Self-Directed IRA LLCs and Prohibited Investments
Generally, as long as the investment does not result in a prohibited transaction, an IRA can invest in anything permitted by the trustee or custodian of the IRA. Collectibles and life insurance contracts are two exceptions to this general rule. Additionally, the IRA owner may not pledge any portion of the IRA account as security for a loan. These exceptions are commonly referred to as prohibited investments.
Tax Liabilities
The price paid by an IRA to purchase a collectible, as defined below, will be treated by the IRS as a distribution from the IRA to the IRA owner. Likewise, the amount of an IRA account used by the IRA owner to secure a loan will be treated as distributed to the IRA owner.
The IRA owner must report the distributed amount as ordinary income on his or her income tax return and pay the corresponding tax due on such distributed amount. The IRA owner may also be liable for interest and penalties on such amount, including a penalty equal to 10% of such distributed amount if the IRA owner has not attained the age of 59 ½ on the day of the distribution. Less certain is the tax consequence of an IRA purchasing a life insurance contract.
Definitions
(A) COLLECTIBLES:
§408(m) of the Internal Revenue Code (IRC) defines collectibles as any:
(i) Work of art
(ii) Rug or antique
(iii) Metal or gem
(iv) Stamp or coin, or
(v) Alcoholic beverage
Collectibles do not include:
(i) Certain gold, silver, or platinum coin, or coins issued under state law, or
(ii) Certain gold, silver, platinum, or palladium bullion, if such bullion remains in the possession of the IRA trustee
(B) LIFE INSURANCE:
As stated above, no portion of an IRA’s assets may be used to buy any life insurance contract. This includes a contact insuring the life of the IRA owner and viatical life insurance contracts, which are typically sold by elderly or terminally ill persons for less than the value of the policy. However, an IRA may invest in annuity contracts which provide, in the case of death prior to the time distributions commence, for a payment equal to the sum of the premiums paid or, if greater, the cash value of the contract. An IRA may also invest in endowment contracts. The portion of the purchase price of an endowment contract not attributable to life insurance will be treated as a rollover contribution as provided by IRC 408(d)(3). The portion that is attributable to life, health, accident, or other insurance will be treated as distributed to the IRA owner.
(C) PLEDGING IRA ACCOUNT AS SECURITY:
IRC 408(e)(4) provides that any portion of an IRA account used by the IRA owner as security for a loan will be treated as distributed to the IRA owner. IRC 408(e)(4) does not specifically limit this tax consequence to loans made to the IRA owner. For example, the statute could be construed as applying to any loan, no matter the borrower, secured with IRA assets. Such borrower might include a self-directed IRA LLC that secures a non-recourse loan with LLC property. However, the IRS does not appear to interpret IRC 408(e)(4) as prohibiting non-recourse loans acquired by IRAs or by self-directed IRA LLCs. Nonetheless, there is some risk of the IRS treating such loans as prohibited.
Self-Directed IRA LLCs
The above prohibited investments apply not only to self-directed IRA LLCs, but to any entity in which the IRA possesses an interest, regardless of whether the entity is a disqualified person. For example, an IRA cannot circumvent the above prohibited investment rules by acquiring an ownership interest in a corporation, LLC, partnership, or trust that invests in collectibles or life insurance contracts.
Investment Strategy
Precious metals are a popular IRA investment. However, IRAs may only own the types of metals permitted under IRC 408(m)(3). The same applies to any entity in which the IRA possesses any interest, like a corporation, LLC (including a self-directed IRA LLC), partnership, or trust. Such entities may likewise possess an interest in precious metals that only meet the specifications of IRC 408(m)(3).
Sewell Law is located in St. Louis, Missouri and offers legal services in the areas of litigation and asset protection strategies, including LLCs and trusts. Feel free to contact Michael Sewell at (314) 942-3232 or at michael@sewelllaw.net if you have any questions about self-directed IRA LLCs.
This article is for general informational purposes only. It does not include all of the laws and regulations related to the topics discussed in this article, and it is not intended as legal, tax, or investment advice. As such, you should not rely in this article alone in making decisions regarding the subject matter discussed in this article.
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