Before we talk about anything regarding investment property and LLC-IRA status, we should make it clear that we’re not telling you that the following procedure is what you should run out and do immediately. Come on, people. With something as big and important as your property portfolio, it would be a good idea to consult a tax and legal professional before you change anything. Having said that, the LLC-IRA arrangement might turn out to be a good fit for your particular situation.
You may be aware that it is entirely legal to invest in real estate through a self-directed Individual Retirement Account (IRA). While there are some seriously advantageous tax benefits to this strategy, let’s not sweep the drawbacks under the rug and ignore them. Funding delays and custodial fees can put a crimp in your profitability – so can lawsuits. With a simple real estate property inside an IRA arrangement, you could conceivably lose it and other IRS assets in the event of a lawsuit.
That’s where the Limited Liability Company (LLC) status can be a life saver. An LLC has been granted the status of being immune from most liability lawsuits, much as would a traditional S-corporation or C-corporation. By setting up a single member LLC owned by your IRA, you can retain the good parts of IRA investing and do away with the one real headache. Keep in mind this is not your run of the mill LLC. The operating agreement will likely have to be drawn up by an attorney, and be properly worded, to avoid having the whole thing disqualified and the investor suddenly liable for federal taxes. Possibly lots and lots of federal taxes.
As a business entity protected by law from personal liability, a properly arranged LLC-IRA can also stop creditors of the LLC from attacking IRA funds. The question that might come to mind is whether or not all this maneuvering is legal. According to case law, Swanson vs. The Commissioner in 1996, it is. In that instance the business entity was a corporation, and not an LLC, but, in a legal sense, the end result should be the same.
Once again, don’t trust us or anyone else out there on the Internet who says you should do this. Maybe you should. Maybe you shouldn’t. Make the decision only with the advice and consent of a tax professional, a legal professional, or both.
The Commercial Investing Center Team
Flickr / Claire Dancer