by Jeff Nabers
One important aspect you should consider when expanding your IRA investments beyond publicly traded securities is liability. Most self directed IRAs are invested in real estate. A common practice of real estate investing and business in general is the use of Limited Liability Company (abbreviated “LLC”) for protection against litigation. The liability of an LLC’s owners (or members) is limited to their capital contributed to the LLC. For this reason, many real estate investors divide their major investments into separate LLCs.
For example, let’s say an investor bought apartment complexes and held on to them for cash flow. Usually, a separate LLC would be created for each apartment complex. Let’s say an investor owns 3 apartment complexes: Apartments A, Apartments B, and Apartments C. Somebody slips and falls in Apartments A, sues the owner/investor, and wins. If each apartment complex is owned in its own individual LLC, the assets associated with Apartments B and Apartments C would not be subject to the settlement of the law suit involving Apartments A.
This same strategy can protect the assets of a self-directed IRA, whether it’s as simple as one LLC or multiple LLCs. The use of one LLC is fairly simple. It requires you to:
1. Roll your 401(k) and/or IRA funds to a new account with a self directed custodian who does not limit your investments. (See “Is it reall self directed? Take the test.”)
2. Create a new LLC specially designed for IRA funding using a qualified attorney who will provide legal opinion. (See “What’s so special about an IRA LLC?”) You will manage this LLC, but not have ownership.
3. Direct your new custodian to invest a certain amount of your IRA funds into this new LLC.
You then have checkbook control of your IRA. Note: Before jumping into investments and writing checks all over town, make sure you understand how to avoid breaking the rules and getting slapped with serious taxes and penalties from the IRS. See “Avoiding Prohibited Transactions”.
Using multiple LLCs ensures asset protection when funding several investments or a handful of high-dollar investments. Don’t try to pinch pennies when it comes to the legal fees involved in executing a safe and smart investment strategy. Remember, in most cases, the goal is to participate in high return investments while legally deferring or eliminating thousands, tens of thousands, or millions of dollars of taxes on profits. If your legal fees are significantly less than what your taxes would be in a non-IRA strategy, then you are still saving money. Beware of price gouging though. The supply of knowledgeable, qualified attorneys to assist with IRA LLC strategies is limited and the demand for their services is growing. Many companies spend so much money marketing that they have to charge ten times the price of a regular LLC formation just for them to maintain a profit margin.
The inclusion of an LLC in your self-directed IRA plans, when created and maintained correctly, will ensure the safety of your investments.
With a background in mortgage banking and real estate investment, Jeff Nabers founded IRA Association of America as a means to provide Americans with accurate information on tax advantageous investing.