Jul 29

IRA Financial Group Sees New Trend of Hard Money Lenders Using Self-Directed IRA to Help Take Advantage of Robust Real Estate Market

New trend of hard money lenders using self-directed IRA LLC to generate strong tax-deferred returns from real estate developers and builders.

IRA Financial Group, the leading provider of “checkbook control” self-directed IRA LLC and solo 401(k) plan solutions, announces the strong demand from hard money lenders for the self-directed IRA LLC solution. Due to the strong real estate market and continued lack of available financing, there has been string demand from real estate developers and builders for real estate related loans. Because most financial institutions continue to require solid credit scores and spend weeks reviewing financial statements, tax returns and business plans, there is a growing need for quick financing for real estate developers and builders for their real estate projects. As a result, over the last year or so, a growing number of nontraditional lenders have stepped into the void. Many of these nontraditional lenders have decided to take advantage of the lucrative private lending financing market, and have started using their retirement funds, either via a self-directed IRA or solo 401(k) Plan to make private loans and generate tax-deferred returns especially in the real estate industry. “Over the last year, we have seen a growing demand from hard money lenders to establish self-directed IRA accounts to make attractive loans to real estate developers and builders, stated Adam Bergman, a tax partner with the IRA Financial Group. “Due to the very limited amount of financing available to many real estate developers and builders, many hard money lenders have been able to generate strong tax-deferred income from using a self-directed IRA to make hard money real estate loans.“ stated Mr. Bergman.

The main advantage of using a Self Directed IRA LLC to make hard money loans is that the loan can be made by simply writing a check. In addition, all income and gains associated with the self directed IRA hard money loan would grow tax-deferred.

With IRA Financial Group’s self directed IRA hard money lending solution, traditional IRA or Roth IRA funds can be used to make secured or unsecured private loans to small business owners or home builders.

IRA Financial Group Sees New Trend of Hard Money Lenders Using Self-Directed IRA to Help Take Advantage of Robust Real Estate Market IRA Financial Group’s Self-Directed IRA for hard money investors, is an IRS approved structure that allows one to use their retirement funds to make hard money loans, either secured or unsecured, to any non-disqualified third-party by simply writing a check. The Self-Directed IRA real estate LLC involves the establishment of a limited liability company (“LLC”) that is owned by the IRA (care of the Roth IRA custodian) and managed by the IRA holder or any third-party. As manager of the IRA LLC, the IRA owner will have control over the IRA assets to make traditional as well as non-traditional investments, such as hard money loans by simply writing a check

Using IRA Financial Group’s self directed IRA LLC with “checkbook control” solution to make hard money loan investments offers hard money lenders the ability to make loans quickly without any custodian delay. “By using a “checkbook control” self-directed IRA LLC our clients have been able to make hard money loans quickly and without any custodian delay and without immediate tax,” stated Jacky Ospina, a retirement tax specialist.

The IRA Financial Group was founded by a group of top law firm tax and ERISA lawyers who have worked at some of the largest law firms in the United States, such as White & Case LLP, Dewey & LeBoeuf LLP, and Thelen LLP.

IRA Financial Group is the market’s leading “checkbook control” Self Directed IRA Facilitator. IRA Financial Group has helped thousands of clients take back control over their retirement funds while gaining the ability to invest in almost any type of investment, including real estate without custodian consent.

To learn more about the IRA Financial Group please visit our website at http://www.irafinancialgroup.com or call 800-472-0646.

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Jul 28

THE DOL Plan Asset Rules

The Department of Labor (“DOL”) Plan Asset Rules were generally enacted to limit an investment fund participant from using his retirement funds to transact with the investment fund or its assets. The Plan Asset Rules set forth the circumstances that can cause assets owned by an entity to be deemed to be assets of an ERISA qualified plan (i.e. 401(k) Plan) or an IRA unless an exemption applies.  Under the Plan Assets Rules, if an IRA/401(k) Plan owns greater than 25% of an investment entity that is neither a “publicly-offered security” nor a mutual fund, the equity interests and assets of the “investment company” will be deemed assets of the IRA/401(k). This is sometimes referred to as the “Look- Through Rule”. Under the “Look-Through Rules, if a retirement plan owns 25% or more of any class of equity interests in an “investment company”, the Plan Asset Rules state that the assets of the entire “investment company” are deemed to be assets of the IRA/401(k).  In other words, if your IRA owns 25% or more of the membership interests of a LLC engaged in passive investments (i.e. private equity fund, hedge fund, or real estate fund), the assets of the LLC are deemed to be assets of the IRA. If the Plan Asset Rules cause the assets of an “investment company” to be deemed to be assets of the IRA/401(k), any transaction involving the “investment company” and a disqualified person will be a prohibited transaction.

The Plan Asset RulesPlan Asset Rules

The DOL’s Plan Asset Rules essentially define when the assets of an entity are considered ‘Plan” assets. Under the rules, IRAs are frequently viewed as pension plans subjecting them to the Plan Asset Rules. Under the Plan Asset Rules, if the aggregate plan (IRA/401(k)) ownership of an entity is 25% or more of all the assets of the entity, then the equity interests and assets of the “investment entity” are viewed as assets of the investing IRA/401(k) for purposes of the prohibited transactions rules, unless an exception applies. Also, if a plan (i.e. IRA or 401(k)) or group of related plans owns 100% of an “operating company”, the operating company exception will not apply and the company’s assets will still be treated as plan assets.

In summary, the Plan Asset Rules can be triggered if:

  • 100% of an “operating company” is owned by one or more IRAs/401(k) and disqualified persons, in which case all the assets of the “operating company” are deemed Plan assets (assets of the IRA/401(k)), or
  • If 25% or more of an “investment company” is owned by IRAs/401(k) and disqualified persons, in which case all the assets of the “investment company” are deemed Plan assets (assets of the IRA/401(k)). In determining whether the 25% threshold is met, all IRAs/401(k) owners are considered, even if they are owned by unrelated individuals.

Exceptions to the DOL Plan Asset Regulations

The Plan Asset look-through rules do not apply if the entity is an operating company or the partnership interests or membership interests are publicly offered or registered under the Investment Company Act of 1940 (e.g., REITs). They also do not apply if the entity is an “operating company,” which refers to a partnership or LLC that is primarily engaged in the real estate development , venture capital or companies making or providing goods and services, such as a gas station, unless the “operating company” is owned 100% by a Plan and/or disqualified persons. In other words, if an IRA or 401(k) Plan owns less than 100% of an LLC that is engaged in an active trade or business, such as a restaurant or manufacturing plant, the Plan Asset Rules would not apply. However, the IRA or 401(k) Plan investment may still be treated as a prohibited transaction under Internal Revenue Code Section 4975. In addition, the Unrelated Business Taxable Income may apply to subject to the IRA or 401(k) Plan to tax on the income or gains generated from the operating business.

How can the Plan Asset Rules Impact my IRA/401(k) Plan Investments ?

The Plan Asset Rules are typically only triggered if your IRA/401(k) Plan assets will own greater than 25% of an investment company (i.e. a passive investment fund) or will own 100% of an operating company (i.e. gas station). In general, the majority of investments involving IRA/401(k) Plan funds will not cause the Plan Asset Rules to trigger a prohibited transaction. For example, any direct purchase of real estate, precious metals, tax liens, or lending transaction not involving a disqualified person will likely not trigger the prohibited transaction rules or Plan Asset Rules. Even if the Plan Asset Rules were to apply, as long as a disqualified person is not involve in a transaction with the investment entity, the prohibited transaction rules would not apply.

