What is a Self-Directed IRA?
A self-directed IRA, or SDIRA, is an IRA that can be invested in assets that are not available on brokerage platforms. The most common SDIRA investment is real estate, but an SDIRA can hold private loans, private stock, tax liens, tax deeds, mortgage notes, livestock, mineral rights and nearly anything else. Section 408 of Tax Code disallows only life insurance and collectibles for IRAs; everything else is allowed. In addition, S-corp regulations don’t allow IRA shareholders for small business corporations. Self-directed IRAs are held by specialized trust companies that are qualified to administer such accounts.
What is an IRA-LLC? What is Checkbook-Control? Checkbook Control IRA?
According to Section 408 of the Tax Code all IRAs assets must be held by a qualified custodian. Although there has been a proliferation of self-directed IRA custodians that allow investing in alternative assets, having them administer investments can be costly and inefficient for many investors. Having an SDIRA custodian process each investment related cash outlay adds lots of paperwork, lots of time, and lots of fees. When you spot a deal, you don’t want to wait a week while a custodian reviews the paperwork and an additional week if the paperwork is not to their liking…you need to control the checkbook!
A popular structure has the SDIRA make an investment in a specially formed IRA-LLC over which you have management control. This IRA-LLC will have a business checking account which you control as IRA-LLC manager. Hence, the name checkbook control IRA.
What are prohibited transactions?
Prohibited transactions, described in Section 4975 of the Tax Code, keep an IRA from doing business with certain related parties. These rules ensure that your IRA is used to provide for your future retirement needs and not for your – or anybody else’s – current benefit. The law designates certain individuals and entities as disqualified persons, who may not transact with your IRA. Among those are you – the account-owner – and your lineal ascendants and descendants, spouses of lineal descendants, your spouse and certain other related parties. The upshot is that, while your SDIRA can buy real estate, it can’t buy real estate from you.
Can I Get Loans To Finance My SDIRA and IRA-LLC investments?
Yes, you can obtain loans, but those loans must be nonrecourse to you. You, as a disqualified person to you IRA, cannot personally guarantee any loans made to your IRA. Guaranteeing a loan taken by your IRA would be an extension of credit prohibited transaction. See IRC 4975.
What are UBIT, UBTI, and UDFI?
UBIT is the acronym for Unrelated Business Income Tax. UBIT is payable on certain types of income generated by non-taxable entities, such as IRAs. UBIT is payable on UBTI, Unrelated Business Taxable Income. UBTI is generated through ongoing engagement in an active trade or business by an SDIRA. This may sound intimidating, but due to exemptions outlined in Section 512 of the Tax Code most SDIRA investments do not generate UBIT.
Unrelated Debt Financed Income, UDFI, is a subcategory of UBIT and is generated when an SDIRA generates income through leverage. This applies when an SDIRA uses a nonrecoruse loan to purchase rental property. There’s a specific deduction that automatically eliminates the first $1,000 of UBTI/UDFI. Qualified Plans, such as 401(k)s – including Solo 401K Plans – and Defined Benefit Plans do not generate UDFI on debt-financed real estate investments.
Use an SDIRA to take control of your financial future. For maximum efficiency and flexibility, get checkbook-control of your SDIRA.