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The good and bad about "Checkbook Control" with a Self-directed IRA

• By Tom Anderson
• PENSCO Trust Company
• CEO & Founder
• San Francisco, CA

When you go shopping for a Hummer, do you expect the salesman to emphasize the fact that it only gets eight miles to the gallon? Of course not. Similarly, if you are approached by someone who gets paid if you contract with them to create a Limited Liability Company (LLC), do you expect them to talk about the less attractive features? Well, I think you know the answer. Sure there are benefits to using an LLC to faciliate IRA investments and Hummers to climb mountainous terrain. But what if you don't need to climb mountains in suburbia? Is the Hummer going to be cumbersome to parallel park? You see we I'm going with this analogy?

LLCs can serve as a valuable vehicle for certain IRA investment scenarios. First, if there are multiple investors going into a single deal, the LLC can facilitate the acquisition and disposition of assets by allowing a single member (e.g., managing member) to sign all documents for the other members. If you have multiple investors going in on an undivided property as co-tenants, then all need to sign at the closing. Another attribute of an LLC or 'C' corporation structure is that both provide an element of asset protection by virtue of the fact that creditors can't pierce the "corporate veil" in most cases. In simple terms, the most you can lose as an investor is your stake in the LLC; not your personal assets or any remaining assets in your IRA(s). On the other hand, you can accomplish the same thing by dividing up your IRA into multiple IRAs and using each IRA for each separate investment, if you think there is a significant liability risk that isn't covered by your insurance.

The attribute that is touted most frequently by promotors of the use of LLCs for IRA investing is "checkbook control"; that is, the ability of the managing member (which may be the IRA owner if the IRA owner's IRA is the only member or 'C' corporation stockholder) to write checks directly to fund investment purchases, without having to go through the IRA custodian. While it is very true that this is possible, it is also a cause for concern amongst custodians, IRA regulators and professionals who serve customers who have employed the "Checkbook Control" approach. Why? because many of them feel that there is significant risk of the IRA owner(s) creating a prohibited transaction through the "checkbook control" mechanism. To demonstrate the reason for this concern, I can think of no better example other than that coming during a recent presentation I gave on this topic to a group of IRA real estate investors in Texas. I had spent about 15 minutes discussing prohibited transactions and "checkbook control" scenarios (involving LLCs) that would create prohibited transactions, and, in summing up, asked the audience if their were any questions. Hands went up, and one gentlemen asked whether the IRS regulations that govern prohibited transactions for IRAs also applied for LLCs that had IRAs as investors!!! I said, to the audience, "I think that comment made my point to all of you as to why some of us are concerned!" Most smiled back, acknowledging the basis of my argument. Of course, it is understandable that the gentleman isn't as focused as I am as the CEO of a major IRA custodian. That's the point. When you remove the experienced custodian from the process, you create an exposure that can result in the invalidation of the IRA and possible penalties.

So if you are considering "Checkbook control" make sure you can drive the car. If you not ready for a Ferrari, then consider sticking with your custodian (not as sexy, but maybe more like a Volvo than a Ferrari-it might be more likely to get you where you're going safely). Some other considerations of investing through a legal entity like an LLC or 'C' corporation are the costs for forming them (up to $5,000 or more), the potential need to have a professional prepare a K-1 once a year; file state franchise taxes or federal taxes; keep books and records; conduct meetings; and pay professional fees associated with technical questions that most custodians will answer for free. Finally, recent events have indicated that it is very likely that the IRS or related regulators may start taking a closer look at IRA investors who use this approach to fund IRA investments. In short, consider all aspects of your next car, before get behind the wheel.

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