Consequences of a Transaction Falling under the Plan Asset Rules

If your Self Directed IRA LLC or 401(k) Plan investment involves an investment in one of the following: (i) an “operating company” that your IRA will own 100% of, or (ii) an investment company in which 25% of more of the “investment company” is owned by IRAs/401(K) Plans and disqualified persons, then all assets of the entity are deemed owned by the IRA/401(k) and all transactions between the investment entity or its assets and a disqualified person may be prohibited.

Note: The fact that a transaction does not trigger the Plan Asset Rules does not mean that the transaction may not be deemed a prohibited transaction under Internal Revenue Code Section 4975. In other words, a transaction that does not fall under the Plan Asset Rules can still be treated as a prohibited transaction.

The following are a number of examples that demonstrate the scope of the Plan Asset Rules.

Example 1: A general partner of a hedge fund wishes to invest his Self Directed IRA LLC in the hedge fund he manages. If the percentage of IRA ownership, including what it would be after the General Partner invests his IRA in the fund, equals or exceeds 25% of the equity interests, then the fund’s assets are considered “plan asset.” That means that a transaction between the general partner, as a disqualified person, and the fund, could be deemed a prohibited transaction because the assets of the fund are viewed as assets of his IRA, since a disqualified person cannot transact with the assets of his plan or IRA. Accordingly, the General Partner cannot receive benefits from his IRA investment into the fund. Thus the General Partner would not be permitted to receive any management fees associated with the IRA’s ownership interest in the fund because he would be receiving a personal benefit from his IRA. Note – the General Partner’s IRA investment in the fund may also be deemed a direct or indirect prohibited transaction under Internal Revenue Code Section 4975.

Example 2: Jane ‘s Self Directed IRA LLC owns 100% of ABC, LLC, which operates a retail store. ABC, LLC makes a loan to Jane. The loan is subject to the Plan Asset Rules and will also be considered a prohibited transaction pursuant to Internal Revenue Code Section 4975. Note – any income generated by ABC, LLC that is allocated to the Self Directed IRA LLC would also likely be subject to the Unrelated Business Income tax.

Example 3: Steve’s Self Directed IRA LLC owns 15% of ABC, LLC, an investment company. Allan’s IRA owns 20% of ABC, LLC. Steve and Allan are unrelated. Since IRAs (Plans) own greater than 25% of ABC, LLC, an “investment company”, assets of ABC, LLC are Plan Assets and deemed owned by each IRA. Thus, if ABC, LLC makes a loan to Steve’s father, the loan would be a prohibited transaction under Internal Revenue Code Section 4975.

Example 4: Robert’s Self Directed IRA LLC invests in ABC, LLC, which will purchase a gas station, an “operating company”. Robert will take an annual salary of $50,000 to run the gas station. The payment of the salary would be a “prohibited transaction under Internal Revenue Code Section 4975 (self dealing indirect prohibited transaction). Note – any income generated by the as station that is allocated to the Self-Directed IRA LLC would also likely be subject to the Unrelated Business Income tax.

Please contact one of our IRA Experts at 800-472-0646 for more information.

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Jul 25

All ABout Using a Self-Directed IRA to Purchase Real Estate

Most people mistakenly believe that their IRA must be invested in bank CDs, the stock market, or mutual funds. Few Investors realize that the IRS has always permitted real estate to be held inside IRA retirement accounts. Investments in real estate with a Self-Directed IRA LLC are fully permissible under the Employee Retirement Income Security Act of 1974 (ERISA). IRS rules permit you to engage in almost any type of real estate investment, aside generally from any investment involving a disqualified person.

In addition, the IRS states the following on their website: “…..IRA law does not prohibit investing in real estate but trustees are not required to offer real estate as an option.”

Advantages of Using a Self-Directed IRA LLC to Purchase Real Estate

Income or gains generated by an IRA generate tax-deferred/tax-free profits. Using a Self-Directed IRA LLC to purchase real estate Using a Self Directed IRA LLC To Purchase Real Estateallows the IRA to earn tax-free income/gains and pay taxes at a future date (in the case of a Roth IRA the income/gains are always tax-free), rather than in the year the investment produces income.

With a Self-Directed IRA LLC, you can invest tax-free and not have to pay taxes right away – or in the case of a Roth IRA – ever! All the income or gains from your real estate deals flow through to your IRA tax-free!

Why Buy Real Estate Using a Self-Directed IRA LLC

  • Gains are tax free
  • Positive cash flow is tax free
  • No time limit for holding property
  • IRA can borrow money – Leverage your investment with non-recourse financing
  • Potential to earn a larger rate of return on invested capital

Tax Advantages of Buying Real estate with a Self-Directed IRA LLC

When purchasing real estate with a Self-Directed IRA LLC, in general, all income and gains generated by your pre-tax retirement account investment would generally flow back into the retirement account tax-free. Instead of paying tax on the returns of a real estate investment, tax is paid only at a later date, leaving the real estate investment to grow unhindered. Generally, self-directed IRA real estate investments are usually made when a person is earning higher income and is taxed at a higher tax rate. Withdrawals are made from an investment account when a person is earning little or no income and is taxed at a lower rate.

For example, if Joe established a Self-Directed IRA LLC with $100,000 to purchase real estate and make other investments. Assume Joe kept his Self-Directed IRA LLC open for 20 years. Further assume that Joe was able to generate an average annual pre-tax rate of return of 8% and the average tax rate was 25%. By using a tax-deferred Self-Directed IRA LLC strategy, after 20 years Joe’s $100,000 investment would be worth $466,098 – a whopping $349,572 after taxes on the earnings. Whereas, if Joe made the investments with taxable funds (non-retirement funds) Joe would have only accumulated $320,714 after 20 years.

Types of Real Estate Investments

Below is a partial list of domestic or foreign real estate-related investments that you can make with a Self-Directed IRA LLC:

  • Raw land
  • Residential homes
  • Commercial property
  • Apartments
  • Duplexes
  • Condos/townhomes
  • Mobile homes
  • Real estate notes
  • Real estate purchase options
  • Tax liens certificates
  • Tax deeds

Investing in Real Estate with a Self-Directed IRA LLC is Quick & Easy!

Purchasing real estate with a Self-Directed IRA LLC is essentially the same as purchasing real estate personally.

  • Set-up a Self-Directed IRA LLC with the IRA Financial GroupSelf Directed IRA LLC
  • Identify the investment property
  • Purchase the investment property with the Self-Directed IRA LLC – no need to seek the consent of the custodian with a Self-Directed IRA LLC with “Checkbook Control
  • Title to the investment property and all transaction documents should be in the name of the Self-Directed IRA LLC. Documents pertaining to the property investment must be signed by the LLC manager
  • All expenses paid from the investment property go through the Self-Directed IRA LLC. Likewise, all rental income checks must be deposited directly in to the Self-Directed IRA LLC bank account. No IRA related investment checks should be deposited into your personal accounts.
  • All income or gains from the investment flow through to the IRA tax-free!

