Question Regarding SD IRA Checking Acct

[Kevin L.]

I have used my ROTH, housed at Equity Trust, to invest in properties. These properties require extensive renovations. Getting to the funds and paying contractors timely is an issue with ET and assume this is an issue with other custodians as well? Its more than just paying large contractor bills... smaller transactions like trips to the hardware store for light bulbs for instance. I've tried to pay for them with my cash and have my IRA pay me back, but ET says that is a no-no.

At the advice of my accountant, I have set up a checking acct for my IRA at Wells Fargo. For an investment, I withdraw all of my ROTH funds above and beyond the purchase price of the property. I pay for the property and put the excess in the designated Wells Fargo acct to use for the rehab.

When the property sells, I put all of the sales proceeds and any remaining balance of the WF account back into my ET acct.

Am I putting my ROTH in jeopardy or is this OK? Everything is meticulously documented.

[Jared Lopez]

Hello Kevin,

First, ET is correct in that you can not be reimbursed. The goods you purchased can not be used on an IRA held property unless the IRA purchased them.

Moving on, do the checks you have at Wells Fargo state the IRA name or your own personal name? From the information you provided, the area of concern for me is centered around Wells Fargo setting up a checking account in your own personal name and you place your IRA funds in that account.

I hope you can clarify.

-Jared Lopez

[Doreen Chaisson]

I would be surprised if Equity would release your IRA funds to a checking account that you control. The main reason for the custodian cutting checks is to ensure there are no prohibited transactions going on. If you have oversight and check-writing ability for this WF checking account, there is no one "tracking" how the funds are being used. Normally for a real estate purchase, a custodian would release the only funds needed to complete the transaction and not send extra above and beyond the purchase amount.

From my view, with years of experience working for a regulated SD IRA custodian, I think you are putting your Roth in considerable jeopardy. Are you sure your accountant is willing to back up his advice to the IRS if you are audited? Is the checking account set up with your Tax ID# or the Tax ID # of your IRA?

Our clients avoid the hassle of the situation you describe above by creating a Single Member LLC, which they then fund with their IRA funds. The LLC has its own bank account, funded by the IRA funds. The LLC then purchases the property, collects rents, pays taxes and contracts and pays for repairs. Most custodians who accept Single Member LLCs as IRA investments will require that you appoint some kind of "special advisor" - a licensed CPA or attorney - who will provide the required oversight and review of all of the LLC's transactions to be sure no prohibited transactions are occurring.

Another solution is to designate a property manager (should be a non-disqualified party to keep things at arm's length). Your custodian would then release funds directly to the property manager to have on deposit in their account. They can then pay the contractors, as well as purchase those small incidentals like light bulbs (which the property, not you, should be installing).

[Kevin L.]

Its a personal checking account. You can label these accounts however you like. The name on this account is my name followed by "IRA". That is how the statement reads and how debit card reads. But again, I can put whatever I like there...no real official tie to my IRA.

As an example, lets say I have $50k in my ROTH with ET. I withdraw it 100% to buy a $40k property. ET allows me to fully withdraw because this is for an auction, price is TBD. I then put the remaining $10k in my Wells Acct and use those funds to renovate, pay contractors, buy bulbs with the debit card, etc.

[Doreen Chaisson]

When you purchase the property at auction, you are adding an asset valued at the sale price to your IRA's holdings. How are you accounting for the "missing" $10,000? It has been released from your Roth, no corresponding purchase or asset to account for it. This would most likely result in that $10,000 being considered a distribution, triggering a 1099 issued to you. Even though it is a Roth, if you are younger than 59 1/2 and the money has not been in the account for at least 5 years, you will face a 10% early distribution penalty.

[Kevin L.]

The last deal I did, I did have a partner who funded renovations. He was paid back upon sale of the property on the HUD.

This time around (only my second rodeo) I own the property 100%. I was going to submit my expenses with the HUD at closing to account for the missing dollars. It is well documented, but again, not sure if that is enough to protect my IRA.

Maybe it is time to step away from ET and go with someone that allows for a Single Member LLC. That seems to be exactly what I need to continue my current practice.

The money, minus reno costs, will be back with ET inside of 6 mths.

[Jared Lopez]

Kevin,

I am not a banking expert, however it is my understanding that a standard checking account is associated with 2 forms of lines of credit. One for overdraft allowance and the other for early availability of un-cleared funds. Both of these are tied to your social security number, which means you are providing a personal guarantee for these lines of credit. In addition, if the account bears interest your SSN is tied to the interest gains.

As far as the single member LLC, those bank accounts and lines of credit are typically non-recourse, which allows your IRA LLC to be offered these lines of credit.

It is my opinion that you should seek the advice of an ERISA specialist to preserve your IRAs tax advantaged status and the integrity of your retirement wealth.

[Doreen Chaisson]

I suggest you get advice quickly from a qualified CPA or attorney who is familiar with IRS regulations regarding alternative assets in a Self-Directed IRA and thoroughly review your current and past transactions.

