When you’re buying and selling investments for your self-directed IRA and time is of the essence, having checkbook control of your IRA assets can sound appealing—but it does come with increased risks. IRA owners can easily cross the line into prohibited transaction territory if they’re not careful. Concerns over how checkbook features attached to an IRA may violate IRA rules have made these features an enforcement target for tax agents.
Investors who are thinking about establishing a checkbook control IRA should seek ongoing expert legal and tax advice, to ensure their IRA continues to comply with all the requirements of the tax code.
Understanding Checkbook Control
The checkbook IRA is a complicated business structure within a self-directed IRA (SDIRA). To create a checkbook IRA, an investor would typically establish a single-member limited liability company (SMLLC) and a checking account for the business. The IRA owner would direct the self-directed IRA to invest in the SMLLC by purchasing shares and paying the investment to the company checking account. The IRA owner would then manage the SMLLC and be free to purchase investments with IRA assets through the SMLLC checking account.
A recent U.S. Tax Court case proves how easily IRA owners can run afoul of the rules when using a checkbook IRA. In the 2021 McNulty v. Commissioner case, the IRA owner worked with an online entity to establish an SMLLC. The LLC was funded with IRA assets and the account holder used the IRA checkbook to purchase American Eagle gold and silver coins in the name of the SMLLC in a series of transactions. The account holder directed the coins to be delivered to a home address (also the listed address for her SMLLC) and put the coins in a safe in the home. The Tax Court found that the IRA owner violated the IRA rules because the assets were held at home and she did not involve the IRA custodian in the administration of the IRA, the investment transactions, or custody of the assets. The Tax Court deemed the coin purchases taxable distributions (a “deemed distribution”) from the IRA upon the IRA owner’s receipt of the coins, determining income tax deficiencies of more than $250k, and imposed penalties for a substantial understatement of taxable income since the IRA owner failed to report the investments as distributions in the years they occurred.
Self-directed IRA accounts holding cryptocurrency, precious metals, and real estate are especially at risk of a “deemed distribution” if IRS rules are not followed very carefully – which can create an instant tax liability. The court stated in the McNulty v. Commissioner case that independent oversight of IRA activities by a third-party fiduciary is a key aspect of complying with the requirements to qualify for IRA tax benefits.
Checkbook IRA Pros
Having checkbook control of IRA assets could allow you to purchase investments, pay expenses incurred by IRA investments (e.g., property maintenance), and receive investment income—all while bypassing an IRA custodian. This often shortens the time it takes to onboard an investment, or request fund transfers or distributions from an IRA custodian. A checkbook IRA could be useful for investments that require immediate payment to claim ownership, such as purchasing real estate at an auction. Some benefits include:
QUICK ACCESS TO
FASTER TRANSACTION TIMES
LESS TRANSACTIONAL PAPERWORK
The ease of transactions also comes with great responsibility. Mistakes are easy to make and can have a devastating impact on your financial well-being just like in the McNulty v. Commissioner case. It is up to the account holder to navigate adherence to IRS rules in addition to applicable state and/or federal guidelines. Not knowing or not understanding the regulations typically is not a justification held up in a tax court.
Checkbook IRA Cons
Checkbook IRAs are open to abuse because of the unrestricted control IRA owners have over these tax-advantaged, highly regulated assets. IRA custodians are subject to strict federal and state oversight and have the expertise to handle the assets, including tracking investment transactions and generating proper IRS reporting. If an IRA owner violates the tax rules in the process of buying, selling, moving, or holding IRA assets, they can be subject to significant tax and penalties. Some cons include:
|DIFFICULT RULES TO MASTER
|POTENTIAL FOR IMMEDIATE TAX CONSEQUENCES
|EASY TO ABUSE
STRATA Trust Does Not Offer SMLLC Structures
STRATA Trust Company does not support checkbook control IRAs, single-member LLCs, or LLCs that are owned 50% or more by family members. Self-directed IRA owners should always exercise extreme caution when using checkbook control. According to Groom Law Group, “We have for many years counseled clients to beware of arrangements that give IRA owners complete “checkbook control” over their IRA assets. While the IRS has done little to regulate these structures to date, we know that they have been aware of them and suspect that they consider some such arrangements to be abusive. The recent Congressional focus on “self-directed” IRAs as part of the Build Back Better legislation, and that legislation’s emphasis on IRS enforcement, likely will spur further activity from the regulators.”
STRATA Offers Investment Flexibility with Oversight
Our account holders still enjoy full control of their investments and flexibility when it comes to investment choices without the added weight and risk checkbook IRAs carry. As a custodian, STRATA:
- Provides a pre-custody check to ensure investments meet the guidelines set forth by state and federal regulators.
- Receives income/expenses from the assets held in the IRA on behalf of the account holder.
- Adheres to BSA/AML policies and procedures.
- Performs tax reporting of IRS Forms 1099-R and 5498 as required by the IRS.
If you’re considering establishing a checkbook IRA, it’s important to seek financial, tax, or legal advice from those that are experienced in ERISA law to understand the tax implications and the full impact this avenue will have on your IRA and financial plans.
STRATA’s team of knowledgeable self-directed IRA experts are ready to help you with your next alternative investment transaction. Connect with us today to start your retirement savings journey.