Structuring the Purchase of Real Estate with a Self-Directed IRA LLC

When using a Self-Directed IRA LLC to make a real estate investment there are a number of ways you can structure the transaction:

1. Use your Self-Directed IRA LLC funds to make 100% of the investment

If you have enough funds in your Self-Directed IRA LLC to cover the entire real estate purchase, including closing costs, taxes, fees, insurance, you may make the purchase outright using your Self-Directed IRA LLC. All ongoing expenses relating to the real estate investment must be paid out of your Self-Directed IRA LLC bank account. In addition, all income or gains relating to your real estate investment must be returned to your Self-Directed IRA LLC bank account.

2. Partner with Family, Friends, Colleagues

If you don’t have sufficient funds in your Self-Directed IRA LLC to make a real estate purchase outright, your Self-Directed IRA LLC can purchase an interest in the property along with a family member (non-disqualified person – any family member other than a parent, child, spouse, daughter-in-law, son-in–law), friend, or colleague. The investment would not be made into an entity owned by the IRA owner, but instead would be invested directly into the property.

For example, your Self-Directed IRA LLC could partner with a family member (non disqualified person – any family member other than a parent, child, spouse, daughter-in-law, son-in–law), friend, or colleague to purchase a piece of property for $150,000. Your Self-Directed IRA LLC could purchase an interest in the property (i.e. 50% for $75,000) and your family member, friend, or colleague could purchase the remaining interest (i.e. 50% for $75,000).

All income or gain from the property would be allocated to the parties in relation to their percentage of ownership in the property. Likewise, all property expenses must be paid in relation to the parties’ percentage of ownership in the property. Based on the above example, for a $2,000 property tax bill, the Self-Directed IRA LLC would be responsible for 50% of the bill ($1000) and the family member, friend, or colleague would be responsible for the remaining $1000 (50%).

Isn’t Partnering with a family member in a Real Estate Transaction a Prohibited Transaction?

Likely not if the transaction is structured correctly. Investing in an investment entity with a family member and investing in an investment property directly are two different transaction structures that impact whether the transaction will be prohibited under Code Section 4975. The different tax treatment is based on who currently owns the investment. Using a Self-Directed IRA LLC to invest in an entity that is owned by a family member who is a disqualified person will likely be treated as a prohibited transaction. However, partnering with a family member that is a non-disqualified person directly into an investment property would likely not be a prohibited transaction. Note: If you, a family member, or other disqualified person already owns a property, then investing in that property with your Self-Directed IRA LLC would be prohibited.

3. Borrow Money for your Self-Directed IRA LLC

You may obtain financing through a loan or mortgage to finance a real estate purchase using a Self-Directed IRA LLC. However, two important points must be considered when selecting this option:

  • Loan must be non-recourse – A “prohibited transaction” is a transaction that, directly or indirectly involves the loan of money or other extension of credit between a plan and a disqualified person. Normally, when an individual purchases real estate with a mortgage, the traditional loan provides for recourse against the borrower (i.e., personal liability for the mortgage). However, if the IRA purchases real estate and secures a mortgage for the purchase, the loan must be non-recourse; otherwise there will be a prohibited transaction. A non-recourse loan only uses the property for collateral. In the event of default, the lender can collect only the property and cannot go after the IRA itself.
  • Tax is due on profits from leveraged real estate – Pursuant to Code Section 514, if your Self-Directed IRA LLC uses non-recourse debt financing (i.e., a loan) on a real estate investment, some portion of each item of gross income from the property are subject to Unrelated Business Income Tax (UBTI). “Debt-financed property” refers to borrowing money to purchase the real estate (i.e., a leveraged asset that is held to produce income). In such cases, only the income attributable to the financed portion of the property is taxed; gain on the profit from the sale of the leveraged assets is also UDFI (unless the debt is paid off more than 12 months before the property is sold). There are some important exceptions from UBTI: those exclusions relate to the central importance of investment in real estate – dividends, interest, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate. However, rental income generated from real estate that is “debt financed” loses the exclusion, and that portion of the income becomes subject to UBTI. Thus, if the IRA borrows money to finance the purchase of real estate, the portion of the rental income attributable to that debt will be taxable as UBTI.

For example, if the average acquisition indebtedness is $50 and the average adjusted basis is $100, 50 percent of each item of gross income from the property is included in UBTI.

A Self-Directed IRA LLC subject to UBTI is taxed at the trust tax rate because an IRA is considered a trust. For 2011, a Self-Directed IRA LLC subject to UBTI is taxed at the following rates:

  • $0 – $2,300 = 15%
  • $2,300 – $5,350 = $345 + 25%
  • $5,350 – $8,200 = $1,107.50 + 28%
  • $8200 – $11,200 = $1,905.50 + 33%
  • Over $11,200 = $2,895.50 + 35%

Why Work With the IRA Financial Group?

The IRA Financial Group was founded by a group of top law firm tax and ERISA lawyers who have worked at some of the largest law firms in the United States, such as White & Case LLP, Dewey & LeBoeuf LLP, and Thelen LLP. Over the years, we have helped thousands of clients establish IRS compliant Self-Directed IRA LLC solutions. With our work experience at some of the largest law firms in the country, our retirement tax professionals’ tax and real estate IRA knowledge in this area is unmatched.

To learn more about using a Self-Directed IRA LLC to invest in real estate, please contact one of our Self-Directed IRA Experts at 800-472-0646 for more information.

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Jul 23

Using a Self-Directed IRA to Invest in Options

When it comes to making investments with a self-directed IRA LLC, the IRS generally does not tell you what you can invest in, only what you cannot invest in.  The types of investments that are not permitted to be made using retirement funds is outlined in Internal Revenue Code Section 408 and 4975.  These rules are generally known as the “Prohibited Transaction” rules.

In addition to the Prohibited Transaction rules, the IRS imposes a levy or tax on certain transactions involving IRA funds.  In general, when one uses IRA funds to invest in an active business, such as a restaurant, store, factory that is operated through a passthrough entity such as a Limited Liability Company or Partnership or used nonrecourse financing, such as a nonrecourse loan or margin in a stock or trading account, a percentage of net profits or income generated by that activity could be subject to a tax. The tax imposed is often referred to as Unrelated Business Taxable Income or UBIT or UBTI.  The UBTI rules are generally outlined in Internal Revenue Code Sections 512-514.

Using a Self-Directed IRA to Invest in OptionsThe reason the UBTI tax rules do not impact most retirement investors, is that Internal Revenue Code Section 512(b) provides a general exemption for the following categories of income generated by a retirement account:  dividends, interest, royalties, rental income, and capital gain type transaction,  As a result, since the majority of retirement investors purchase publicly traded company stock, which is exempted from the UBTI tax pursuant to Internal Revenue Code Section 512, the UBTI tax rules are not widely known.

When it comes to investing in options with a self-directed IRA LLC, the question then becomes whether the investment would trigger the UBTI rules. An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties.

According to the IRS , any gain from the lapse or termination of options to buy or sell securities is excluded from unrelated business taxable income. Note – the exclusion is not available if the organization is engaged in the trade or business of writing options or the options are held by the organization as inventory or for sale to customers in the ordinary course of a trade or business. Hence, if option trading is not being done as an active trade or business, then using a self-directed IRA LLC to invest in options would not trigger the UBTI tax rules.

