The appeal of investing retirement funds in real estate and other alternative investments has driven the growth in the use of self-directed IRA (SDIRA) investments arrangements. These arrangements come in various forms, but they all start when an IRA account holder forms an SDIRA with a custodian (e.g., a bank or trust company) that is agreeable to holding “nontraditional” types of investments.

Investments within SDIRAs frequently include real estate, closely held business entities, and can include any other investment that is not specifically prohibited by federal law—anything other than life insurance and collectibles can be held in an SDIRA.

Once the SDIRA is formed and funded, there are two general choices for investing the SDIRA’s cash. The account holder can either instruct the custodian to execute an investment directly out of the SDIRA, in which case the SDIRA becomes the legal owner of the asset, or the account holder can invest substantially all of the SDIRA’s assets into a limited liability company (LLC). In the latter case, the SDIRA is usually, but not always, the 100% owner/member of the LLC (SDIRA/LLC). The SDIRA/LLC can then execute investments, generally with the LLC’s manager as the SDIRA account holder, and thus the LLC becomes the legal owner of the asset in question (e.g., real estate). Both investment methods are legally viable, but each leads to legal and tax challenges.

It is likely that less than 50% of SDIRA and SDIRA/LLC investors handle the legal and tax issues correctly, and many of these investors are unaware that these problems even exist. Unfortunately, these pitfalls can result in the complete invalidation of the SDIRA due to a “prohibited transaction” and/or current tax consequences within the SDIRA itself. If you need help with the tax compliance for your Self-directed IRA or Self-directed IRA LLC, especially as it relates to real estate, please contact us.


Source: Journal of Accountancy

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