I hear a radio ad every week that says, “there is a loophole that allows you to use your IRA to buy physical gold “tax-free” and that you can EVEN store this gold in your home.” If these radio ads were on T.V., there’d probably be an image of Scrooge McDuck swimming in gold at his McMansion. These ads cause much concern as they give some misleading information. The good news is that you really can use your IRA to invest in gold. In fact, I have many clients who like to buy actual physical gold with their IRAs. And we’re not talking about gold funds or gold ETFs, but actual solid gold. You can also own silver, platinum, and palladium with your IRA so long as those metals meet certain legal requirements. Here’s the catch though and what the radio ads are missing, you can only own precious metals that meet certain legal requirements and you cannot personally store the metals. Don’t count on someone who sells precious metals to be an expert on IRA rules. They make money when you buy precious metals and they have no training or license to properly advise you, so get your legal and tax advice from a competent lawyer or tax adviser.
LEGAL RULES FOR IRA OWNED PRECIOUS METALS
Precious metals have been a popular investment for retirement plans since the financial market collapse in 2008. Most standard IRAs with financial institution custodians will typically only offer precious metals through funds or other complex structures whereby the IRA does not directly own the precious metals. A self-directed IRA can hold actual precious metals as long as those metals are not considered collectibles under law and as long as they are properly stored.
Only precious metals which meet the requirements of IRC § 408(m)(3) may be owned by an IRA. All other metals or coins are considered collectible items and cannot be held by an IRA. IRC § 408(m)(2)(C), and (D).
There are two categories of approved precious metals. The first category are specifically approved coins, such as American Gold or Silver eagles. The second category is bullion (e.g bars, or coin form bullion) that is gold, silver, platinum, or palladium, AND that meets certain purity requirements. The purity requirements are outlined below.
Gold, meeting minimum fineness requirements of 99.5%.
Silver, meeting minimum fineness requirements of 99.9%.
Platinum, meeting minimum fineness requirements of 99.95%.
Palladium, meeting minimum fineness requirements of 99.95%
Precious metals must be stored with a “bank” (eg. bank, credit union, or trust company). Personal storage of precious metals owned by an IRA is not allowed. A broker-dealer, third-party administrator, or any company not licensed as a bank, credit union, or trust company may not store precious metals owned by an IRA. IRS Private Letter Ruling 200217059.
There has been much confusion about owning precious metals with an IRA and there is confusion over some “loophole” that allows you to store them in your home. Our advice is against home storage, for tax code reasons and for security reasons. We’ve outlined the tax reasons more fully in a prior blog article you can check out here. In general though, our advice is that if your self-directed account owns metals directly through your custodian account then those metals will be stored with the custodian or with a “bank” whom the custodian uses for customers. If the metals are bought with an IRA owned LLC, then the metals of the LLC are subject to the storage rules and this can be satisfied by the LLC opening up a safe deposit box with a bank and by physically storing the metals there.
If an IRA purchases precious metals that do not meet the specific requirements of IRC § 408(m)(3), then the precious metals are deemed collectible items. As a result, they are considered distributed from the IRA at the time of purchase. IRC § 408(m)(1). Similarly, if the storage requirement is violated, then the precious metals are also deemed distributed as of the date of the storage violation. IRS Private Letter Ruling 20021705. The consequence of distribution is that the value of the amount involved is deemed distributed and is subject to the applicable taxes and penalty.
Go for the gold, or silver, or the other approved metals with your IRA. But make sure the metals meet the code requirements and that they are properly stored.
This article is an excerpt from Chapter 12: Precious Metals of The Self Directed IRA Handbook by Mat Sorensen
The recent case of Niemann v. Commissioner involves a successful real estate investor who unknowingly used his self-directed IRA owned LLC (aka, checkbook control IRA) in a way that caused a prohibited transaction under IRC § 4975. While the Tax Court’s holding and decision focused on other tax matters, the Court did outline the history of the case and the prohibited transactions that occurred and that disqualified Niemann’s IRA. Here are the pertinent facts regarding Niemann’s self directed IRA investments.
Neimann formed Real Estate Rabbit, LLC with his IRA as the sole member and himself as manager.
Neimann used Real Estate Rabbit, LLC for numerous real estate investments including buying homes at auction and slipping them for a profit. Real Estate Rabbit, LLC also bought mineral rights investments and held notes.
Neimann personally engaged in real estate investments in his own name and in the name of an LLC he personally owned called Magic, LLC. Neimann intended for Magic, LLC to be a multi-member LLC to be owned by himself, his personal LLC, and his IRA/LLC. This LLC was not properly established nor was it properly operated. He learned about it from a seminar and engaged a non-lawyer (“vendor”) to set up the LLC.