For more information on using a self-directed IRA LLC to invest in options, please contact a tax professional at 800-472-0646.

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Jul 21

Converting Retirement Plans to a Self-Directed Roth IRA

IRA Rollovers to the Self-Directed Roth IRA Conversion

In general, Roth IRA conversions and retirement plan rollovers to a Roth IRA are taxable events. The reason for this is a Roth IRA is an after-tax account that allows for tax-free distributions if certain rules are satisfied.

A conversion is a taxable movement of cash or other assets, such as real estate from a Traditional IRA, SEP IRA, or a SIMPLE IRA to a Roth IRA. Note – a SIMPLE IRA can only be converted to a Roth IRA after a two-year period, which begins on the date that the first SIMPLE IRA contribution was deposited.

IRA Rollovers to the Self-Directed Roth IRA ConversionAre there any Eligibility Requirements to do a Roth IRA Conversion?

Under the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) eliminated the eligibility restrictions for Roth IRA conversions, beginning with conversions made after January 1, 2010. Thus, beginning in January 1, 2010, there is no longer any eligibility requirements for making a Roth IRA conversion.

Due to this change, many individuals who earn to much to make a Roth IRA contribution, because earning limitations continue to apply to Roth IRA contributions, can contribute to a Traditional IRA and then complete a Roth IRA conversion.

Roth IRA Conversion Tax & Penalty Applications

An individual engaging in a Roth conversion to a Self-Directed Roth IRA LLC structure must pay tax on the Roth IRA conversion on a pro rata basis – the portion representing pretax assets is taxable in the year of the conversion, and the portion representing after-tax assets is not taxable. The taxpayer must file Form 8606 to determine the taxable portion of the conversion. The taxpayer must aggregate all the pre-tax IRA assets to determine the taxable and nontaxable assets.

Procedures for Doing a Self-Directed Roth IRA Conversion

A Roth IRA conversion can technically be completed either via a direct or indirect rollover. A conversion in which the check is made payable to the receiving financial institution for the benefit of the individual’s Roth IRA is a direct conversion. An indirect conversion occurs when the IRA holder requests and receives a distribution from his or her pre-tax IRA custodian and deposits the amount into a Roth IRA account within 60 days. Note – with an indirect Roth IRA conversion, the one rollover per 12-month restriction does not apply.

Reporting a Roth IRA Conversion to a Self-Directed Roth IRA

Because all conversions are generally subject to taxation, the financial organization distributing the pre-tax IRA assets must apply the withholding rules under Internal Revenue Code Section 3405. However, an exception applies to IRA funds that are being converted to a Roth IRA. The financial institution executing the Roth IRA conversion would report the conversion on the IRS Form 1099-R. On IRS Form 1099-R the amount being converted would be reported in Box 7, using distribution reason code 2, Early distribution, exception applies.

A Roth IRA conversion is a reportable transaction regardless of whether it was handled directly or indirectly.

Retirement Plan Rollovers to a Self-Directed Roth IRA

Eligible participants of a qualified retirement plan, such as a 401(k), 403(b), or 457(b) plan have been able to roll over plan assets to a Traditional IRA for several years. Since 2006, individuals have been allowed to roll over designated Roth account distributions to Roth IRAs, but not Traditional IRAs. However, beginning January 1, 2008, individual may roll over all employer plan assets to a Roth IRA.

Retirement Plan Rollovers to a Self-Directed Roth IRA

Eligible individuals may directly or indirectly roll over retirement plan assets to a Self-Directed Roth IRA. Like a Roth IRA rollover, indirect rollovers must be completed within 60 days after constructive receipt of the IRA assets.

Direct Rollover to a Self-Directed Roth IRA

When an individual directly rolls over an employee sponsored retirement plan distribution to a Self-Directed Roth IRA (excluding a designated Roth account rollover to a Roth IRA), the financial institution transferring the retirement funds must report the tax-free direct rollover distribution on IRS Form 1099-R, using code G, Direct rollover and rollover contribution. The receiving Self-Directed Roth IRA custodian must report the amount as a rollover contribution in Box 2 of IRS Form 5498.

Indirect Rollover to a Self-Directed Roth IRA

If an individual is eligible and takes a distribution from an employer sponsored retirement plan (i.e. 401(k) Plan), the financial institution sending the payment should make the check payable to the individual. If the distribution is eligible for a rollover, the payer financial institution must apply withholding. The payer financial institution must report such distributions on IRS form 1099-R using the applicable distribution code ( code 1,4,7).

The plan participant would then be required to deposit the amount into a Traditional IRA account within 60 days. Once the funds have been deposited in a Traditional IRA account, the IRA funds can be converted into a Roth IRA. The new Self-Directed Roth IRA custodian receiving the rollover assets must report the amounts on IRS Form 5498 as a rollover contribution in Box 2.

To learn more about the Self-Directed Roth IRA conversion rules, please contact a tax professional at 800-472-0646.

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Jul 18

Full Service CPA Experts for Your Self-Directed IRA

IRA Financial Group is the only full service Self-Directed IRA facilitator that offers its clients the ability to consult with our in-house tax accountants and CPAs, in addition, to our tax professions. Our in-house CPAs are specially trained in the taxation of retirement accounts, which allows us to provide our clients with specialized tax advice and offer tax filing and reporting services relating to the use and taxation of retirement funds to make investments. Because the use of retirement funds to make investments, such as real estate via a Self-Directed IRA LLC are governed by a set of multifaceted and not widely known tax rules, having the ability to consult and work directly with specially trained tax professionals and CPAs is crucial.

The Taxation of a Self-Directed IRA LLC

Self-Directed IRA LLC owned by one IRA – Disregarded Entity

Using a Self-Directed IRA LLC to make investments, such as real estate presents many exciting investment and tax deferral opportunities. In general, when a wholly owned IRA LLC, also known as a single member Self-Directed IRA LLC is used to make a retirement account investment, there is generally no Federal Income tax return filing requirements, as the LLC will be treated as a disregarded entity for tax purposes. An LLC is treated as passthrough entity for tax purposes, which means it is not subject to tax. The owner (IRA member) of the LLC would be the party responsible for the payment of tax on the allocated net profits generated by the LLC.

Self-Directed IRA In-House CPA ServiceWhen it comes to the payment of tax, in the case of a single member LLC treated as a disregarded entity for tax purposes, the member (owner) of the LLC, and not the LLC would be responsible for the payment of tax in connection with any net profits generated by the LLC. However, in the case of a single-member Self-Directed IRA LLC, an IRA, which is exempt from tax pursuant to IRC Section 408, is the sole owner of the LLC, not an individual or taxable entity. Hence, since a tax-exempt retirement account is the sole owner of the LLC, in general, no tax is due when making real estate and other passive investments with a Self-Directed IRA LLC.

In addition, most states do not require single member LLC to file a state tax return. However, certain some states do impose certain filing and tax requirements on single-member Self-Directed IRA LLCs. As a result, it is vital to work with specially trained tax professionals and CPAs who can properly advise on all the federal and state tax matters involving using a single-member Self-Directed IRA LLC.

