If your IRA is a member of an IRA LLC, you must know and follow the prohibited transaction rules set forth in Internal Revenue Code Section 4975. Many prohibited transaction rules are obvious such as the IRA LLC cannot loan money to the IRA owner or buy, sell or lease property with the IRA owner.
The prohibited transaction rules also contain a general, but nebulous rule some times referred to as the “indirect benefits” rule. If the IRA LLC engages in a transaction that creates an “indirect benefit” for the IRA owner, it is also a prohibited transaction that will disqualify the IRA, cause the IRA to lose its tax-exempt status and result in a deemed distribution of the all the assets to the IRA owner as of the first day of the tax year in which the prohibited transaction occurred.
The indirect benefit rule is codified in Internal Revenue Code Section 4975(c)(1) (E), which states that a:
“prohibited transaction means any direct or indirect . . . act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account;”
Before an IRA LLC engages in a transaction, its members and managers must be able to answer the following question with a clear NO!
If the IRA LLC engages in the proposed transaction, will the IRA owner receive an indirect benefit?
This rule does not apply if the only indirect benefit is that the IRA LLC will make a profit some or of all of which will ultimately be distributed to the IRA and then to the IRA owner.
Here are some examples of common situations that involve violations of the indirect benefit rule and that will result in the disqualification of the IRA from its tax-exempt status. The IRA owner or a member of his or her family (defined in Internal Revenue Code Section 4975(e)(6) as a spouse, ancestor, lineal descendant, and any spouse of a lineal descendant) or any other disqualified person:
- lives in a home owned by the IRA LLC.
- uses a ski boat owned by the IRA LLC.
- is an employee of the IRA LLC and is paid a salary.