Self Directed IRA LLC Must File a Tax Return

The IRS has stringent rules when it comes to self-directed IRAs and LLCs, and any breach could incur heavy fines or even the cancellation of tax-sheltered status. Be wary when engaging in self-directed accounts as these could run foul of these restrictions and be met with penalties from them.

An IRA LLC provides an excellent investment option for retirement funds, but it is imperative that all rules relating to disqualified persons and prohibited transactions are observed.

Unrelated Business Income Tax (UBIT)

Your IRA generally will not need to file IRS tax forms; however, if the investment vehicle you use to create self-directed IRA LLC investments generates income not directly related to its exempt purpose of saving for retirement (i.e. UBTI or UDFI), filing may become necessary.

Example of unrelated business taxable income would include investing your SDIRA in a restaurant that generated rental income; such an investment may not meet its exempt purposes and could generate unrelated business taxable income (UBTI). Flipping properties is another activity which could generate unrelated business taxable income (UBTI).

Tax advisors can help you understand the rules surrounding UBTI and UDFI to determine whether your IRA requires filing IRS Form 990-T; this tax provides a good reason for consulting an experienced retirement account attorney.

Unrelated Debt-Financed Income (UDFI)

UDFI taxes must also be paid on certain self directed IRA LLC investments that employ debt leverage, specifically when profit from that portion is distributed according to how much was borrowed. These taxes must be submitted directly to the IRS as they pertain directly to those investments using debt leverage.

Self directed IRA LLCs provide an ideal vehicle for investing in real estate such as rental homes or condominium projects, while they can also be used to purchase other assets like gold bullion and privately held companies. However, to comply with IRS rules concerning prohibited transactions and disqualified parties.

People using self-directed IRA LLCs to invest in commercial properties purchased by investment groups may use this approach for greater investment capital pooling, however this could trigger UDFI taxes. Qualified retirement plans such as 401ks and defined benefit plans generally do not face these taxes, pursuant to Section 514(c)(9) of the Internal Revenue Code.

Unrelated Business Activity Tax (UBAT)

Due to the proliferation of self-directed IRAs and nontraditional investments, advisors must remain diligent to make sure clients don’t run into IRS compliance issues involving UBTI/UDFI.

Underlying business activity tax income (UBTI) occurs when an IRA-owned trade or business generates non-tax-exempt income that does not directly relate to its tax-exempt purposes, for instance a hospital that performs diagnostic laboratory testing on samples taken from staff physicians’ private offices could generate income that exceeds its tax exempt purposes and generate UBTI.

UDFI occurs when an IRA invests in real estate with debt and generates income attributed to this borrowed fund. An example would be an IRA investing in short-term “fix and flip” strategy with 20 homes per year being “flipped”, producing UDFI income. Any time an IRA has $1,000 or more of either UBTI or UDFI, they must file IRS Form 990-T with the IRS; LLCs with only one owner usually do not generate either form of income, however these LLCs must still file returns to report all income received.

Taxes on Distributions

An LLC owned by a self-directed IRA may be used to invest in real estate. To avoid UBITI tax consequences, however, rent checks must flow directly into the LLC bank account rather than directly back to its IRA owner.

Utilizing an IRA LLC with checkbook control enables you to invest in alternative assets such as real estate, private loans and precious metals without being restricted by traditional custodial-directed retirement accounts. As always, please consult with a financial professional in order to make sure that you’re not engaging in a prohibited transaction with your IRA.

If your IRA LLC incurs either UBTI or UDFI, you must file IRS Form 990-T and pay taxes using funds held within your IRA account. This only occurs when investments that do not fall into “passive activity” are made using borrowed money (UDFI). Additional state taxes may also be assessed based on these activities.