Category: investing

Stablecoins 101: What Are They, How Are They Taxed, and Can I Use Them In My Business?

Cryptocurrency has significant business utility, especially in international transactions. Companies can exchange funds directly, without wiring fees or banking delays, and easily convert their native currencies into crypto and vice-versa using a mobile phone. However, traditional cryptocurrencies like Bitcoin and Ethereum are extremely volatile and their exchange values can easily fluctuate 10-20% or more in a matter of days or even hours. Market supply and demand forces determine the prices of these most popular cryptocurrencies and their value is particularly sensitive to various external factors. Events like China’s crypto clampdown, significant buys or sells by capital investors, or even Elon Musk’s tweets can crash the market or send the price of crypto soaring. Obviously, price volatility makes businesses and consumers reluctant to adopt these cryptocurrencies for day-to-day transactions. Price volatility translates into purchasing power uncertainty, which in turn devalues the currency.

Stablecoins are cryptocurrencies that try to solve the volatility problem. They do so by pegging their price to the price of another asset (such as the U.S. Dollar or an ounce of gold). For example, the USD Coin (USDC) can be acquired and sold for U.S. Dollars on a 1 to 1 ratio. USDC is actually backed by existing dollar reserves, meaning that each USDC has a real-world dollar counterpart held by regulated financial institutions. USDC reserves are also periodically verified by a third party (but not audited).

There are other stablecoins as well, for example Tether, Binance USD, TrueUSD, DAI, and more. Like USDC, some are tied 1 to 1 to U.S. Dollar reserves. Others are backed by commodities like gold, silver, or oil. The price of a commodity-backed stablecoin is tied to the market price of a commodity unit, like an ounce of gold. There are also stablecoins that attempt stability through overcollateralization using other cryptocurrencies. Finally, there are algorithmic stablecoins that automatically adjust the cryptcurrency’s supply to keep its market price within certain parameters.

Stablecoins are however still cryptocurrency. Even if the stablecoin has a pegged 1 to 1 exchange ratio with the U.S. Dollar, it is not the same as cash. For tax and regulatory purposes, the IRS treats all cryptocurrency as intangible property subject to capital gains tax. They may be subject to separate state-level regulation as well.

Paying for goods and services in stablecoin is a taxable event because the IRS treats it like a sale or exchange of an asset, which is subject to capital gains tax. Technically, if the stablecoin is pegged to the dollar at a 1 to 1 ratio, the capital gain is 0 and there is no tax owed. But the transaction must still be recorded and reported, just like if you were buying and selling a stock at zero net gain/loss. Otherwise, you risk attracting an IRS audit to determine whether you underreprted taxable income. Buying stablecoin for cash and holding it is a non-taxable event.

Receiving stablecoin in exchange for goods and services is a taxable event. It is not much different than receiving payment in fiat currency, which is income subject to tax. The fair market value of the cryptocurrency as of the date of receipt determines its value for income reporting purposes. With stablecoin, it is easy to calculate because of the 1 to 1 ratio. Receiving 500 USDC is the equivalent of receiving $500 cash. However, spending the 500 USDC is not the same as spending $500 cash – rather, the transaction is considered a liquidation of property (subject to capital gains). Again, if the value of the stablecoin is pegged to the dollar, you are not going to have capital gains. But you must still keep records and record the transaction. If you are using a stablecoin that is pegged to an asset like gold, its price will fluctuate and you may record a capital gain or loss.

Converting other cryptocurrencies into stablecoin and vice-versa is also a taxable event. The sale of the crypto is an asset disposition that is subject to capital gains tax even if the transaction is an exchange of one currency to another. Similarly, using stablecoin to purchase other cryptocurrencies is a sale of the stablecoin that must be reported as income, even if the the capital gain is $0.

Stablecoins are still risky and unregulated. Not all stablecoins are created equal and it is a mistake to think that “stablecoin” means there is no risk involved. The LUNA/TERRA debacle is a good example because TERRA was supposedly a “stablecoin” pegged 1 to 1 to the U.S. dollar, yet it was pegged algorithmically (meaning artificially without any actual assets or fiat currencies backing it). An algorithm that no one really understands is not the same backing as fiat in a vault or money market securities or corporate bonds or commodities portfolios. The bottom line is that without a uniform definition of “stablecoin,” users should at a minimum know what “stabilizes” the value of the purported “stablecoin.”

There are other hurdles to using stablecoins in day-to-day business operations. As cryptocurrency, they are still subject to government regulation. For instance, it is illegal under federal labor law to pay workers in anything other than U.S. Dollars. On the international scene, China recently tightened anti-crypto regulations, prohibiting financial institutions from providing crypto exchange services, which presumably includes stablecoins. At the same time, China is rolling out its “digital yuan,” which is a sovereign-backed virtual currency. United States regulators have also expressed interest in the “digital dollar,” in part to improve financial services access to unbanked or underbanked communities. Additionally, all cryptocurrency transactions are still subject to exchange fees imposed by the intermediaries, and there may be delays or additional processing costs associated with converting stablecoin into fiat currency. Widespread adoption by merchants and the public is a must for stablecoins to develop practical utility – but right now, holding a wallet full of stablecoin is not the most practical or liquid solution for most businesses. Nor does a 1 to 1 dollar stablecoin provide any investment upside and in fact periodically loses value due to inflation.

