Written By: Brianna Avillo
Key Points
- A Self-Directed IRA LLC is a retirement account that gives you the ability to invest in alternative assets in real time with no everyday transaction fees.
- Typically, single-member Self-Directed IRA LLCs do not have to file federal income tax. However, there are a few circumstances where your SDIRA IRA LLC may be subject to taxes.
- If taxes are due, the owner(s) of the LLC (the Self-Directed IRA) is responsible for paying.
- Madison Trust works seamlessly with our sister company Broad Financial to upgrade your Self-Directed IRA to the checkbook control model.
Contributing to a Self-Directed IRA (SDIRA) is generally known as a good way to save for retirement and receive tax breaks. Along with the benefits of tax-advantaged investing and the freedom to invest in alternative assets, comes with the responsibility to navigate the tax landscape. This includes understanding when taxes are due, filing the correct IRS forms, and reporting the fair market value of your account.
Let’s explore how to prepare for tax season by exploring five Self-Directed IRA LLC tax filing tips and considerations.
Understanding the Basics: What Is an IRA LLC?
Before we get into navigating potential taxes, let’s first discuss “what is an IRA LLC?” An IRA LLC is a limited liability company owned by your Self-Directed IRA. Just like a Self-Directed IRA, a Self-Directed IRA LLC is a powerful retirement account that gives you the ability to invest in alternative investments such as real estate, private placements, and precious metals within a tax-advantaged account.
A Self-Directed IRA LLC, also known as a Checkbook IRA, adds the benefit of checkbook control to your account. This allows you to place transactions using your retirement funds without having to go through your Self-Directed IRA custodian. This is possible through the creation of an IRA LLC for your IRA and a designated checking account.
An IRA LLC is considered a “pass-through” entity for federal (and typically for state) income tax purposes. All taxable gains and losses are passed through to the LLC’s owners, which is the Self-Directed IRA. The Self-Directed IRA is then responsible for paying applicable taxes.
5 Tax Filing Tips and Considerations for Self-Directed IRA LLCs
When it comes to taxes and Self-Directed IRAs, we often are asked, “does a Self-Directed IRA LLC have to file a tax return?”
In general, a Self-Directed IRA LLC does not have to file an annual tax return. This is because the owner of the LLC is a Self-Directed IRA. As Self-Directed IRAs are tax-advantaged vehicles, earnings are not typically subject to taxes annually.
However, some of the LLC’s activities may trigger tax reporting requirements. Let’s discuss these situations as well as other tax considerations of a Self-Directed IRA LLC.
1. Unrelated Business Income Tax (UBIT)
One situation that causes your Self-Directed IRA LLC to be subject to taxes is Unrelated Business Income Tax (UBIT). This is income generated from a trade or business that is regularly carried on and not related to the IRA’s tax-exempt purpose.
For example, real estate investments such as construction, development, or short-term fix-and-flips generally incur UBIT. Another example is an investment that generates income from an active trade or business – such as a store that sells goods and services - is typically is subject to UBIT.
A few exceptions to UBIT are real estate income such as rental from rental property or a sale from a property (no debt leverage), dividends, interest income, and capital gain income.
If UBIT occurs, you will file IRS Form 990-T and pay the taxes with the funds from your Self-Directed IRA.
2. Unrelated Debt Financed Income (UDFI)
Another scenario that will cause your SDIRA to be subject to tax is Unrelated Debt Financed Income (UDFI). This is when a Self-Directed IRA receives income from an investment obtained with borrowed funds. The IRA is subject to taxes on the debt-financed portion of the investment.
For example, assume you are looking to purchase a rental property that costs $600,000 with your Self-Directed IRA LLC. You decide to invest $480,000 in the property and use a non-recourse loan to finance the remaining $120,000. In this case, 20% of the net income generated from the property will be subject to taxes.
Similar to UBIT, if UDFI occurs, you will file IRS Form 990-T and pay the taxes with your Self-Directed IRA funds, not your personal funds.
3. Potential State IRA LLC Taxes
In general, LLCs owned by a Self-Directed IRA are generally not subject to state tax. IRAs are tax-exempt under most state’s laws. However, some states may charge the LLC based on the LLC's income, in addition to the income tax the owner pays.
Some states may also have an annual fee that is not income related. This fee can be known as a “franchise tax”, “annual registration fee”, or “renewal fee”. It is considered best practice to speak with a tax professional to discuss your state’s tax treatment of IRA LLCs.
4. Single-Member IRA LLC vs. Multi-Member IRA LLC Tax Treatment
Depending on the number of owners of your IRA LLC, the tax status may change.
Single-Member IRA LLC
Single-member IRA LLCs are treated as a sole proprietorship for tax purposes. Generally, income is passed through to one owner and the owner must report the income on their federal tax return. Since the income received by an SDIRA is tax-exempt, the SDIRA does not need to report the income nor file a federal income tax return. If your IRA owns 100% of an LLC, then it is disregarded for tax purposes as a single-member IRA LLC, and the LLC does not need to file.
Multi-Member IRA LLC
Multi-Member IRA LLCs are treated as a partnership for tax purposes. Multi-Member IRA LLCs are required to file a tax return even if no taxes are due. If you are investing in a multi-member LLC, IRS Form 1065 must be filed to report profits, losses, credits, and deductions related to the LLC. A Schedule K-1 should also be issued to each owner (your SDIRA in this case) to show its share of income, credits, and deductions received from the LLC.
The percentage each member of the LLC receives is pre-determined in the LLC’s Operating Agreement. In the case of a Self-Directed IRA LLC, the custodian’s EIN should be used for your IRA’s Schedule K-1, not your personal Social Security Number or IRA’s tax ID.
5. Form 5498 and Form 1099-R
Although most Self-Directed IRA LLCs do not have tax filing requirements, the IRS requires the completion of a few annual forms.
Form 5498 is an informational form that reports your account’s fair market value (FMV). As the manager of the LLC, you are responsible for determining the value of each asset in your LLC and the account’s total value. Once determined, you will send the value to your Self-Directed IRA custodian, who will report it to the IRS. Form 5498 also reports any IRA contributions, rollovers, Roth Conversions, and recharacterizations received in your account during the prior tax year.
Another form that may have to be filed is IRS Form 1099-R. This form reports any funds or assets that left your IRA. This can be through a distribution, Roth Conversion, or rollover. If no funds or assets left your IRA during a given year, the account will not receive a 1099-R.
Checklist: Self-Directed IRA LLC Tax Season Prep
Conclusion: Let's Tie It All Up
Self-Directed IRA LLCs usually do not need to file annual taxes. However, it is important to know the situation when your LLC might owe taxes and understand which IRS forms to file. The Self-Directed IRA LLC account holder must keep records of all income, expenses, investments made and their fair market value.
It is considered best practice to contact a financial and tax professional to discuss the rules and potential taxes incurred by your Self-Directed IRA. If you have questions about self-directed investing, schedule a call today. Talk to one of our knowledgeable Self-Directed IRA Specialists!
