Can an LLC Own an IRA or Can an IRA Own an LLC?

An individual retirement account (IRA) provides a tax-advantaged way for individuals to save for their retirement. An IRA, by its very definition, is a retirement savings vehicle established for the benefit of an individual. Therefore, an LLC, which is a business entity, cannot be the direct owner of an IRA. However, an IRA can indeed invest in an LLC. This distinction is important for understanding the rules and potential strategies involved.

Distinguishing IRA Ownership from IRA Investments

An IRA is a personal retirement savings vehicle designed for individuals, meaning only a natural person can be the account holder. Financial institutions serve as custodians for these accounts, holding assets on behalf of the individual, not for a business entity. This structure ensures tax benefits are directed toward an individual’s retirement savings. While an LLC cannot own an IRA, an IRA can hold various assets, including ownership interests in an LLC. The LLC functions as an investment asset within the IRA, similar to how an IRA might hold stocks or mutual funds. The IRA itself remains under the ownership of the individual, with the LLC interest being one component of its diversified portfolio.

Investing in an LLC through a Self-Directed IRA

For an IRA to invest in an LLC, a Self-Directed IRA (SDIRA) is used. Unlike traditional IRAs, an SDIRA provides the account holder with the flexibility to invest in a broader array of alternative assets, including real estate, precious metals, private equity, and ownership interests in LLCs. A specialized SDIRA custodian is required to facilitate these non-traditional investments, as the IRS mandates all IRAs must be held by a custodian or trustee. While the individual directs the investments, the custodian maintains legal custody of the assets and ensures compliance with IRS regulations. The custodian’s role involves executing investment directions, processing transactions, and handling administrative duties to preserve the IRA’s tax-deferred status. The process involves opening an SDIRA with a qualified custodian and funding it. Once funded, the individual directs the custodian to invest a portion of the SDIRA’s assets into an LLC. The custodian then makes the investment directly to the LLC, ensuring the LLC’s ownership interest is properly titled in the name of the SDIRA. The SDIRA owner assumes responsibility for conducting due diligence on the investment, as custodians do not provide investment advice or recommendations.

Structuring and Managing Your IRA’s LLC Investment

When an SDIRA invests in an LLC, there are several ways this can be structured. An SDIRA might purchase membership interests in an existing operating business organized as an LLC, becoming a passive investor. Alternatively, a common strategy involves forming a new LLC wholly owned by the SDIRA, often referred to as an “IRA/LLC” or “checkbook control LLC.” This new LLC then holds specific assets, such as real estate or private lending notes, directly within the IRA’s structure. The investment process begins with identifying the suitable LLC investment opportunity. Thorough due diligence on the LLC and its underlying assets is essential. Work closely with the SDIRA custodian to execute the investment. The custodian will transfer the SDIRA funds directly to the LLC in exchange for its membership units, ensuring all investment documents, such as the LLC operating agreement and subscription agreements, clearly reflect the SDIRA as the investor. The investment must be titled in the name of the SDIRA, via its custodian, not in the individual’s personal name. In the case of an SDIRA-owned LLC, the IRA owner can serve as the manager of the LLC. This arrangement provides “checkbook control,” allowing the individual to make direct investment decisions and manage the LLC’s bank account without requiring the custodian’s approval for every transaction. This control streamlines the investment process, particularly for time-sensitive opportunities. However, the individual acting as manager must adhere strictly to IRS rules, ensuring all income and expenses flow through the LLC’s business account and that personal funds are never commingled.

Important Rules for IRA Investments in LLCs

Investing in an LLC through an SDIRA requires strict adherence to IRS regulations to maintain the IRA’s tax-advantaged status. A primary concern is avoiding “prohibited transactions,” as defined under Internal Revenue Code Section 4975. These rules prevent the IRA owner or “disqualified persons” from personally benefiting from or engaging in certain transactions with the IRA’s assets. Disqualified persons include the IRA owner, their spouse, lineal descendants, and any fiduciary of the IRA. Examples of prohibited transactions include buying assets from or selling assets to a disqualified person, borrowing money from the IRA, using IRA assets as security for a loan, or providing services to the IRA-owned LLC for personal compensation. If a prohibited transaction occurs, the IRA can lose its tax-exempt status, leading to immediate taxation of all its assets at their fair market value on the first day of the year the transaction occurred. The IRA owner may also face a 10% early withdrawal penalty if they are under age 59½. Another significant consideration is Unrelated Business Taxable Income (UBIT), governed by Internal Revenue Code Section 511. UBIT is a tax on income generated by an IRA from an active trade or business that is regularly carried on and is unrelated to the IRA’s tax-exempt purpose. For instance, if an IRA-owned LLC actively operates a business, such as a manufacturing company or a retail store, rather than simply holding passive investments like rental real estate, the income generated from such operations could be subject to UBIT. This tax is assessed at corporate tax rates and requires the IRA to file Form 990-T. Proper annual valuation of illiquid assets, such as LLC interests, is necessary for SDIRA reporting purposes. Custodians require fair market valuations to accurately report the IRA’s assets to the IRS on Form 5498. Seeking professional advice from a tax advisor and working with an experienced SDIRA custodian is highly recommended.