Self-Directed IRA LLC owned by two or more IRAs – Partnership

In the case of an LLC owned by two or more IRA accounts, the LLC would be treated as a partnership for Federal Income tax purposes and as a result an IRS Form 1065, Partnership Return, must be filed with the IRS even though no tax is due at the partnership level. An LLC owned by two or more IRAs is treated as a partnership for tax purposes. Like a single member LLC, multiple-member LLCs are treated as passthrough entities for tax purposes and, thus, are not subject to tax. The owner(s) (IRA member(s)) of the LLC would be the parties responsible for the payment of tax on the allocated net profits generated by the LLC. However, in the case of a multiple-member Self-Directed IRA LLC, two or more IRAs, which are exempt from tax pursuant to IRC Section 408, would be the owners of the LLC, not an individual or taxable entity. Hence, since a tax-exempt retirement account are the sole owners of the LLC, in general, no tax is due when making real estate and other passive investments with a Self-Directed IRA LLC.

In addition, most states require LLCs treated as a partnership for federal income tax purposes to file a partnership return for state purposes. However, in the case of a single member Self-Directed IRA LLC, an IRA, which is exempt from tax pursuant to IRC Section 408 is the sole owner of the LLC, not an individual or taxable entity. Hence, since a tax-exempt retirement account is the sole owner of the LLC, in general, no tax is due when making real estate and other passive investments with a Self-Directed IRA LLC.

However, some states do impose certain filing and tax requirements on multi-member Self-Directed IRA LLCs. As a result, it is vital to work with specialized tax professionals and CPAs who can properly advise you on all the federal and state tax matters involving using a multiple-member Self-Directed IRA LLC.

In-House CPA Services

The IRA Financial Group has designed a specialized Self-Directed IRA LLC CPA service, which will offer clients the ability to consult with specialized Self-Directed IRA LLC trained CPAs on a wide variety of tax matters concerning the Self-Directed IRA. Below is a list of some of the services offered by our in-house CPAs:

  • Advising clients regarding Federal Income tax matters concerning the use of a Self-Directed IRA LLC
  • Advising clients regarding state Income tax matters concerning the use of a Self-Directed IRA LLC
  • Assisting clients with the completion and filing of any Federal Income tax Partnership returns in connection with a Self-Directed IRA LLC
  • Assisting clients the completion and filing of any state Income tax returns in connection with a Self-Directed IRA LLC
  • Advising clients on the IRS prohibited transaction rules as they pertain to federal and state tax matters involving a Self-Directed IRA transaction
  • Assisting clients regarding any state franchise or income tax matters concerning a Self-Directed IRA LLC investment
  • Advising clients regarding the Unrelated Business Taxable Income (UBTI or UBIT) rules
  • Advising clients regarding the Unrelated Debt Finance Income (UDFI) tax rules
  • Assisting clients the completion and filing of the IRS Form 990-T in connection with a Self-Directed IRA LLC investment that generates UBTI and/or UDFI
  • Assisting clients with the day-to-day accounting and management of the Self-Directed IRA LLC & investments (QuickBooks)
  • Self-Directed IRA valuation services
  • Advising on the federal and state asset & creditor protection rules relating to the use of a Self-Directed IRA LLC

Specialized In-House CPA Service for Real Estate Investors

When it comes to engaging in a real estate transaction with a Self-Directed IRA LLC there are a number of important IRS and tax rules that must be followed. For example, IRC Section 4975 prohibits an IRA owner to engage in a transaction that directly or indirectly benefits him/or her or any other “disqualified person”. A “disqualified person” is defined in IRC Section 4975 as the IRA owner and any of his or her lineal descendants, which include parents, children, spouse, daughter-in-laws, and son-in-laws. In addition, a “disqualified person” is not permitted to provide any services or receive any personal benefit from the Self-Directed IRA LLC investment. Therefore, IRA Financial Group has specially designed a CPA tax service program for Self-Directed IRA investors. The specialized CPA service will offer special federal and state tax advice regarding real estate matters as well will cover federal and state tax reporting and filing obligations. Our specially designed Self-Directed IRA real estate CPA service will also offer clients that ability to work with our in-house CPAs to develop an internal accounting system that could keep track of all IRA LLC related expenses and income in order to be in a position to properly value the Self-Directed IRA LLC’s assets. The Self-Directed IRA real estate CPA service is designed to offer a retirement investor with a more detailed accounting of the activities of the Self-Directed IRA LLC.

The tax professionals and CPAs at the IRA Financial Group are committed to making sure your Self-Directed IRA LLC solution remains in full IRS and state compliance from establishment through investment.

For more information on IRA Financial Group’s in-house CPA services, please contact a Self-Directed IRA expert at 800-472-0646.

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Jul 17

Funding a Self-Directed IRA With a Rollover

Individuals may generally rollover their retirement savings between eligible defined contribution plans, defined benefit plans and pre-tax IRAs, including SEP IRAs and SIMPLE IRAs to a Self-Directed IRA. Eligible defined contribution plans include qualified 401(k) retirement plans under Internal Revenue Code Section 401(a), 403(a), 403(b), and governmental 457(b) plans. Individuals may also roll over after-tax retirement funds to a Roth Self-Directed IRA.

What is the most Common Way to Fund a Self-Directed IRA?

Transfers and rollovers are types of transactions that allow movements of assets between like IRAs – Traditional IRA to Traditional IRA and Roth IRA to Roth IRA. An IRA transfer is the most common method of funding a Self-Directed IRA LLC or Self-Directed Roth IRA.

The Rollover IRA FAQsIRA Transfers to a Self-Directed IRA

An IRA-to-IRA transfer is one of the most common methods of moving assets from one IRA to another. A transfer usually occurs between two separate financial organizations, but a transfer may also occur between IRAs held at the same organization. If an IRA transfer is handled correctly the transfer is neither taxable nor reportable to the IRS. With an IRA transfer, the IRA holder directs the transfer, but does not actually receive the IRA assets. Instead, the transaction in completed by the distributing and receiving financial institutions. In sum, in order for the IRA transfer to be tax-free and penalty-free, the IRA holder must not receive the IRA funds in a transfer. Rather, the check must be made payable to the new IRA custodian. Also, there is no reporting or withholding to the IRS on an IRA transfer.

The retirement tax professionals at the IRA Financial Group will assist you fund your Self-Directed IRA LLC by transferring your current pre-tax or after-tax IRA funds to your new Self-Directed IRA or Self-Directed Roth IRA structure tax-free and penalty-free. In order

How the Self-Directed IRA Transfer Works?

Your assigned retirement tax professional will work with you to establish a new Self-Directed IRA account at a new FDIC and IRS approved IRA custodian. The new custodian will then, with your consent, request the transfer of IRA assets from your existing IRA custodian in a tax-free and penalty-free IRA transfer. Once the IRA funds are either transferred by wire or check tax-free to the new IRA custodian, the new custodian will be able to invest the IRA assets into the new IRA LLC “checkbook control” structure. Once the funds have been transferred to the new IRA LLC, you, as manager of the IRA LLC, you would have “checkbook control” over your retirement funds so you can make traditional as well as non-traditional investments tax-free and penalty-free.

Moving 401(k) Plan & Qualified Retirement Plan Assets to a Self-Directed IRA

The 2001 Economic Growth and Tax Relief Reconciliation Act expanded the rollover opportunities between employer-sponsored retirement plans, such as 401(k) Plans and IRAs. Since 2002, individuals may rollover both pre-tax and after-tax 401(k) Plan fund assets from a 401(a), 403(a), 403(b), and governmental 457(b) plans into a Traditional IRA tax-free and penalty-free.