Neimann transferred properties from his Real Estate Rabbit, LLC (his IRA/LLC) to himself personally and to his personally owned LLC. These transfers caused a prohibited transaction and resulted in the entire distribution of Neimann’s self directed IRA.
It is quite clear from the case and from the Court’s analysis that Neimann was not intending to unfairly avoid tax nor was he attempting to improperly engage in a prohibited transactions. In fact, his real estate transactions were very successful. And if you were a successful real estate investor looking to illegally avoid taxes, you wouldn’t transfer properties from your IRA owned LLC (that pays no taxes on gains) to yourself personally (where you do pay taxes on the gains). If you were a tax cheat, you’d do the opposite and would transfer properties with gains from yourself personally to your IRA. It is quite clear instead, that Neimann was unaware of the rules and as a result he moved his real estate investments around between his LLCs and his personal name as he would with any property he owned. These transfers were made without regard to IRA rules which require IRA investments to be held separately from personal assets and which restrict transactions between the IRA (and IRA/LLC) and the IRA owner personally.
Neimann conceded with the Court and the IRS that he engaged in a prohibited transaction when his IRA owned LLC (Real Estate Rabbit, LLC) transferred property to himself personally and to his personally owned LLC.
LEARN THE RULES AND SEEK OUT QUALIFIED LICENSED PROFESSIONALS
This case illustrates a critical point that self-directed IRA investors must first become acquainted with the self-directed IRA rules before they enter into real estate, LLC, or other transactions with their IRA. Neimann was a successful investor and a former engineer but he either received poor advice or he sought no professional legal or tax advice in the process.
Learning how to self-direct your IRA is like learning a new board game. At first, it takes some time to learn what you can and cannot do but once you understand the rules for the investments you intend to make it becomes second nature and you can proceed without having to consult the “rulebook” or a lawyer, or CPA, or other licensed advisor. So, if you’re new to self directing your IRA, make sure you’ve received competent advice from licensed professionals. Don’t rely on something you’ve heard at a seminar or by someone trying to sell you an investment. Instead, seek a specific consult with a licensed attorney or CPA who is competent in the rules effecting your self-directed IRA.
Many real estate investors and landlords often ask whether they should use an umbrella insurance policy or an LLC to protect them from liabilities that may arise on their rental property. An LLC protects the owner of the LLC from liabilities that arise on any property in the LLC and prevents a plaintiff from being able to go after the LLC owner personally. As a result, we often say that an LLC protects a business owner’s personal assets from the risks and liabilities of the LLC business. An umbrella policy is coverage above and beyond the typical property insurance but it only adds additional coverage to insurance the property owner already has in place.
There are many issues and factors to consider in making this decision and there is no one-sized fits all recommendation. In many instances we recommend that you have both an LLC and an umbrella policy and in other instances we may recommend just an LLC or just an umbrella policy. The first factor to consider is the cost. The cost of an LLC in our office is $800 and on average you can expect about $200 in fees a year to keep that LLC active with the State (about $900 annually in California, each state is different). As a result, the major cost of an LLC is in the first year but you can plan on having about $200 in fees each year to keep your LLC active. If you have a partnership LLC then you also have the cost of a LLC partnership tax return but the LLC also provides a significant amount of partnership advantages and protections and we would almost always recommend an LLC for property owned between two or more parties.
An umbrella policy on the other hand is typically paid for monthly and there isn’t an un-front cost. Let’s say you are able to get a $1M umbrella policy at a cost of $50 a month. That would run you about $600 a year. Insurance policies have benefits which include attorneys whom the insurance company will appoint and pay to defend you (and protect themselves from having to pay) but also contain certain exclusions to coverage that may leave you with no coverage for the liability you incur.
One very common misunderstanding about umbrella policies is that they ONLY provide additional insurance coverage on top of insurance coverage you already have. So, for example, let’s say you have a property insurance policy with landlord liability protection of $100,000 and an accident occurs on the property that is covered by the policy. If that liability is covered by existing insurance and once that insurance has been exceeded, then the umbrella insurance provides coverage. Umbrella insurance does not, however, provide coverage in areas where you don’t already have coverage. This is a major limitation to and misunderstanding about umbrella insurance. I’ve talked to a few clients over the years who’ve needed to make claims on their umbrella insurance policy and who were surprised to find out and learn that the umbrella insurance didn’t cover any new liabilities or gaps in their existing insurance. As a result, just make sure you understand what the umbrella insurance actually covers.
