because the IRS does not want you to personally have access to your IRA funds. There is a possible exception for single-member LLCs. Again, contact Midland Trust for more information on single-member LLCs with checkbook control.
  2. Your IRA cannot invest in a corporation that you (or lineal descendants) personally already have more than a 50% interest in and/or are considered a director/officer/highly compensated employee. This would be considered “self-dealing”. A good way to avoid self-dealing is to set up a newly formed Corporation, in which case you and your IRA can partner together with no restrictions on percentages of interest.

Simplify Your IRA Investments With an LLC Today

Purchasing non-traditional assets with a self directed IRA can help you diversify your retirement portfolio. This strategy may guard against economic changes. An LLC investment is one of the many options available within your IRA. If you are interested in self-direction, feel free to contact Midland or, open an account today.

Who is Considered a Disqualified Person and Who Can Your Self-Directed IRA Partner With?

Who Is Considered a Disqualified Person and Who Can Your Self-Directed IRA Partner With

Sometimes understanding who your IRA can and can’t do business with is confusing. Who is considered a disqualified person? Who can your IRA partner with? What are the differences? This article answers all of those questions and provides a better understanding of the self-directed IRA rules. Self-directed accounts have many benefits, but if not operated within compliance of IRS regulations, your account can lose its tax-free or tax-deferred status.

Disqualified Persons & Transactions

A disqualified person is one whom your IRA cannot do business with. These people include yourself and all lineal ascendants and descendants such as your spouse, your children, your grandchildren, your parents, and your grandparents. When dealing with real estate in an IRA this means that you cannot buy to, sell to, or rent to any of these disqualified people. For example, you cannot purchase a piece of real estate that you already personally own. This is considered self-dealing and benefits you currently—instead of at the time of your retirement. You may purchase a property from your aunt, uncle, brother, sister, or cousin, as long as there are no “sweetheart deals” (family discounts) involved.

The same applies to people your IRA can make payments to. Your IRA cannot write a check to a disqualified party or to you. For example, if you personally pay expenses related to your IRA by check or credit card, your IRA is prohibited from reimbursing you. If your IRA were to write you a check or make a payment toward your own credit card, it could look like a distribution to the IRS.

Qualified Persons & Transactions

Although you cannot do business with disqualified parties as explained above, you can partner with those people. For example, if you wanted to partner with your father to purchase a piece of real estate your IRA could own a percentage and your father could own a percentage. This wouldn’t be considered a disqualified transaction since you’re not renting the property to your father and you didn’t buy the property from him. You’re simply partnering with him to make the investment. If your IRA owned 50 percent of that property and your father owned the other 50 percent, your IRA and your father would split all income and expenses 50/50. Income and expenses relevant to the percentage owned flow directly into and out of your retirement account. Your IRA never writes your father or you a check—making the partnership a legal transaction.

The same applies to you personally partnering with your IRA. Although self-dealing is a disqualified transaction, partnering your self-directed account with yourself to make a new investment does qualify. To learn more about who your IRA can partner with, you can read our previous blog “Are You Short of Funds to Purchase Investment Property?”

In short, think of it this way: Your IRA can partner with any family member you’d like to make a new investment. However, if your IRA performs an action that involves (or should involve) writing or receiving a check from a lineal ascendant or descendant—then that transaction is prohibited.

To avoid confusion, always consult with a tax advisor and do your due diligence before making any investment.

For questions regarding disqualified persons or oher rules & regulations regarding self-directed IRAs, please contact Midland Trust.