In the world of self-directed IRA investing, there are essentially two investment types, these are “direct” and “indirect”. However, before jumping in to these two ownership structures, let us first explore the end goal, or rather, your intended investment.
The end goal is the asset in which you ultimately wish to invest in, for example, a rental property. Your IRA may invest in it directly through the custodial model (direct); whereby your IRA is the owner of the intended investment. In this case the asset purchase and subsequent purchase, sale, or exchange activities are facilitated by the IRA custodian directly. An IRA LLC (checkbook/indirect) on the other hand, while technically an investment made by the IRA account, is not a direct investment in the intended investment. Rather, it’s an investment made by the IRA account into a newly created business entity which then in turn makes an investment in the intended, or end goal investment. Thus circumventing the reliance of the IRA custodian to facilitate subsequent investment activities.
This structure is ideal for assets, or investments, which may be time-sensitive, complex, or that require the freedom and flexibility to execute activities at a moment’s notice. Below we will explore the two forms of asset ownership by an IRA account. The first being Direct Ownership and the second Indirect Ownership
As mentioned in an earlier post, your IRA account is treated very similar to a trust. That said you may think of your IRA as its own separate legal and financial entity. Accordingly, whatever assets the IRA buys are the legal property of the IRA account. Although you are the beneficial owner of the IRA account and may take possession of the assets held at any time, the IRA’s assets must be considered distinctly separate from you until you’ve taken a qualified distribution from the IRA account.
Direct ownership is when an IRA account purchases an asset directly from a seller. For example, in the case of an IRA buying Real Estate, an offer to purchase would be drawn up with the IRA’s legal titling showing the IRA as the buyer. The self-directed IRA account would then pay earnest money and secure financing if needed; all orchestrated by the IRA account owner. Upon closing the IRA would be recorded on title as legal owner and the IRA custodian would hold the deed.
As owner of the property, the IRA is solely responsible for paying all property related expenses, and is entitled to all revenues generated from the property. You, as the IRA owner, are responsible for coordinating all of the activities involved in the purchase, but the IRA custodian is the only entity authorized to sign on behalf of the self-directed IRA account. The IRA custodian would house the deed and any cash left over in the IRA account. As expenses arise you would direct your custodian to issue payment. Income generated from the property would be sent directly to your IRA custodian for deposit.
The direct ownership model is most common, but because of the reliance on the custodian for various, and sometimes timely activities, this is not the ideal option for many investors.
Indirect ownership simply means that your IRA is the owner of an asset which owns the intended asset. For instance, following the example above, if the real-estate was purchased through an Checkbook IRA, your IRA would be the registered owner of the newly created business entity. But the business entity would be the registered owner of the property. Accordingly, the LLC would house any cash, issue expense payments, and deposit all revenue. The self-directed IRA account does not technically own the property, but it does own the LLC which owns the property.
Below is a visual representation of control under the two structures.
On the left (direct ownership), the IRA custodian is involved in every aspect of the IRA’s investment. The custodian houses the cash and facilitates any transactions made through the IRA account. Cash flows to and from the IRA account. All activities are directed by you, but the custodian oversees the movement of cash and houses the investment ownership documentation. .
On the right is the IRA LLC structure. You’ll notice that the custodian is still involved in buying an asset, but only for the first transaction (funding the LLC). Once funded the cash and investments are overseen by the LLC Manager. Consequently, the LLC manager has complete control over the Checkbook IRA’s activities. Instead of reporting cash and ownership of real estate, the IRA Custodian records and custodies the IRA’s record of ownership in a private business.