An additional factor to consider is the type of property you own. If you own a multi-unit property or commercial property we would recommend having both an LLC and an umbrella policy because you have more liability exposure when you have more tenants. On the other hand, if you have a single family rental in an otherwise good neighborhood where you feel less likely to be sued then we may only recommend an LLC or an umbrella policy on its own. Bottom line, consider both an LLC and an umbrella policy in your analysis and get quotes and advice upon which to make an informed decision so that you are protecting your assets in the most efficient and effective way as possible.
And finally, consider the equity that is in the property and your overall net worth. The more equity you have in the property and the more personal assets you have in general then the more reason to have both an LLC and an umbrella policy.
In Ellis v. Commissioner, a Federal Appeals Court recently held that an IRA owner engaged in a prohibited transaction when he paid himself compensation from his IRA/LLC. An IRA/LLC (aka, “checkbook control IRA”), is an LLC owned by an IRA and is used primarily by real estate investors who choose to have their self directed IRAs own an interest in an LLC (usually 100%) and then this IRA/LLC in turn owns the real estate asset. The LLC will typically have a bank checking account and will receive income from the property and will be used to pay property expenses. The most common IRA/LLC structure is one where the IRA owner serves as the Manager of the IRA/LLC. Most self directed IRA companies and legal professionals will require that the IRA/LLC documents restrict the IRA owner from receiving any compensation from the IRA/LLC for serving as the Manager of the LLC. This restriction is a result of the prohibited transaction rules for IRAs which effectively state that certain persons called “disqualified persons” (e.g. IRA owner, their spouse, parents, kids) cannot transact with or personally benefit from an IRA’s investments or assets. IRC § 4975 (c)(1)(D), (E). For reference to the underlying Tax Court case and additional case facts and issues, please refer to my 2013 blog article on the Tax Court case here.
As a result of the Ellis case, Self-directed IRA owners should note the following key points from the 8th Circuit Court of Appeals decisions when investing their IRA funds into LLCs or other closely held companies.
No Compensation or Benefit. The company documents must restrict the company from paying any compensation to a disqualified person. In essence, the Tax Code restricts an IRA from transacting with so called disqualified persons and these disqualified persons include the IRA owner (as a fiduciary), their spouse, kids, and parents. For more details on who is a disqualified person, please refer to my disqualified person article and diagram here.
Don’t Rely on the Reasonable Compensation Exemption for Payments from an IRA/LLC to a Disqualified Person. In the Ellis case, the IRA owner made an argument that the compensation paid from the LLC to the IRA owner was “reasonable compensation” exempt from the prohibited transaction rules. This argument was based on the “reasonable compensation” exemption found in IRC § 4975 (d)(10), which exempts “reasonable compensation” paid from an IRA to a disqualified person in the performance of plan duties. The Court held that the reasonable compensation exemption did not apply to Ellis as his compensation was for managing the LLC’s business activities and not in the performance of plan duties. Further, the Court noted the “in-direct” self dealing prohibited transaction restriction and also relied on DOL Opinion 2006-01A, which restricts an IRA from investing into a company if that company is supposed to then transact with or compensate a disqualified person. In the Ellis case, as would be in the case in all IRA/LLC arrangements, compensation paid to an IRA owner would follow this rationale and an in-direct prohibited transaction would a rise. Consequently, compensation should never be paid to a disqualified person in an IRA/LLC or other closely held IRA owned company structure.
IRA/LLCs Are an Excellent Tool for Many Self Directed IRA Investors When Established and Operated Properly. The Ellis case is an excellent example of someone taking a good idea too far. The IRA/LLC is an excellent tool that provides many benefits to self directed IRA owners and the same structure has been used by pension and profits sharing plans for owning real estate or other alternative assets for years. That being said, the tax rules applicable to self-directed IRAs can be tricky to understand and investors self directing these accounts for the first time can find themselves in the middle of a prohibited transaction if they don’t seek competent advice before they invest their account. Before investing tens or hundreds of thousands of dollars into an IRA/LLC or checkbook control IRA, make sure that the documents are established properly by a competent lawyer and that the IRA owner properly understands how to operate the LLC following set-up. Self-directed IRA owners should not rely on advice from their IRA custodian or administrator as they make you sign waivers saying you aren’t relying on their advice. Also, don’t rely on someone selling you an investment as the may have mixed motives in completing the transaction. Instead, seek the guidance of a competent attorney in this area and avoid structures where an IRA owner or other disqualified person would be compensated personally as part of the IRA/LLC structure.
Our office has been establishing LLCs for IRAs and other retirement accounts for over ten years and our basic IRA/LLC set-up fee is $800 plus state filing fees. This fee includes an attorney consult, an operating memo and guidelines, and all of the IRA specific LLC documents your self-directed IRA custodian will require. For additional information on IRA/LLCs, please refer to my book The Self Directed IRA Handbook or my website at www.sdirahandbook.com.
