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The Self Directed IRA Operating Agreement

The LLC Operating Agreement is the core document that is referred to when issues concerning the LLC need to be resolved. The LLC Operating Agreement is the most important document for your LLC. The LLC Operating Agreement reflects the agreement among the members with respect to the affairs and management of the LLC essentially governing the relationship among the members of the LLC.

It is extremely important that you create an Operating Agreement for your LLC entity. The Operating Agreement helps ensure that courts will respect your limited personal liability. This is especially important in a one-person LLC where, without the formality of an agreement, the LLC will look a lot like a sole proprietorship, which does not limit your personal liability for business debts of the LLC. Having a formal written LLC Operating Agreement will lend credibility to your LLC's separate existence. Without the formality of an agreement, the basic operation of the LLC would be governed by state law, which may not be advantageous to the LLC, it members, or the business it conducts.

The standard LLC Operating Agreement will not meet the requirements for your Self Directed IRA LLC. In general, a self directed IRA LLC Operating Agreement should include special tax provisions relating to “Investment Retirement Accounts” and “Prohibited Transactions” pursuant to Internal Revenue Code Sections 408 and 4975. In addition, since the LLC will be managed by a manager and not the member, the Operating Agreement would need to include special management provisions.

It is extremely important to have a properly prepared Operating Agreement to fit the needs of your LLC and meet the requirements of the Internal Revenue Service for a Self Directed IRA LLC. In fact, a copy of the LLC Operating Agreement will be required by the Custodian and also by the bank where you will have your LLC's checking account.

What is a Self-Directed IRA?

The term, IRA, is familiar to most people. The Individual Retirement Account (“IRA”) has become a staple component of most financial plans.
An IRA is a trust. Under specific statutory language, an IRA holder contributes an asset (cash) to the trust. The trust then directs its corpus to a particular investment, typically stocks, bonds and annuities.

This action of investing implicates a trustee who owes various duties to the IRA. Typically, a stock broker manages the account's investment (as a fiduciary) and serves as the IRA's trustee. The broker exercises virtually all fiduciary power in crafting the investment.
With a Self-Directed IRA, the IRA holder keeps most of this power. He or she directs the investment, instead of a broker. A custodial trustee holds and administers an IRA account. The investor determines which investment(s) are appropriate for the IRA, and tells the custodian where to invest the IRA account.

Taking this a step further, the Internal Revenue Service (“IRS”) does not put many limits on the types of assets in which an IRA may invest. While IRAs typically invest in public stocks or mutual funds, Self-Directed IRAs commonly invest in real estate, private business entities and commercial paper. The only investments precluded by the IRS are life insurance, collectibles and certain “prohibited transactions” listed under Internal Revenue Code Section 4975.

Advantages of using a Self-Directed IRA

With a Self-Directed IRA, the IRA holder keeps most of this power. He or she directs the investment, instead of a broker. Aside from life insurance, collectibles and certain “prohibited transaction” investments outlined in Internal Revenue Code Section 4975, a Self-Directed IRAs can invest in most commonly made investments, including real estate, private business entities, public stocks, private stocks, and commercial paper. In the case of a self-directed IRA, the IRA holder is typically the person that serves as manager of the LLC.
Within that investment, any gains (or losses) accumulate with all IRA tax advantages. In fact, all traditional IRA rules apply to Self-Directed IRAs, including contribution limits, tax deferral or exemption rules, and required minimum distributions.

What are Types of Investments I Cannot Make with a Self-Directed IRA?
Internal Revenue Code Sections 4975 & 408 prohibit fiduciary and other disqualified persons from engaging in certain type of transactions. The definition of a disqualified person (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRS holder, any ancestors or lineal descendants of the IRS holder, and entities in which the IRS holder holds a controlling equity or management interest.
Under Internal Revenue Code Section 4975, “prohibited transactions” generally include the following transactions.

1. A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person.
2. Any act of a fiduciary by which he or she deals with plan income or assets in his or her own interest.
3. The receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets.
4. Any of the following acts between the plan and a disqualified person.
a. Selling, exchanging, or leasing property.
b. Lending money or extending credit.
c. Furnishing goods, services, or facilities.

In addition, under Internal Revenue Code Section 408, a Self Directed IRA shall not be permitted to make (a) investments in life insurance contracts, (ii) pledge an IRA or any IRA asset as a security for a loan, or (iii) invest in collectibles.

Common Prohibited Transactions

• Borrowing money from an self-directed IRA
• Using the self-directed IRA as security for a loan
• Selling personal assets to the self-directed IRA
• Buying property in the self-directed IRA for personal use
• Purchasing property from a disqualified relative i.e. Spouse, Children, Parents of the self-directed IRA holder.

However, certain transactions are exempt from being treated as prohibited transactions. For example, a prohibited transaction does not take place if you are a disqualified person and receive any benefit to which you are entitled as a plan participant or beneficiary. However, the benefit must be figured and paid under the same terms as for all other participants and beneficiaries. For other transactions that are exempt, see section 4975 and its regulations.
Disqualified Person(s)

An IRA owner may not invest in property that he/she, a relative, or his/her business, already owns. Prohibited transactions are transactions that occur between the self-directed IRA and disqualified person(s). The following are, generally, considered disqualified persons.

• The IRA holder
• The IRA holder’s spouse
• The IRA holder’s ancestors and lineal descendants
• Spouses of the IRA holder’s lineal descendants
• Investment managers and advisors
• Anyone providing services to the plan (IRA), e.g., the IRA trustee or custodian
• Any corporation, partnership, trust, or estate in which the IRA holder has a 50% or greater interest

What are the Consequences of a Prohibited Transaction?
If an IRA holder is found to have engaged in a prohibited transaction under Internal Revenue Code Sections 4975 or 408 with IRA funds, it will result in a “deemed distribution” of the IRA. The taxes and penalties are severe and are applicable to all of the IRA’s assets on the first day of the year in which the prohibited transaction occurred. If this deemed “distribution” occurs, it will be subject to ordinary income tax and, if you were under the age of 591/2 at that time, a ten (10%) percent excise tax on premature distributions may also be assessed. In addition, if the “prohibited transaction” is not corrected within the taxable period, Internal Revenue Code Section 4975(b) imposes a tax equal to 100 percent of the amount involved.