Even your first investment, as you describe it, has some possible prohibited issues. If your IRA owned the property, you can't have someone else "fund" the renovations if they are not a co-owner of the property. If the IRA owned the property 100%, the renovations needed to be paid for with IRA funds. Someone else can't "front" the money. If your IRA was 100% owner and didn't have the needed funds for renovations, your IRA should have secured a non-recourse loan to cover the costs.

[Kevin L.]

I did not own the first one 100%, the co-owner funded renovations, held a note for the total amount of the reno, and we paid that note at closing. The IRA owned ~75% of the deal.

If ET does not allow for the Single Member LLC funding, can you recommend companies that do. Thanks for your help here.

[Doreen Chaisson]

Ok, that's more clear and definitely a better scenario for your Roth.

However, this current one, with the checking account, is highly concerning. I am quite frankly surprised Equity has not contacted you about the discrepancy in the amount released for the sale vs. the value of the asset purchased and held in the account. Is Equity aware that you've set up this checking account?

[Kevin L.]

No, they are not aware of the checking acct. I just purchased the property and can fund the total excess back to ET if need be.

I just don't know how I pay people or buy things. Not as if ET is going to cut a check for a run to Home Depot. If I pay with my own funds, I can't get reimbursed. Which I don't necessarily care about, but that is a disallowed contribution to my ROTH when I go to sell the property and 100% of the proceeds go back to my acct.

[Doreen Chaisson]

I highly recommend returning the funds to ET and letting them know it's a return of excess funds released for purchase of an asset. (so they don't think it's a contribution).

As I mentioned earlier, if you secure a property management company, ET should be able to release funds to that property manager's bank account to have on deposit for your IRA - owned property. They would then be able to cut checks for expenses and keep an accounting of expenses and payments, which would need to be returned to ET. Of course, they will charge a fee for their services but this is a small price to pay in exchange for protecting the tax advantaged status of your IRA and its investments. The property manager fee needs to be paid for with IRA funds - they can take it from the account they maintain, provided they supply a corresponding invoice to justify the expense.

Keep in mind, any non-disqualified party can be the property manager - perhaps you have a brother or acquaintance willing to perform these duties who will not charge you a fee, or charge a very minimal fee for their time. In this situation, they MUST have a separate bank account for your IRA funds, they cannot commingle the money with their personal funds.

You are correct in that you absolutely cannot use personal funds to purchase items or pay for repairs or improvements, nor can you do any of the work yourself. A property management company solves this problem. They would cut checks, using your IRA funds that they have "in escrow" in a sense, to pay contractors and for supplies.

[Victor A.]

@Kevin L. , I agree with everything @Doreen Chaisson is saying with respect to how careful you need to be with these retirement funds. You're correct that it isn't like Equity Trust will cut you a check every time you need to run to the hardware store for something. What you're looking for is called a "checkbook IRA" or IRA-LLC, but it's not something you can set up or maintain all by yourself. You need a firm or attorney to set up the LLC structure, and a custodian to maintain it for you. Then you can open up a business (LLC) checking account and make investments (and cover appropriate expenses - like trips to the hardware store) by writing checks, or using a debit card. (Credit cards are strictly forbidden.)

In the unlikely event that it's been less than 60 days since you pulled money out of your Equity Trust account, you should return the original balance as Doreen suggested, because transferring money from an IRA account to a personal account isn't allowed, and that would be a quick and easy way to make it right.

When you open a checkbook IRA, you're responsible for following lots of rules and run the risk of having the IRA invalidated if you run afoul of any of them. Some clear no-no's are transferring funds to/from an IRA account, even if it's just for reimbursement. You can't put down a good faith deposit with a personal check, even if you reimburse yourself prior to closing. In fact, you can't even sign any documents in your own name, only in the name of your LLC. There's an excellent book on the subject written by an attorney that you can pick up at Amazon for less than $20: The Self Directed IRA Handbook. The attorney, Mat Sorensen, also happens to set up IRA-LLCs for a couple thousand dollars. Other companies that set up IRA-LLCs include IRA Financial Group and IRA Capital Partners (their fee is $750, last time I checked).

There are also a number of companies that will act as custodians, like Equity Trust, for the IRA. IRA Services Trust Company seems to have the lowest fees. Udirect Services, LLC is another one.

I listed these companies only because I've been researching the topic and plan to set up one of these accounts for myself, but I haven't done it yet and haven't had first-hand experience with any of them. I'm sure there are other companies out there that are also worth considering.

[Doreen Chaisson]

There are many Self-Directed IRA custodians out there. It is advisable to do your due diligence and ask about such things as how long have they been in business, are alternative assets their sole focus, are they BBB accredited and rated, are they a regulated financial institution, have they ever been sanctioned by any regulatory bodies, how many accounts and how much in assets do they administer?

What often gets overlooked is the type of company you are choosing. IRA providers can be put into three separate categories: Custodians, Administrators, and Facilitators.