Many business owners and investors doing business in multiple states often ask the question of whether their company, that is set up in one state needs to be registered into the other state(s) where they are doing business. This registration from your state of incorporation/organization into another state where you also do business is called a foreign registration. For example, let’s say I’m a real estate investor in Arizona and end up buying a rental property in Florida. Do I need to register my Arizona LLC that I use to hold my real estate investments into Florida to take ownership of this property? The answer is generally yes, but after reviewing a few states laws on the subject I decided to outline the details of when you need to register your LLC or Corporation into another state where you are not incorporated/organized. (Please note that the issue of whether state taxes are owed outside of your home state when doing business in multiple states is a different analysis).
In analyzing whether you need to register your out of state company into a state where you do business or own property it is helpful to understand two things: First, what does the state I’m looking to do business in require of out of state companies; and Second, what is the penalty for failure to comply.
WHEN DO I NEED TO REGISTER FOREIGN?
First, a survey of a few state statutes on foreign registration of out of state companies shows that the typical requirement for when an out of state company must register foreign into another state is when the out of state company is deemed to be “transacting business” into the other state. So, the next question is what constitutes “transacting business”? The state laws vary on this but here are some examples of what constitutes “transacting business” for purposes of foreign registration filings.
Employees or storefront located in the foreign registration state.
Ownership of real property that is leased in the foreign registration state. Note that some states (e.g. Florida) state that ownership of property by an out of state LLC does not by itself require a foreign registration (e.g. a second home or maybe land) but if that property was rented then foreign registration is required.
Here is an example of what does not typically constitute “transacting business” for foreign registration requirements.
Maintaining a bank account in the state in question.
Holding a meeting of the owners or management in the state in question.
So, in summary, the general rule is that transacting business for foreign registration requirements occurs when you make a physical presence in the state that results in commerce. Ask, do I have employees or real property in the state in question that generates income for my company? If so, you probably need to register. If not, you probably don’t need to register foreign. Note that there are some nuances between states and I’ve tried to generalize what constitutes transacting business so check with your attorney or particular state laws when in question.
WHAT IS THE PENALTY IF I DON’T REGISTER FOREIGN?
Second, what is the penalty and consequence for failing to file a foreign registration when one was required? This issue had a few common characteristics amongst the states surveyed. Many company owners fear that they could lose the liability protection of the LLC or corporation for failing to file a foreign registration when they should have but most states have a provision in their laws that states something like the following, “A member [owner] of a foreign limited liability company is not liable for the debts and obligations of the foreign limited liability company solely by reason of its having transacted business in this state without registration.” A similar provision to this language was found in Arizona, California and Florida, but this provision is not found in all states that I surveyed. This language is good for business owners since it keeps the principal asset protection benefits of the company in tact in the event that you fail to register foreign. On the other hand, many states have some other negative consequences to companies that fail to register foreign. Here is a summary of some of those consequences.
The out of state company won’t be recognized in courts to sue or bring legal action in the state where the business should be registered as a foreign company.
Penalty of $20 per day that the company was “transacting business” in the state when it should have been registered foreign into the state but wasn’t. This penalty maxes out at $10,000 in California. Florida’s penalty is a minimum of $500 and a maximum of $1,000 per year of violation. Some states such as Arizona and Texas do not charge a penalty fee for failure to file.
The State where you should have registered as a foreign company becomes the registered agent for your company and receives legal notices on behalf of your company. This is really problematic because it means you don’t get notice to legal actions or proceedings affecting your company and it allows Plaintiff’s to sue your company and to send notice to the state without being required to send notice to your company. Now, presumably, the state will try to get notice to your company but what steps the states actually takes and how much time that takes is something I couldn’t find. With twenty to thirty day deadlines to respond in most legal actions I wouldn’t put much trust in a state government agency to get me legal notice in a timely manner nor am I even certain that they would even try.
In addition to the statutory issues written into law there are some practical issues you will face if your out of state company is not registered into a state where you transact business. For example, some county recorders in certain states won’t allow title to transfer into your out of state company unless the LLC or corporation is registered foreign into the state where the property is located. It is also common to run into insurance and banking issues for your company until you register foreign into the state where the income generating property, employee, or storefront is located.
In summary, you should register your company as a foreign company in every state where you are “transacting business”. Generally speaking, transacting business occurs when you have a storefront in the foreign state, employees in the foreign state, or property that produces income in the foreign state. Failure to file varies amongst the states but can result in penalties from $1,000 to $10,000 a year and failure to receive legal notices and/or be recognized in court proceedings. Bottom line, if you are transacting business outside of your state of incorporation/organization you should register as a foreign entity in the other state(s) to ensure proper legal protections in court and to avoid costly penalties for non-compliance.
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