Self-Directed IRA Investing Using an LLC

Many investors like to invest in real estate and other assets by forming a Limited Liability Company (or LLC). LLCs are often recommended by attorneys and other professionals as a way to limit the liability exposure of the LLC owners from particular investment hazards.  LLCs can also be used to make the acquisition and management of investment assets easier. It is certainly possible to have a self-directed IRA acquire real estate and other assets by using an LLC. The example below shows how this can be done.

Steve and Linda both have self-directed IRAs with $75,000 of cash in each that they would like to put to use by investing in foreclosed properties available through public auctions. Often, the purchase of foreclosed properties at courthouse auctions requires the successful bidder to furnish the full purchase price within a 24 hour period, if not immediately as is true in some cases! Due to these time constraints and because of the amount of purchases they hope to make at each auction, Steve and Linda decide it would be easier to set up an LLC for their IRAs to own. Investing a self-directed IRA within an LLC offers what is referred to as “checkbook control” meaning that the members of the LLC have immediate access to cash needed to operate and invest.  Instead of having to go through a custodian for access to cash, they merely write the check straight from the LLC account.

Steve and Linda use a local attorney to establish the LLC, named Foreclosed Properties, LLC, whereby their individual Advanta IRA accounts are listed within the LLC operating agreement as the Members (or Owners).  Steve and Linda decide to choose a third person, their friend, Ron (who is not related to Steve or Linda), to serve as manager of the LLC. Since he is not a disqualified person for Steve or Linda’s IRA, Ron may even receive compensation for his services as manager of the LLC. The manager within the LLC will have the ability to sign contracts, write checks, and wire funds out of the LLC’s bank account, as instructed by Steve and Linda. If either Steve or Linda wanted to be the manager of the LLC, then they would be well-served to speak with an attorney on this issue as there can be many problems that arise with an IRA-owned LLC where the IRA owner is a manager.

Their attorney prepares the operating agreement for the LLC, and Steve and Linda complete the necessary documents with Advanta to invest in the LLC. They have instructed Advanta that each IRA will purchase a 50 percent interest in the LLC, in exchange for a capital contribution of $75,000 from each IRA account.   Once Steve and Linda have reviewed and approved the LLC operating agreement, the document is sent to Advanta for signatures of authorized representatives who execute the operating agreement on behalf of each IRA account. Ron also signs the operating agreement as the manager of the LLC, and opens a bank account in the name of Foreclosed Properties, LLC. Upon receipt of the approved operating agreement and other documentation, Advanta wires $150,000 ($75,000 from each IRA account) to the LLC bank account.

Now that the LLC has been capitalized, Steve, Linda and Ron are ready to start bidding on and purchasing properties. At Linda and Steve’s direction, Ron bids on 10 properties to be purchased and he is successful at buying four foreclosures for a total of $120,000. The properties purchased are titled in the name of Foreclosed Properties, LLC and Ron signs the necessary documents and wires the funds to the county clerk to complete the purchase of the properties.

Steve and Linda have decided to maintain and rent the acquired properties for a period of three years before selling them.  Once the LLC has purchased the assets, any expenses that are due (taxes, insurance, maintenance, etc.) are paid by Ron out of the LLC bank account. Any rental incomes for the properties are received into the LLC bank account, as well. As cash grows within the LLC bank account, the LLC can purchase additional properties and other assets to further diversify the investment portfolio if Linda and Steve make that decision.

Rental income and expenses for all of the properties flow in and out of the LLC account. The profits made by the LLC receive the same tax deduction treatment as the IRAs.  During the next three years, each of the four properties average a net cash flow of $500 a month deposited into the LLC bank account.  This means that almost $72,000 is returned to the LLC account, a 16 percent growth on the cash flow alone! After the three year period, Steve and Linda instruct Ron to sell the properties within the LLC and close the LLC. Ron sells the four properties for a total of $200,000, and the sale proceeds are deposited in the LLC account.  Thus, in three years time, the LLC bank account has grown from the $150,000 initial investment to a total of $272,000. After selling the properties within the LLC, Ron dissolves the LLC and closes the LLC bank account.  Ron then returns $136,000 to both Steve and Linda’s IRA accounts from the closed LLC account, resulting in over a 27 percent growth to their retirement accounts!

As you can see, investing in real estate through an LLC owned by your Advanta IRA can allow you immediate access to funds.  And while this process may seem easy at first glance, it is important that you employ a competent attorney and/or accountant for solid advice.  You want to be fully informed of transactions deemed as prohibited by the IRS, which can invalidate your IRA and make it open to taxes and penalties.  Eliminating the use of a custodian makes investing within an LLC easy on one hand, but also can increase your margin of error in other realms if you are not aware of the laws under which you must operate your LLC.  However, the investment potential is great if managed in an informed and proper manner.