If an IRA owner wants to set up a self-directed IRA, certain steps must be followed. In order to set up a self-directed IRA, an LLC should be formed to act as holding company for the IRA property. The LLC should be incorporated where the IRA real estate is located. The LLC should have a tax ID number and a separate checking account. The IRA owner can be the member-manager. The members of the LLC can be the IRA Custodian acting on behalf of the IRA owner and the IRA owner. The LLC will be the purchaser and the mortgagor of the real estate purchased with IRA funds.
The self-directed IRA must be set up with an IRS-qualified custodian, and the IRA will have a custodian account funded with IRA funds only. The IRA owner must comply with all custodian requirements in timely manner. The IRA owner must report all transactions, income, and expenses to custodian, in most cases before the transaction occurs. The custodian will keep records of all investments, transactions, contributions, and distributions and file required reports with I.R.S.
The IRA owner must send contract, title, closing, appraisal, and other documents to custodian for approval and with wiring instructions to fund transaction. IRA funds from the LLC bank account must pay closing costs, maintenance, mortgage payments, and other expenses
A third-party property manager can be hired and paid by with IRA funds. The IRA owner cannot be compensated for property management, commission, accounting, or other duties performed. Property-related expenses must be paid from LLC checking account with IRA funds. No “self-dealing” is permitted, and IRA funds cannot be co-mingled with personal or other funds. Property-related income must be deposited into the LLC checking account and becomes IRA-owned funds. The IRA owner can continue to make IRA contributions to the custodian account in the full amount allowed by I.R.S. The IRA contribution limits still apply, and the custodian keeps track of contributions and report them to IRS.
According to the IRS, a “
cannot directly or indirectly buy, sell, or use the IRA real estate. A disqualified person would be the IRA owner, the IRA owner’s spouse, children, parents, and children’s spouses. A disqualified person would also be fiduciary of the IRA owner, an entity owned 50% by the above-stated relatives of the IRA owner, or a 10% owner, officer, director, or highly compensated employee of such entity. The tax laws prevent “self-dealing” between the IRA, the IRA owner, and disqualified persons.
IRA real estate mortgages are usually 70% loan-to-value. The IRA loan must be non-recourse. It is recommended that the IRA real estate be appraised yearly to determine the actual value of the IRA investment. The IRA property can be sold, and the proceeds from the sale must be held in a separate account until they are reinvested. Net income or gain from the non-leveraged portion of real estate is part of the IRA and is not taxed. Net gains from sale of the leveraged portion of the IRA real estate are taxable as capital gains.
Before setting up a self-directed IRA, you should consult a tax professional who is familiar with IRS laws relating to IRAs. Many accountants are opposed to self-directed IRAs, because they are concerned about the lack of IRS guidance on the subject. They are also concerned that the IRS may eventually consider self-directed IRA investments to be taxable IRA distributions.
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