Written By
Jessy Gilger
Unfortunately, many self-directed assets lack liquidity, making them difficult to sell quickly. Examples include real estate, privately held businesses, precious metals, etc. If cash is ever needed for a distribution or internal expense, selling an asset fast could be a problem (which compounds into other problems)..
Self-directed IRA owners should conduct thorough due diligence on asset liquidity before committing to an investment strategy.
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When forming a checkbook IRA, a self-directed IRA LLC is established first. Then, the LLC establishes a checking account just like any other business entity. Next, the LLC is funded by sending the IRA funds to the checking account.
With the proper legal structure, the IRA owner can become the sole managing member of the LLC and have signing authority over the checking account. However, improper legal structure, registration, or titling could all cause serious problems for the tax-advantaged status of the IRA.
Within a checkbook IRA, owners can fund investments quickly and freely, but this comes with the responsibility of properly following rules and self-reporting transactions.
Without oversight into each transaction you make, a custodian is more likely to misreport income on your investments. Always ensure the custodian has accurate information to avoid accidentally breaking the law.
Clients looking to buy precious metals, real estate, or digital assets should know the risk of “deemed distributions” treatment. A recent United States tax court case, McNulty v. Commissioner, illustrates the considerable risks of maintaining a checkbook IRA.
In the McNulty case, a taxpayer used her checkbook IRA LLC to purchase gold from a precious metals dealer. She stored the LLC’s gold at home in her personal safe. The court ruled that her “unfettered control” over the LLC’s gold without third party supervision created a deemed taxable distribution from her IRA.
All self-directed IRA owners are always prohibited from commingling personal and IRA assets or using any personal funds to improve IRA assets. “Self-dealing” is one of the most common pitfalls for self-directed account holders.
These are stringent rules and can result in huge tax headaches if breached. I don’t intend to crush any dreams, but investing your 401k/IRA into your lakefront Airbnb vacation home and having you or your family stay there even once is a bad idea.
Financing within a self-directed IRA is also more complicated. Typically, a non-recourse loan and larger down payment are needed for any property purchases. Unexpected costs and fees can add up quickly and eat into any profits.
IRA-owned active businesses could run into the issue of UBIT (Unrelated Business Income Tax). This also affects the overlap of bitcoin mining within an IRA. Any income and expenses must also remain within the IRA structure and never commingled with personal funds.
This article is provided for educational purposes only, and cannot be relied upon as tax or investment advice. Unchained makes no representations regarding the tax consequences or investment suitability of any structure described herein, and all such questions should be directed to a tax or financial advisor of your choice.