Checkbook IRA

By Garrett Sutton, Esq.

IRA (Individual Retirement Account) can provide greater flexibility in investing than a 401(k), but it can also be surprisingly easy to jeopardize your nest egg if you’re not careful to follow the letter of the law.

When you have money in your IRA (Individual Retirement Account) you can make a wider range of investments than you can with a 401(k). You can invest, for example, in real estate, mortgages, tax liens, joint ventures, stocks you select and certain precious metals. The IRS doesn’t allow IRA investments into artwork, rugs, antiques, gems, stamps and the like.

When you want to have more control in directing these investments you can set up a self-directed IRA account whereby a custodian or trustee helps you manage the account and file all the required IRS reports.

The trustee will also help you steer clear of the many prohibited transactions set forth by the IRS. These are self-dealing or conflict of interest transactions, which benefit the IRA holder or other disqualified persons (think family members), and not the IRA account.

If you are caught in a prohibited transaction, your IRA account is treated as being distributed. This means penalties and interest are owed, which can whittle your IRA account down to zero. Not good retirement planning.

Prohibited transactions include:

  • Borrowing money from the IRA
  • Selling property to the IRA
  • Compensation for managing it
  • Using the IRA as security for a personal loan
  • Personally guaranteeing an IRA loan
  • Personal use of IRA owned property
  • Providing services to an IRA investment, including real estate services

The last prohibited transaction has led to a great deal of confusion. If your IRA invests in a single family home you rent out to tenants, can you go in and fix a toilet? More broadly, with an IRA can you be involved in ‘Active Landlording?’ The rules consider that a prohibited transaction—you are providing services directly to your IRA plan.

To stay within the rules you must have your self-directed IRA trustee hire a plumber to fix the toilet. So not only do you have to pay the plumber, but you have to pay the trustee to pay for the plumber.

Into this vortex the promoters of Checkbook IRAs (also called Checkbook LLCs) have arisen.

Their pitch is simple. Instead of paying the trustee for every transaction, you set up an LLC owned by the IRA. Then you are manager of the LLC and get to write checks for it. (Hence, Checkbook IRA.) In doing so, you can save on all the trustee fees.

It sounds great. But there is one big problem.

If you can’t write checks for your self-directed IRA plan (which you absolutely cannot!) then how can you write checks for the LLC owned by the IRA? Aren’t you personally managing your IRA monies? Aren’t you personally providing services to your IRA by managing its money?

Of course you are. And then what if you need to put money into the LLC account?
Once you’ve funded the LLC it becomes a disqualified entity. Any additional outside monies you put into it are a prohibited transaction.

Oops. All the penalties and interest now owed have wiped out your IRA account.

Equity Trust Company is one of the nation’s largest self-directed IRA trustees. They know the law and won’t accept Checkbook IRA arrangements. Jeff Desich is the CEO of Equity Trust. Jeff states, “I strongly believe there is a tremendous risk with using the Checkbook IRA scheme.”

If that admonition is not enough, consider the issues on the administration of the account. With the Checkbook IRA you are now the custodian, you are now responsible for maintaining all the paperwork associated with the file, and responsible for any mistakes that are made. If you get audited will your paperwork stand up?

The safer course is to stay away from Checkbook IRAs. For more information see my book Finance Your Own Business: Get on the Financial Fast Track.