In general, in order to rollover qualified retirement plans to a Traditional IRA there must be a plan-triggering event. A plan-triggering event is typically based on the plan documents, but they generally include the following: (i) the termination of the plan, (ii) the plan participant reaching the age of 591/2, or (iii) the plan participating leaving the employer.

A Direct Rollover to a Self-Directed IRA

A direct rollover transpires when a plan participant, who has access to his or her retirement funds, moves the eligible qualified retirement plan funds to an IRA custodian. In other words, a direct rollover is between a qualified retirement plan and an IRA, whereas, a transfer is between IRA financial institutions. In general, employer 401(k) plan providers must offer the direct rollover option if it is reasonable anticipated that the total amount of eligible rollover distributions to a recipient for the year would be more than $200.

How to Complete a Direct Rollover

Your assigned retirement tax professional will work with you to establish a new Self-Directed IRA account at a new FDIC and IRS approved IRA custodian. With a direct rollover from a defined contribution plan, the plan participant must initiate the direct rollover request. What this means is that the plan participant must request the movement of 401(k) plan funds to the new IRA custodian, not the IRA custodian, like with an IRA transfer. Your assigned retirement tax professional will assist you in completing the direct rollover request form which will allow you to move your 401(k), 403(a), 403(b), 457(b), or defined benefit plan assets to your new IRA account.

A direct rollover may be accomplished by any reasonable means of direct payment to an IRA. Regulations state that the reasonable means may include, wire, mailing check to new IRA custodian, or mailing check made out to new IRA custodian to plan participant.

Reporting a Direct Rollover

When an individual directly rolls over a qualified retirement plan distribution to a Traditional IRA, the employer is generally required to report the distribution on an IRS Form 1099-R, using Code G in Box 7, Direct rollover and rollover contribution. The receiving IRA administrator would them be required to report the amount as a rollover distribution in Box 2 of IRS Form 5498.

Rollover Chart

Click the image below to view the Rollover Chart.

IRA Rollover Chart

An Indirect Rollover to a Self-Directed IRA

An indirect rollover occurs when the IRA assets or qualified retirement plan assets are moved first to the IRA holder or plan participant before they are ultimately sent to an IRA custodian.

60-Day Rollover Rule

An individual generally has sixty (60) days from receipt of the eligible rollover distribution to roll the funds into an IRA. The 60-day period starts the day after the individual receives the distribution. Usually, no exceptions apply to the 60-day time period. However, in cases where the 60-day period expires on a Saturday, Sunday, or legal holiday, the individual may execute the rollover on the following business day.

An individual receiving an eligible rollover distribution may rollover the entire amount received or any portion of the amount received. The amount of the eligible rollover distribution that is not rolled over to an IRA is generally included in the individual’s gross income and could be subject to a 10% early distribution penalty if the individual is under the age of 591/2.

How the 60-Day Rollover Works with a Self-Directed IRA

The retirement tax professionals at the IRA Financial Group will assist you in rolling over your 60-day eligible rollover distribution to a new FDIC and IRS approved IRA custodian. Once the 60-day eligible rollover distribution has been deposited with the new IRA custodian within the 60-day period, the new custodian will be able to invest the IRA assets into the new IRA LLC “checkbook control” structure. Once the funds have been transferred to the new IRA LLC, you, as manager of the IRA LLC, you would have “checkbook control” over your retirement funds so you can make traditional as well as non-traditional investments tax-free and penalty-free.

60-Day Rollover from an Employer Retirement Plan

In general, when a plan participant requests a distribution from an employer qualified retirement plan. IRS rules require the employer to withhold 20% from the amount of the eligible rollover distribution. If an individual receives an eligible rollover distribution and then elects to rollover the assets to an IRA custodian within 60 days, the individual can make up the 20% withheld by the employer retirement plan provider for federal income tax purposes.

Employer sponsored retirement plans are required to withhold at a rate of 20% on all eligible rollover distributions of taxable funds or assets, unless the participants elects to directly rollover the distribution to an IRA or to another eligible retirement plan. In other words, when taking an indirect rollover from an employer qualified retirement plan, the employer is required to withhold 20% of the eligible rollover distribution. The 20% withholding requirements is not applicable for IRA-to-IRA transfers or for direct rollover distributions.

Reporting Indirect Rollovers

When an individual takes a distribution from an employer sponsored retirement plan, such as 401(k) Plan, the employer should make the individual, even if the individual intends to roll the funds over to an IRA. The employer would be required to withhold 20% from the eligible rollover distribution since the funds will be rolled to the plan participant and not directly to the IRA or qualified retirement plan custodian. The employer (payer) would report the indirect distribution on IRS Form 1099-R, using the applicable distribution Code (1,4, or 7). If the funds are deposited with an IRA custodian within 60-days, the receiving IRA custodian would report the rollover assets on the IRS Form 5498 as a rollover contribution in Box 2.

Self-Directed IRA Transfer & Rollover Experts

The retirement tax professionals at the IRA Financial Group will assist you in determining how best to fund your Self-Directed IRA or Self-Directed Roth IRA LLC structure. Whether it’s by IRA transfer or direct or indirect rollover, each client of the IRA Financial Group will work directly with an assigned retirement tax professional to make sure his or her Self-Directed IRA LLC structure is funded in the most tax efficient manner.

To learn more about the Self-Directed IRA transfer or direct or indirect rollover rules, please contact a tax professional at 800-472-0646.

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Jul 15

Why You Should Invest in a Roth IRA

For those of you who don’t know, especially young savers, a Roth IRA is a retirement plan option that is funded with already-taxed money.  There’s no immediate tax break as with traditional plans, but all qualified withdrawals are tax-free (both contributions AND earnings).  There are several reasons why you should consider a Roth IRA in your retirement savings.

First and foremost are the tax implications.  Whether you’re a young person just getting started in the workplace or someone who thinks the federal tax rate is going to be a lot higher when you retire, a Roth is perfect for you.  By paying the taxes now at a lower rate, you protect yourself from a bigger hit later on in life.

Why should you invest in a Roth IRAWhether you’re a high earner, plan to work well into the retirement years or want to leave your assets to your children or other loved ones, a Roth will benefit you greatly because there are no required minimum distributions or RMDs.  The IRS requires you to take RMDs from a traditional IRA once you reach age 70 1/2.  These plans are tax-deferred and the IRS wants its cut sooner rather than later.  The Roth option allows you to contribute to save well past 70 years old.

Another great feature of a Roth IRA conversion is the ability to re-characterize.  If you convert traditional funds to a Roth IRA, you have the ability to undo this conversion if your investments under-perform.  During the original conversion, you would owe tax on any funds you move.  If you decide to undo this, you do not have to pay those taxes and your traditional plan will continue to grow tax-deferred.

When you lose a spouse, finances are not on the top of your mind.  At some point though, you should take into consideration the tax implications of being a widow(er).  Married couples who file jointly have more favorable tax rates than do single filers.  Take advantage of this by converting to a Roth as soon as possible.

