3713.09 / What should clients know before establishing a self-directed, or “checkbook control” IRA?

Clients who are interested in alternative or non-traditional investment strategies often wish to use their retirement funds for those investments. The IRS limits the types of investments that can be made within the traditional IRA structure. For many, a self-directed “checkbook control” IRA can provide a investment tool that allows the account owner to have a greater degree of control over retirement investment choices, all while minimizing custodian involvement and the red tape associated with traditional self-directed IRAs.

A checkbook control IRA is an IRS-approved retirement account structure that allows the account owner to make independent investment decisions. Like self-directed IRA owners, owners of checkbook control IRAs can investment in non-traditional assets, such as bitcoin, precious metals and real estate.

To form a checkbook control IRA, a self-directed IRA LLC is first formed. The LLC establishes a checking account like any other business entity. However, the LLC is funded using the IRA funds—which are then transferred to the checking account. With the advice of tax counsel, the IRA owner can become the managing member of the LLC and retain signature authority over the checking account (i.e., “checkbook control”).

The checkbook control can allow the IRA owner to act more quickly when making an investment. Despite this, the owner is prohibited from receiving assets—and any distributions must be properly processed through the IRA custodian, who is required to report the distribution.

The key to preserving tax-preferred treatment is to ensure that the IRA investments never revert directly to the IRA owner, but always back to the IRA itself.

A recent U.S. Tax Court case¹ illustrates the substantial risks associated with maintaining a checkbook control IRA. In this case, the taxpayer used a third-party service provider to purchase American Eagle coins with the IRA and stored them at home. She first directed her IRA custodian to form a single-member LLC (of which she was the managing member) and to transfer her IRA funds to the LLC’s bank account.

She used the bank account to purchase the coins (using records to establish the LLC as the legal purchaser). While the IRA custodian filed a Form 5498 to report the value of the IRA assets, the court found that the custodian had no role in the management of the LLC, the purchase of the coins or administration of the LLC/IRA.

The court found that, under IRC Section 408(a), an IRA must be administered by an IRA trustee that is a bank or IRS-approved custodian. While the court did recognize the legality of the checkbook control IRA structure, it found that the IRA owner cannot have “unfettered control” over IRA assets without negative tax consequences. More specifically, the court found that the custodian’s role in the self-directed IRA structure included maintaining custody over the assets, maintaining records, and processing the actual transactions involving the IRA assets.

The IRA owner, on the other hand, can only permissibly act as a conduit or agent for the IRA custodian. Personal control over the IRA assets resulted in deemed distribution treatment in this case—because the IRA owner took physical possession of the coins in her own home and failed to purchase the coins directly through the IRA.

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Planning Point: While it’s difficult to know how far the Tax Court will go in applying deemed distribution treatment to any particular transaction, it’s always a good idea to exercise caution—and note that Congress and the IRS have been paying close attention to self-directed IRAs generally in recent months.

Any client who is interested in the checkbook control IRA structure should be extremely cautious and be sure to involve the IRA custodian in order to avoid deemed distribution treatment.

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