Investment LLCs: Harness an Unsung Hero of Retirement Diversification
For many people, using a traditional or Roth 401(k) or IRA is their only retirement plan, and selecting an index fund is their only plan for diversification. But that may simply be because they haven’t heard about a potential retirement tool: an LLC owned by a self-directed IRA.
This powerful investment tool allows you to invest your retirement savings in a broader variety of assets such as real estate or private equity.
Diversifying your investment portfolio is crucial for managing risk and enhancing returns. An IRA-owned LLC enables you to safely invest in other asset classes, diversifying away from traditional financial assets. These assets often behave differently from stocks and bonds, providing a hedge against market volatility.
What Is an Ira-Owned LLC?
An IRA-owned LLC is a limited liability company wholly owned by a self-directed IRA. This structure allows the IRA to invest in a broader range of assets while enjoying the tax benefits of traditional IRAs.
Unlike traditional IRAs that limit investments to stocks, bonds, and mutual funds, a self-directed IRA allows you to invest in assets like real estate, private equity, and more. To learn more about the differences between a traditional IRA and a self-directed IRA, read our previous self-directed IRA 101 post.
While you have many options in a self-directed IRA, there may be one that you have not considered: using your self-directed IRA to create an LLC. By creating an LLC within your self-directed IRA, you gain a flexible investment vehicle that can directly purchase and manage assets.
Why Own an LLC with Your Self-Directed IRA Account?
To explain the benefits of an IRA-owned LLC, let’s use a case study of one of the most common reasons to go this route: investing in a rental property. If you see real estate as a way to diversify your investments, you have three options you can use:
1. Form an LLC outside of your IRA to own rental property. An LLC is advisable for this type of investment because it protects your wealth by limiting your personal liability for anything that should happen within your property.
If you have a renter who is injured on your property and wants to sue, they can only hold the LLC liable and cannot pursue damages beyond what the LLC owns. They cannot come after your house, your car, or your personal bank accounts.
2. Buy a rental property directly from your self-directed IRA account. Like traditional IRAs, the earnings within an IRA-owned LLC grow tax-deferred until distributions are taken. This means that you can own a property that generates tax-free income.
Your IRA can do this and still give you tax-free income without the LLC, but each transaction you have for your property will then need to go through your IRA custodian, slowing things down and generating management fees. This means that you would have to contact your account custodian every time you need to buy materials, pay a service person, or deposit a rent check.
3. Create an LLC owned by your self-directed IRA account. This third scenario gives you the protections of an LLC (the rest of your IRA portfolio is protected from liability so there is no chance of wiping out your entire savings), the tax advantages of an IRA, and enables you to be the manager of the LLC, eliminating the need for a custodian to carry out regular transactions. This is sometimes referred to as “checkbook control.”
Checkbook control allows you to make investment decisions quickly and efficiently without waiting for custodian approval. This can be particularly beneficial in the real estate market, where opportunities can arise and disappear quickly. Imagine finding a great deal on a rental property at an auction. With checkbook control, you can write a check on the spot to secure the purchase, whereas traditional IRA structures might miss the opportunity due to procedural delays.
Steps to Set up an IRA-Owned LLC for Rental Properties
Setting up an IRA-owned LLC to invest in rental properties involves several critical steps, each requiring careful attention to detail and adherence to regulatory requirements.
The first step in this process is to choose a custodian who is experienced in handling self-directed IRAs and familiar with the intricacies of IRA-owned LLCs. This professional will be your guide through the maze of regulatory requirements, ensuring that your setup complies with all IRS rules. Their expertise is crucial in navigating the legal and financial complexities involved in forming and managing your LLC within the IRA framework.
Once you have a custodian, the next step is to work with legal professionals to establish the LLC according to your state’s laws. It’s essential to ensure the LLC's operating agreement explicitly states that the IRA is the owner and names you as a manager to give you checkbook control. This documentation is a key element that must be meticulously crafted to avoid any potential legal issues down the line. Your state may have a set-up or annual fee associated with establishing an LLC.
With the LLC formed, you then transfer funds from your self-directed IRA into the newly created LLC. These funds will serve as the capital for the LLC to purchase rental properties and cover related expenses. This step is critical as it establishes the financial basis upon which your LLC will operate and invest.
How Chicago Trust Administration Services Can Help
At Chicago Trust Administration Services, we are experienced custodians of self-directed IRAs and have helped clients set up their LLCs and run them according to legal requirements. We know the regulations around these complex tax entities and provide guidance so that you can get down to the business of managing your assets.
We help investors make the investment deals they want, such as investing in rental properties while staying compliant with IRS regulations. If you have questions about using a self-directed IRA to create an LLC that opens the doors to new investment opportunities, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.
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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.