Checkbook SDIRA LLC - how are taxes handled?

Question

I am planning to open a Checkbook Self-Directed IRA LLC through a custodian that supports these accounts.  I understand that you also need to obtain an EIN for the purpose of opening a bank account in the LLC's name, and I expect that's also necessary if you use the LLC to invest in investment accounts, such as brokerage accounts.

My question is, what happens when you earn interest or other earnings that would otherwise be taxable for an LLC?  The bank or brokerage would report that interest against the EIN for your LLC.  How do you go about deferring taxes on the LLC's earnings, as it is owned by the IRA?

I believe you don't normally have to file a tax return for a single-member LLC, but if your LLC earns interest, is a separate return required?  On that return, do you indicate that the LLC earnings should be charged against the custodian's EIN?

Brian Eastman · Answer

@Victor A.

While @Steven Hamilton II has provided a good answer, I felt some simplicity and clarity could be added.

Generally speaking, a single-member IRA LLC is disregarded for tax purposes.  No state or federal tax filing will be required, unless there is some kind of state franchise tax (none in Colorado, for example).

The tax reporting liability of the LLC flows through to the IRA, and the reporting is handled by the IRA custodian using standard form 5498.  The custodian will generally ask you to provide a statement of fair market value for the LLC that they use to prepare this filing.  Otherwise, you simply need to keep a paper trail of LLC activities for audit defense (and to help you monitor how your investments are performing).

You use the LLC EIN when establishing bank account and otherwise transacting, and the counter parties to the LLC such as banks, title companies, etc. will view this as a taxable entity.  It is not, but they can treat it as if it is and any resulting income reporting such as a 1099-INT or 1099-S would simply go into your LLC records.  Because the IRS knows the LLC is wholly owned by a tax-exempt IRA, they will not expect such income to show up on a tax return.

Income that is passive in nature such as rent from real property, interest, dividends and royalties will be exempt from taxes under the umbrella of the IRA.

There are, however, two types of activities that can expose the IRA to trust taxation as Steven indicates.

• If the income is sources from a trade or business activity conducted on a regular or repeated basis (flipping houses, equity share of a operating business like a restaurant, etc.) the UBIT applies.  
• If the IRA uses debt-financing such as a mortgage to acquire property, the a sub-set of UBIT known as UDFI applies to the percentage of the income derived from the non-IRA capital.

Both of the above are covered in IRS publication 598, and a 990-T would then need to be filed by the IRA.  In this case, you will need to obtain a separate EIN for the IRA itself.

Steven Hamilton II · Answer

Great question. Depending upon the type of income your IRA may or may not have to file a Form 990-T.  There are certain types of earnings that are excluded: Excluded Income Publication 598

The LLC is disregarded. That said if you have income from a trade/business such as flipping houses you can be subject to UBTI Unrelated Business Taxable Income.

It is taxed as a trust with some very high tax rates.Here is a link to chapter 4 of Publication 598

Jayman Petel · Answer

I got my questions re. SD IRA taxation answered. It appears that it can be straightforward processing based on the type of underlying investment.

The tax rate can be pretty high depending on the type of UBIT liability (longterm vs shorterm).

Another big concern I had was about the actual payment of taxes under UBIT/UDFI. In other words where do the funds come from?

The payment has to come from your IRA and IS NOT considered a distribution. In other words you will not be charged a penalty + tax for early withdrawal of IRA funds that are used to pay UBIT taxes.

I am not expert or professional in this matter. Just providing info here in case it helps someone..

Jayman Petel · Answer

Steve, Thanks for replying to my post on the other forum. Here is the basic offering structure from the PE and am wondering how it might be taxed for a SD IRA:

--------

Class A Membership Units

Minimum Class A Units Offered: 40

Maximum Class A Units Offered: 100

Price Per Class A Unit: $50,000

Minimum Purchase Per Investor: 1 Class A Units

Dylan Doone · Answer

Just to preface I'm not a tax advisor or attorney and do not provide tax advice, but it's my understanding that If your IRA is an owner in an LLC, LP, or other partnership, then the Partnership should file a 1065 Tax Return for the company to the IRS and should issue a K-1 to your IRA for its share of income or loss. Make sure the account preparing the company return knows to use your custodian’s tax ID for your IRA’s K-1’s and not your personal SSN. If your IRA owns an LLC 100%, then it is disregarded (single member LLC) and the LLC does not need to file a tax return to the IRS. This may change from year to year so go on IRS.gov to get the updated guidelines and also there are articles on the journal of accountancy website regarding the complexities.

https://www.irs.gov/pub/irs-pdf/i1065.pdf

All the best!

-Dylan

Checkbook SDIRA LLC - how are taxes handled?

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