One last reason is geographic.  Certain states such as Florida and Texas do not hit you with income tax.  If you plan on moving (or retiring) to a different state, such as New York or Hawaii, which has high taxes, it’s best to contribute to a Roth before you move.

To be properly prepared for retirement, you should not only be diversified within your plan, but also with the plans themselves.  Contributing to a Roth IRA will do that for you.  Having funds that are tax-free during your retirement years is the way to diversify your accounts.  If you have any questions about whether a Roth IRA is right for you, contact one of the IRA experts at the IRA Financial Group @ 800.472.0646 or visit our website today!

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Jul 14

Using a Self-Directed IRA LLC To Invest in a Hedge Fund

The Internal Revenue Code does not describe what a Self Directed IRA can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain type of transactions. The purpose of these rules is to encourage the use of IRAs for accumulation of retirement savings and to prohibit those in control of IRAs from taking advantage of the tax benefits for their personal account.

When it comes to using retirement funds to invest in a hedge fund, it is important to be mindful of the IRS prohibited transaction rules under Internal Revenue Code Section 4975. In general, the IRS has restricted certain transactions between the IRA and a “disqualified person”. The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder (i.e. parents, children, spouse, daughter-in-law, or son-in-law), and entities in which the IRA holder or a disqualified person holds a controlling or management interest. Furthermore, Internal Revenue Code Section 4975(c)(1)(D) and (E) outlines rules that relate to self-dealing or conflict of interest transactions that involves an investment that could directly or indirectly personally benefit a disqualified person. The self-dealing or conflict of interest prohibited transaction rules have the broadest application especially when it comes to hedge fund type investments.

Using a Self-Directed IRA LLC To Invest in a Hedge FundA hedge fund is an alternative investment vehicle available only to sophisticated investors, such as institutions and individuals with significant assets. In general, retirement funds are permitted to invest in hedge funds. The prohibited transactions rules tend to become more of an issue when the person using the IRA funds or any disqualified person related to the IRA owner has a personal interest or relationship with the hedge fund investment. In other words, an IRA can generally make an investment into a hedge fund in which neither the IRA holder nor any disqualified person has any personal ownership or relationship with. The issues begin to arise from an IRS prohibited transaction standpoint when the IRA owner wishes to use retirement funds to invest in a hedge fund where her or she or a disqualified person is either an owner, employee or, in some cases, has a professional relationship with the fund in question.

In general, if structured correctly, there may be a way for one to use their retirement funds to invest in a hedge fund that one is personally involved in.  The key is to make sure that the IRA investment into the hedge fund will not directly or indirectly personally benefit the IRA owners since that type of investment would likely trigger a prohibited transaction.

Generally, hedge funds are structured as limited partnerships or LLCs. In the case of a limited partnership, a general partner (“GP”) is created that tends to perform all the hedge fund management tasks. The GP generally owns a small percentage of the partnership. The investors are limited partners (“LP”) of the partnership. A typical fee structure for a hedge fund is the 2 and 20 model, which means the hedge fund manager will take a 2% management fee of all assets under management and then take 20% of the profits generated by the fund after the LP investors have received their money they invested back and, in some cases, a preferred return on the money invested is also returned to the investor.

A popular question is whether an individual who is a principal or in a management position with the hedge fund can use their retirement funds to invest in the fund. To begin with, the use of the retirement funds cannot be invested into the GP entity since that is the entity where the services are generally being performed on behalf of the hedge fund and where the management fee and carried interest are typically being directed as investing IRA funds into a company where the IRA holder has a personal ownership or is performing services as an employee would likely violate the IRS prohibited transaction rules. Therefore, the question then becomes can the IRA holder who has some personal ownership in the hedge fund use retirement funds to invest as an LP of the fund? The answer generally depends on the facts and circumstances involved in the transaction. However, in general, there are ways that one can properly structure an investment of retirement funds into a hedge fund in which the IRA holder has some personal interest. The main question that needs to be asked and answered positively is if the IRS looked at the transaction, could they argue that the IRA owner has in any way directly or indirectly personally benefited by the IRA investment. If the IRA owner cannot prove that he or she did not receive any direct or indirect personal benefit from the IRA investment into the hedge fund, then the IRS would likely argue that the investment triggered a prohibited transaction. Since the onus is always on the taxpayer to disprove a claim made by the IRS, it is crucial that the IRA owner that is seeking to make a retirement investment into a hedge fund in which he or she has some personal connection to be extremely confident that he or she can prove, if requested, that no personal benefit was derived from the retirement account investment, either directly or indirectly. Accordingly, when it comes to using retirement funds to make investments into a hedge fund in which the IRA owner has a personal relationship with, issues such as the management fee and carried interests are items that need to be taken into account when structuring the self-directed IRA hedge fund investment.

The Tax Court in Rollins v. Commissioner, a 2008 Tax Court case, offers some insight as to how the IRS looks at transactions that involve investments into entity’s where the IRA owner has a small ownership interest in. Even though the Rollins case not involve using retirement funds to invest in a hedge fund, it nevertheless offers some insight as to the IRS thoughts on the application of the IRA self-dealing and conflict of interest rules. The Rollins case is especially helpful in examining how the IRS could look at a transaction involving the use of retirement funds into a hedge fund in which the IRA owner has some personal relationship or ownership interest. Mr. Rollins was a CPA who had an ownership in several companies. One of the companies, in which he owned less than 10%, served as a director, but received no compensation, was in financial trouble and needed additional funds. Mr. Rollins decided to use his 401(k) plan funds to lend the company money at prevailing interest rates. The IRS audited the transaction and argued that the loan from Mr. Rollins 401(k) plan to the company was a prohibited transaction as the loan personally benefited him. The Tax Court agreed and basically stated that even though the company was not itself a disqualified person because Mr. Rollins owned less than 50% of the company, nonetheless he could not provide that he did not directly or indirectly personally benefit from the loan made to the company by his 401(k) plan. Clearly the Tax Court felt that Mr. Rollins personally benefited from the loan since without the loan his personal investment would have been lost. The Rollins case is a good illustration as to how the IRS could view an investment into a hedge fund by an IRA owner who has some personal interest in the hedge fund below the 50% ownership threshold.

Below are several examples that highlight the complexities involved in structuring an investment of retirement funds into a hedge fund in which the IRA owner has some personal relationship or ownership.

1. Joe is looking to start a hedge fund and needs $100,000 to begin operations. The hedge fund would be a limited partnership and Joe would be charging a traditional 2% management fee and 20% carried interest on fund profits. Joe will own 100% of the general partner of the hedge fund and is looking for investors to invest in the hedge fund. Joe wishes to use his IRA funds to invest in his hedge fund.

Issues for Joe to consider: Joe would clearly not be able to use his IRA funds to invest in the general partner since he will own 100% of that entity personally and that would likely trigger a prohibited transaction. What if Joe wanted to invest the funds as a limited partner of the fund? Unfortunately, there is no clear answer to this question as the answer is generally dependent on the facts and circumstances involved in the transaction. For example, if the only way Joe could attract investors to the fund is to show he also has invested in the fund and the only funds he had available to invest were IRA funds, the IRS could argue that the use of his IRA funds would personally benefit him since without his IRA funds being used he would not be able to attract investors to his fund and derive a personal financial return from owning the fund.

