Risk Considerations for “Checkbook Control” IRAs

Mike: Welcome back to the FlipNerd.com REI classroom, where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.

Clay: Hi, everyone. This is Clay Malcolm from New Direction IRA and welcome to the REI Classroom. Today, we’re going to be talking about some of the risk considerations involved in checkbook control IRAs.

Mike: This REI Classroom real estate lesson is sponsored by UglyOpportunities.com.

Clay: Checkbook control IRAs can be very popular because of the convenience that they provide. For those of you who are not exactly sure how it gets set up, keep in mind that it usually looks like this, the generic form of it is this. An IRA, usually the IRA holder affects an LLC creation so an unowned LLC. The IRA then buy the 100% share of that LLC. And it doesn’t have to be an LLC, incidentally. That’s a corporate entity that’s commonly used, but it could be a trust or an LP or even a C corp.

So the IRA buys a 100% share of the LLC. So a single-member LLC is then created and funded and the account holder is named the manager. So that person then has in one hand a check of IRA money that’s made out to the LLC and in the other hand, the state documents that say that they are the manager of that LLC. So they go to their bank and they open a business checking account and so they’re actually writing checks on IRA money.

So, as you can imagine, that can be very convenient. The things that I like to make sure that people understand about that are a few of them and it’s a little bit of balance give and take. So things to consider: number one, when you have an LLC, you definitely need to be doing the regular bookkeeping that’s associated with an LLC. So that may mean that you would be doing a little extra work or hiring somebody to do some work for that LLC so that if it ever got audited, you could certainly give them the records about where the IRA money went, how it was spent, so on and so forth.

Part of the reason that’s really important is because the IRA investment rules follow that money. The LLC does not absolve the LLC manager from any of the IRS rules that are associated with IRA investments. So disqualified persons, prohibited transactions, all those kinds of rules still need to be followed even though the money is flowing through the LLC.

The other thing that I sometimes hear in terms of discussion about LLCs and checkbook control or checkbook IRAs is the fact that Swanson vs. Commissioner is the court case that most people point to when they say either this is legal or this is not legal. And the funny thing is that I hear both. I hear attorneys on both sides of that argument. And it depends on their particular interpretation of the decision. So that’s one thing to consider as an IRA account holder that you are always the person who is in charge of the due diligence. So it might be something that you want to look into to see if it matches your risk tolerance.

The other thing that I’ve been hearing a lot about and I know from working in the business, of course, is that this year, this tax year, well 2015 tax year, so in May of 2016, when we report to the IRS the value of the IRA, we will now, this year, have to have some categorization of those assets. Heretofore, so from the ’70s up until 2014 tax year, that report only said the value of the IRA not really what assets are in the IRA. So if the IRS ever does want to look into particular investment types starting now, they’re going to actually have a lot more information than they used to. Will they use that information? I have no idea, but it will be with them so just understand that that’s part of the equation.

So to wrap it up, I just want to make sure that everybody understands that taking on checkbook control of an IRA can be a very convenient thing and it also, in some cases, can save you some money. But it does have some risks associated with it depending upon who you ask. And certainly, it circumvents the idea that the IRS would like to have, which is keeping an arm’s length between the account holder and the IRA’s assets. So the net effect of all this is to some extent get around what the IRS . . . what their desire is for these accounts.

All of those things are just a part of the consideration in the equation for you, the account holder, to decide, again, if that setup meets your risk tolerance. Join us next time on the REI classroom. My name’s Clay Malcolm.

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