- What's up guys.
In this video, we're gonna talk about
how not to screw up an LLC
that's gonna be owned by your self-directed IRA.
Okay, let's get started.
All right, so here's the thing.
If you're thinking about investing
with your self-directed IRA into real estate,
you probably realized,
"Hey, I don't wanna own the property
directly in my IRA because if anything goes wrong,
then someone could sue my IRA
and then I'll lose all the other investments."
Now, I understand that.
We talked about protecting real estate on this channel,
about how you use limited liability companies,
but here's what happens when you wanna use it
with your self-directed IRA.
That operating agreement that you set up
has to be a very specific LLC operating agreement.
I'm just amazed how many people will send in their LLC
operating agreements for review,
and these LLCs are presumably owned by a self-directed IRA,
and they just do not pass the test.
And what I mean by that
is that if the IRS were to audit the IRA owner,
the IRA, the LLC, they're gonna see
some major deficiencies there
that could give rise to disqualification
of their self-directed IRA.
Now, it's simple.
If you just put together the operating agreement
and you put in clauses to ensure
that your LLC will not fail,
that means it won't enter into a prohibited transaction
or do something that will create issues for you,
then you're gonna be on your road to some safe investing.
Now, I can't protect you from making mistakes on your own,
but your operating agreement can help you.
So here's some things you need to know
if you wanna go down this road.
First off, if you're going to have your self-directed IRA
own real estate inside of a limited liability company,
then you don't wanna be the one setting up the LLC.
That's number one mistake that people make.
They set up the LLC themselves,
then they transfer the ownership interest
over to their IRA custodian.
So what ends up looking like is this.
Here's your LLC.
Let's say we set up this LLC in Ohio,
and remember, when you set up a limited liability company,
you have to ensure that you list the member of that LLC,
that is if the state asks on the filings
for the article of organization,
you wanna make sure that it's listing your IRA
down here as the member.
Don't put your own name down there,
that's gonna screw it up.
Because if you list yourself as the initial member
of this limited liability company,
and then you turn around and transfer the LLC interest
over to your IRA,
that's going to be a prohibited transaction.
That means you just made a contribution of this LLC
to your IRA.
The second problem you have here in this transaction,
let's say you did it right,
you didn't list yourself,
you listed your IRA.
You know, you have to make sure that you're listing
the IRA the right way.
You just don't list your IRA name down.
Say, this was a Clint Coons, IRA.
Okay, that's not gonna work.
And maybe you put your account number
down here as well, 67942B.
Okay, when you're listing your member of an LLC
as your IRA, you wanna ensure that you're listing
the custodian as well.
So PENSCO Trust,
right, you'd put down your PENSCO Trust, FBO,
Clint Coons, Self-Directed IRA ,
account number 67942B.
Something like that is how it would have to be listed out.
So that would be the member.
But the other problem here that people run into
is that when you set up your own LLC
to be owned by your IRA,
you have to pay a fee, right?
You have to pay a fee to the Secretary of State.
Who's paying that fee?
Well, it shouldn't be coming from you.
And many times, you know,
you're gonna put your credit card in online,
so that's a mistake right there.
Another one gets us into problems if we pay it for itself.
The IRA needs to be paying these fees.
So this can get complicated as you can see,
when you try to set these things up on your own
to protect your real estate.
And then you have to have a registered agent,
because every entity needs to have a registered agent.
Again, you don't wanna be your own registered agent
because now you're providing a service
that benefits your IRA,
which is another prohibited transaction.
You can't provide services that increases the value
or benefits in this way.
So you have to then hire someone else to serve as your IRA,
a third party, which makes sense.
It's a smart thing to do.
But here's the other problem,
how are you paying them?
Again, it needs to come from that IRA.
So, those are some of mistakes,
and this is why you wanna have a professional
set up your LLC the right way
to make sure that you're not gonna involve yourself
in any of this.
For example, when we set them up,
we set up the LLC,
we automatically named the IRA as the member in that LLC,
And then we list our client,
that would be you, as the manager
of this limited liability company.
Now, once that is established,
say with the state of Ohio,
in the way I've just described right here,
then you have to draft an operating agreement.
And here's where things can go good
or they can take a turn for the worse.
A lot of people assume that IRAs are just,
you know, they're all the same.
Just use a standard LLC operating agreement
and you're good to go.
Well, unfortunately, in many operating agreements,
there are provisions in there
that benefit me as a member
or manager of my limited liability company.
Why wouldn't I?
I want a draft stuff in there that helps me
in the running of the business
or compensates me for doing certain things
with that business.
Or allows me to do other things
that will help me grow the business.
Now, many of those exact same clauses
that are beneficial when we have an LLC, say set up here
and on the number in this limited liability company.
Or, you know, the way I like to talk about it,
having that holding company there.
Those same provisions that work on this side for ourselves
for investing outside of the IRA
can create problems here
where we're investing with an IRA.
That is why you wanna make sure
that you have a number of provisions in there
that are gonna provide protection for you
in case you are audited.
Just to show that you understand
that this is an IRA making an investment into an LLC
of which you're gonna be the manager.