2. Ben is a 2% partner at a hedge fund that has $500 million under management. The hedge fund is set-up as a limited partnership. The hedge fund has a traditional fee model of 2% management fee and 20% carried interest. The hedge fund is looking to raise an additional $250 million and Ben is seeking to use $250,000 from his IRA to invest as a limited partner of the fund. His limited partnership interest would be 2.5% of the total fund.

Issues for Ben to consider: Ben is clearly a disqualified person because he is the IRA holder, but the hedge fund he is a partner at would likely not be since he owns just 2% of the fund, pursuant to Internal Revenue Code Section 4975(e)(2). However, the self-dealing or conflict of interest rules under Internal Revenue Code Section 4975(c)(1)(D) and (E) could treat Ben’s investment into the fund as a prohibited transaction. The question Ben must ask himself is whether he would receive any personal benefit, either directly or indirectly, from making the fund investment with his IRA funds. For example, would the fund be in financial trouble without Ben’s investment? Will Ben receive a salary bonus if he invests in the fund? Or what if, Ben is required to invest in the fund in order to maintain his position as partner of the fund? These are some of the facts that would need to be examined before determining whether Ben’s investment would rise to the level of a prohibited transaction.

3. Steve is a 99% owner of hedge fund A, which has over $750 million in assets under management. The hedge fund is set-up as a limited partnership. The hedge fund has a traditional fee model of 2% management fee and 20% carried interest. The hedge fund is looking to create fund B, which will be exclusively investing in a pool of loans. Fund B will be looking to raise $500 million from outside investors. Steve and a number of hedge fund A executives want to invest their retirement funds into fund B, but expect to own less than 5% of fund B. Fund A will be charging a management fee and carried interest on the limited partners of fund B.

Issues for Steve to consider: Since Steve owns 99% of hedge fund A and hedge fund A will be receiving a fee from the limited partners of fund B, a management fee and carried interest allocated to Steve’s IRA and potentially his executives could violate the prohibited transaction rules under Internal Revenue Code Section 4975. Fees paid by Steve’s IRA to a company he owns 99% of could be considered a prohibited transaction. What if Steve and his executives were able to have their IRAs exempted from the management fee and carried interest going to the general partner of fund A or were able to buy a different membership class of fund B, which did not have to pay any fees to hedge fund A. Because of Steve’s large ownership interest in hedge fund A, it is especially important that he focuses on the self-dealing and conflict of interest prohibited transaction rules to make sure his IRA investment into fund B could not be viewed as personally benefiting him directly or indirectly.

Unrelated Business Taxable Income

After examining the IRS prohibited transaction rules in order to determine whether an IRA investment into a hedge fund could be made, another set of IRS rules must be reviewed in order to verify whether a tax would be imposed on the income allocated to the IRA from the hedge fund investment.

In general, when it comes to using a Self Directed IRA to make investments most investments are exempt from federal income tax. This is because an IRA is exempt from tax pursuant to Internal Revenue Code 408 and Section 512 of the Internal Revenue Codes exempt most forms of investment income generated by an IRA from taxation. However, in the case of the use of margin, nonrecourse debt, or income generated from an active trade or business conducted via an LLC or partnership, a tax would be imposed on a percentage of the income generated. These rules have become known as the Unrelated Business Taxable Income rules or UBTI or UBIT. If the UBTI rules are triggered, the income generated from that activities will generally be subject to a 35% tax. The UBTI generally applies to the taxable income of “any unrelated trade or business…regularly carried on” by an organization subject to the tax. The regulations separately treat three aspects of the quoted words—“trade or business,” “regularly carried on,” and “unrelated.” In the case of an IRA, all active business activities will be treated as unrelated.

So why have I never heard of these rules before? The reason is that since most Americans with retirement funds invest in publicly traded stocks or mutual funds, which are often structured as a “C” Corporation, an entity subject to tax. A “C” corporation is also known as a blocker corporation. Unlike an LLC, which is treated as a passthrough entity, income from a “C” Corporation is blocked or stays in the “C” Corporation and does not flow to the shareholder. Whereas, income from an LLC passthrough the to the member/owner of the LLC – there is no entity tax with an LLC or partnership. Hence, any income allocated to an IRA via an LLC or passthrough entity would not be subject to an entity level tax and could be subject to the UBTI tax if the LLC was engaged in an active trade or business or margin or debt was used by the LLC. In other words, if one buys stock of a “C” corporation with a retirement account, the UBTI tax rules would not apply. Whereas, if one purchased an interest in a passthrough entity, such as an LLC, with IRA funds and the LLC was engaged in an active trade or business, used margin, or acquired debt, then the income allocated to the IRA could be subject to the UBTI tax.

In the case of an IRA investment into a hedge fund, if the hedge funds activities rise to the level of a trade or business, or if margin or debt is used in the hedge funds trading activities, then even though the investment may not violate the IRS prohibited transaction rules, the income could be subject to the UBTI tax rules. Since most hedge funds are structured as passthrough entities, gaining a solid understanding of the UBTI tax rules is extremely important.

Using retirement funds to invest in a hedge fund is not on its face a prohibited transaction, however, when the IRA owner has some personal involvement with the hedge fund, the IRS prohibited transaction rules must be closely examined to make sure the investment would not trigger a prohibited transaction.

The tax professionals and CPAs of the IRA Financial Group have helped hundreds of hedge fund investors use their retirement funds to make hedge fund related investments, including in their own funds, and have significant experience in this area.

To speak with an IRA Financial Group tax professional, please contact us at 800-472-0646.

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Jul 11

Operating Agreement for a Self-Directed IRA LLC

The LLC Operating Agreement is the core document that is referred to when issues concerning the LLC need to be resolved. The LLC Operating Agreement is the most important document for your Self Directed IRA. It is extremely important that you create an Operating Agreement for your Self Directed IRA LLC.

The standard LLC Operating Agreement will not meet the requirements for your Self-Directed IRA LLC. In general, a self directed IRA LLC Operating Agreement should include special tax provisions relating to “Investment Retirement Accounts” and “Prohibited Transactions” pursuant to Internal Revenue Code Sections 408 and 4975. In addition, since the LLC will be managed by a manager and not the member, the Operating Agreement would need to include special management provisions.

Operating Agreement for a Self-Directed IRA LLCIt is extremely important to have a properly prepared Operating Agreement to fit the needs of your LLC and meet the requirements of the Internal Revenue Service for a Self Directed IRA LLC In fact, a copy of the LLC Operating Agreement will be required by the Custodian and also by the bank where you will have your LLC’s checking account.

IRA Financial Group will generate a special purpose self-directed IRA LLC Operating Agreement that has been approved by all IRA passive custodians. The special purpose self-directed IRA LLC operating agreement has been drafted by tax professionals who worked at some of the largest law firms in the country such as White & Case LLP, Dewey & LeBoeuf LLP, and Thelen LLP. With our work experience at some of the largest law firms in the country, our tax knowledge in this area is unmatched.

Our low one time service fee includes not only the special purpose self-directed IRA LLC operating agreement, but also includes the setting up of the entire Self Directed IRA LLC structure for you, including LLC formation, acquiring a Tax ID#, assisting with the completion of all transfer documents, and self-directed IRA tax advisory service from our in-house tax and ERISA professionals.

Please contact one of our IRA Experts at 800-472-0646 for more information.

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