Custodians are the first type of company, and are usually the most common. They’re either a bank, credit union, or non-bank custodian approved by the IRS (usually a broker dealer who obtains IRA approval). Custodians are permitted to custody assets held in an IRA under IRC Section 408. They’re also subject to strict regulatory oversight at a State or Federal level. Custodians tend to take a more conservative approach when reviewing alternative assets for investment, as they want to avoid the custody of any assets that may be involved in prohibited transactions. Alternative Asset custodians cannot give any tax, legal or investment advice, cannot assist with the structure of an investment, and cannot endorse, promote or align with specific investment sponsors.

Administrators are the next type of company. Essentially anyone can be an administrator, and their main function is to perform administrative functions only. Because of this, they also need to have an identified custodian for the self-directed IRA named in the account disclosure documents. Administrators are only subject to regulation if required due to profession (CPA or attorney), not for role as administrator. This allows administrators to be much more liberal in accepting assets and allows the ability to align with investment sponsors. Review fee schedules carefully – there may be separate charges for whatever 3rd party custodian they are using.

The third company type is a Facilitator. They educate investors on the process of self-directed investing or assist in setting up single-member LLCs for either “check-book control” or to purchase a franchise or ROBS (Roll-Over Business Startup). They may also provide administrative services for the LLC. Like Administrators, Facilitators must have an identified custodian for the self-directed IRA and are only subject to oversight on a professional level. They are also much more liberal in accepting assets and can align with investment sponsors. Again, review fee schedules carefully – there may be separate charges for whatever 3rd party custodian and/or administrator they are using.

Some companies, like Equity and the company I work for, are both administrator and custodian for self-directed IRAs.

So when you’re looking for someone who offers a self-directed IRA, make sure you know the type of company you’re dealing with. This will help when determining which company best fits your investment scenario.

[Dmitriy Fomichenko]

@Kevin L.

I agree with the previous comments that the way you handling your IRA investments and expense transactions by depositing funds into checking account that is in your name is not correct and you should correct that asap to ensure that your IRA will retain it's tax exempt status. I know that going through a custodian for every single transaction can be pain, but you must follow the rules. If you would like to have the checkbook control then utilizing single member LLC will do it for you as Doreen mentioned above. Your IRA will be the member of the LLC and you will be the manager. The checking account at the bank will be in the name of the LLC using it's own EIN, not your SSN.

[Dmitriy Fomichenko]

@Kevin L.

You may also want to consider truly self-directed, trustee managed Solo 401k plan. Just like self-directed IRA it allows you to invest in alternative assets, but offers some unique features that are not available with SD IRA, which make this plan superior to SD IRA and Checkbook IRA (IRA owned LLC). Take a look at few:

• Solo 401k offers Participant Loan Feature which allows you to access your retirement funds any time for any reason (example would be investing in a transactions that would be otherwise prohibited). It's like creating your own bank that will never turn you down. Some may never use this feature, but it is sure great to have this option. With an IRA you can’t touch your money until you are over 59 1/2 and if you do - you are taxed and penalized heavily!
• Roth Solo 401(k) - you can maintain additional, separate 'bucket' under your Solo 401(k) plan where you could make after tax contributions, thus, investing tax free for the rest of your life. The limit on Roth contribution in Solo 401k is up to $23,000 (compared to $6,500 in Roth IRA) and there is no income restriction on contributions unlike with Roth IRA. Also, pre-tax portion could be converted into after-tax (Roth). (Tax professional should be consulted prior doing so).
• With Solo 401(k) custodian is not required. The plan can be self-administered which could mean significant savings $$ on custodian, transactions and asset based fees that would be there in a case of SD IRA. You also have a checkbook control and dont have to obtain custodian consent when making investments. This could be huge on time-sensitive investments and give great level of convenience.
• Large contribution limit of up to $57,000 (significantly higher than an IRA, which is only $6,500). In additional to all other benefits mentioned above, Solo 401k is a great tax-sheltering vehicle, allowing you to shelter huge amount of money from taxes.
• When you use financing to acquire real estate in a SD IRA, the portion of the income from the property will be subject to UDFI tax (type of the UBIT of about 35%)! When you finance real estate inside of Solo 401k – it would be exempt from UDFI, which makes it even more attractive to use for real estate investment with leverage.

Solo 401k subject has been discussed here on BP in details many times and you can find a lot more info and learn about the experience of those who used it.

The bottom line is you should educate yourself, use resources that are available to you and make informed decisions.

[Fanof Mawson]

Hi Kevin,

I have a simple suggestion that can help, although ET cannot provide it to you. Anyway, here it is: The Entrust Group offers what is called a myDirection asset card. It is essentially a debit card that you can use to pay your IRA's expenses, pay an earnest money deposit, or even make investments. It's $25 per year and $3 per month. It's great for anyone rehabbing properties in their IRA, because you have immediate access to funds without delay.

Additionally, I agree with the comments above that you should not be handling your IRA funds in your personal name. You can setup the LLC with checkbook control, as Dmitriy suggests, but I think the debit card is simpler, easier, just as effective, less complicated and less expensive. This link will tell you more about it:

http://www.theentrustgroup.com/product/mydirection-asset/

Good luck!

Gary