And that LLC is not going to engage
in any types of transaction
that would risk disqualification for your IRA.
So, what are some of those provisions
that you should have drafted in there?
Number one, that your IRA will not engage
in any transfers with a disqualified person.
Now, if you don't know what a disqualified person is,
check the Show notes.
I've got a little diagram down there
of what a disqualified person is.
But generally speaking, it's this.
Anybody in your family tree.
So if you had a family tree that looks like this, right?
No branches of course,
just think parents, kids, all disqualified,
bring your spouse over here,
there's another one that's a disqualified party
or any entities that are related to you,
like your corporation or your limited liability company.
Those are all disqualified parties.
So what does that mean?
Well, it means this.
That my LLC that I've set up here
cannot buy property from my corporation,
or from an LLC that I've set up.
Or it couldn't buy property or sell property
to my son or daughter.
So those are disqualified party individuals.
And your IRA is gonna have a provision there
that says this LLC, I said IRA,
I meant LLC will have a provision
that states that the LLC will not engage
in any of those things or any of those people.
Number two, you wanna make sure
that you limit the duties for yourself as manager.
So here's something that comes up a lot.
Whenever you set up an LLC to own your own real estate,
you're gonna say that as manager of this LLC,
you can do all kinds of things.
You know, if you want to rehab,
negotiate sales on the property,
when it comes to an LLC that's owned by an IRA,
you wanna limit that language.
You pare it back.
Now, you wanna typically limit it just to oversight,
to enhance or to maintain the value of the asset,
to do administerial functions with regards to that asset.
You're not going to bring the unlawful detainer action
to remove a tenant.
That means you're not gonna try
to prosecute it on your own.
You're not going to be the one going in
and rehabbing the property.
You're not gonna be the one that picks up a hammer
to do anything on that property.
Because if you did this,
then that is adding value to your IRA.
And that is a disqualifying transaction.
It'll blow your IRA up.
So we wanna make sure that we're limiting
what the manager can do in our operating agreement.
Okay, number three.
You wanna make sure that your manager
is not entitled to compensation.
So who's the manager, I'm the manager.
So you cannot compensate yourself at all,
when you're serving in this capacity.
I've run into a number of individuals before
that have set up LLCs that are owned by their IRAs,
and they're pulling a management fee off the top.
Thinking that since it's okay over here
to take a management fee,
that it should be okay over here.
No, the rules have changed once that LLC
is owned by the IRA,
so that's off the table.
You wanna ensure that you have a provision
that states that the LLC or the manager
will not engage in any prohibited transactions.
Basically, implying that under 4975
that we're going to make sure this LLC is compliant
at all points in time because it's owned by an IRA.
Now, we also want to ensure
that there'll be no transactions with disqualified people.
So we'll have another clause in there
that states that this LLC will not engage,
is prohibited from engaging in any types of transaction
with a disqualified party.
So again, let's assume that your spouse
is a real estate agent.
And this is actually drawn from the archives
of clients that have,
or individuals that have called me before
that have set up an IRA owned LLC,
and they've done just what I'm about to explain to you.
Spouse is a real estate agent,
so they start buying property in the name of the LLC.
They rehabbed it and then they sell it.
Well, since the spouse is a real estate agent,
the spouse lists the property
and earns a commission on the sale of these properties.
Now, because the spouse is a disqualified party,
the spouse just got a benefit
and was performing a service for this IRA
that owned the property.
If this was ever picked up on audit,
it would disqualify the IRA.
So you want to ensure that there'll be no transactions
with disqualified parties.
Have language in your LLC that addresses this.
And the other important clause,
the last one that I think is probably
really, really important for individuals to understand
is you want to ensure
that you have no recourse debt allowed, okay?
So, if you're not familiar with that term,
what recourse, that means is that the members of the LLC
or the manager will not sign a personal guarantee.
So if you're gonna go out
and you're gonna encumber the real estate inside of here,
recourse debt is bad for any type of retirement plan.
And people think, "Well, I'm doing it in the LLC,
I'm not doing it in my IRA."
It doesn't matter,
because whatever happens up here is like,
it occurs down here.
So you want to ensure that you have a provision
that does not permit recourse debt.
And one other thing I would also make sure
that you have inside of your LLC,
that the LLC is either gonna be set up
as a disregarded entity,
which means that it's not gonna file a tax return,
that it's owned 100% by the IRA.
Or maybe you set it up as a partnership
and you elected partnership taxation for it.
The one thing you would never want to elect
for this type of structure is S Corporation
tax treatment for your LLC.
That's gonna blow everything up if you went down that road.
Hey, I hope you got something out of this.
As you can tell, it can be quite complicated
when you're setting up an LLC to be owned by an IRA,
but check the Show notes for what disqualified parties are
or who they are.
And also put in some information
on what is prohibited transactions,
so you can look at that.
But generally speaking,
to be on the safe side,
hire someone to do this for you that is competent
and understands how to set these things up.
Because there's a lot of wealth to be generated
through real estate,
especially inside of your retirement plans,
and you don't wanna jeopardize it
by making simple mistakes along the way.
All right, guys,
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