Finally, there are at least 36 different stablecoins available for purchase via most popular exchanges. It is unknown which stablecoin (if any) will enjoy widespread adoption and popularity sufficient to result in real utility for businesses. Further, stablecoins are not truly decentralized because a central entity is holding the collateral, which in turn must be audited or otherwise verified. If a holding entity starts issuing stablecoins that are not actually collateralized, this would cause hyperinflation and essentially render the stablecoin worthless.

Stablecoin certainly holds a lot of promise for business use, but only solves the problem of volatility. Reduced volatility comes at a cost of a centralized authority and reintroduces trust into the cryptocurrency equation. At the same time, sovereign-issued digital currencies are on the horizon and may very well dispel the need for and demand for stablecoin.

Want to know more? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2021 Artaev at Law PLLC. All rights reserved.

Ask the Crypto Tax Lawyer: Offsetting Capital Gains Through Loss Harvesting.

Update: As of November 10, 2021, Congress is in the process of considering legislation to preclude loss-harvesting through cryptocurrency sales. Congress is also considering other amendments to the Tax Code and other laws to address cryptocurrency specifically. As this is a rapidly developing issue, it is critical that you consult with a tax attorney or other professional about your specific situation and the current state of the law before making any transactions or business decisions.

More than half-way through 2021, cryptocurrency remains an extremely popular investment. Although volatile and subject to unpredictable regulation (yes, that means China), the market has experienced substantial growth. Exchanges like Coinbase and integration with PayPal make owning, trading, and speculating in cryptocurrency easy. Sophisticated investors have even added cryptocurrency into their self-directed retirement portfolios, banking on the continued growth and popularity of the decentralized exchange medium.

As I have previously written, the IRS is keeping a close eye on cryptocurrency investors, transactions, and markets, looking to capture taxes on hundreds of millions in underreported or unreported income. In other words, crypto taxes are going to be an issue for many in the coming tax years, especially after the Biden administration’s mandatory $10,000 or more transaction reporting rule goes into effect in 2023. However, with proper planning and strategy, there are ways to reduce your tax liability even if you are planning to liquidate your crypto positions in the near term.

As a basic matter, know that the IRS classifies cryptocurrency as “property,” which means that it is subject to capital gains tax. General capital gains reduction strategies work for cryptocurrency as well as they do for more traditional property like investment real estate, stocks, and bonds. For instance, waiting at least 365 days to sell lets you take advantage of the lower long-term capital gains tax rate. Selling in a lower income year where your overall income puts you in a lower tax bracket is another strategy.

One advanced tax strategy involves taking advantage of the so-called wash sale rule. Or rather, it is taking advantage of the fact that the wash sale rules does not apply to cryptocurrencies (yet). Under Treasury Regulation 26 CFR 1.1091-1, an investor cannot sell “stock or securities” at a loss, use the loss to reduce taxable income, and then immediately repurchase the stock or security. Under the wash sale rule, there is a 30-day waiting period before purchasing the same or substantially the same stock or security – if an investor repurchases the security within the 30-day restricted period, the loss will be added to the cost basis of the repurchased security and reduce capital gains on the sale of the repurchased security, but it will not be treated as an investment loss to reduce general tax basis. In other words, you cannot manufacture losses in a bear market to reduce your taxable income that you receive from other investments, rentals, or wages.

The IRS has been clear that cryptocurrency is treated as “property” for tax purposes. However, whether it is a “stock or security” remains unanswered and both IRS Notice 2014-21 and the recently amended FAQ are silent on the issue. There is no express definition of “stock or securities” for the purposes of the wash sale rule. Looking elsewhere in the Internal Revenue Code, the definitions of stock and securities in various other sections include traditional shares, notes, bonds, and the like. Indeed, in 1988 the United States Tax Court adopted a narrow interpretation of the Code, holding that stock options were not considered “stock or securities.” Gantner v. Commissioner (91 T.C. 713 (1988). Congress responded by amending the wash sale rule to expressly include stock options, but still did not enact a definition of “securities” for the purpose of the rule.

Based on the current Code and Regulations and the lack of IRS guidance on the issue, there is a strong argument that cryptocurrencies are not “stock or securities” for the purposes of the wash sale rule. What this means is that crypto investors can take advantage of loss harvesting to accrue losses and use those losses to offset income. For example, if you buy one Bitcoin for $30,000 and the next day the price drops to $20,000, you can sell the Bitcoin at a loss of $10,000, “harvest” the loss, and repurchase the Bitcoin for $20,000 shortly thereafter. You still own 1 Bitcoin, but now you have accumulated a loss that you can use to offset capital gains income.

If your losses exceed capital gains, you can use up to $3,000 of loss to reduce regular income. Any excess loss can be carried over to future years to offset future gains.

At the same time, the Securities and Exchange Commission (“SEC”), the Commodities Futures Trading Commission (“CFTC”), and certain United States courts have ruled that cryptocurrencies are indeed “securities” within those Commissions’ regulatory scope. This regulatory effort was generally to stem the fraud and abuse through “initial coin offerings” or ICOs that sought to evade strict regulations designed to protect investors. While there is currently no indication that the IRS would consider cryptocurrency as “stocks or securities,” there is precedent for that conclusion from these other agencies and remains possible that the IRS could issue supplemental guidance and interpretations to that effect.

At the time of this writing, the IRS has not issued any such interpretation and savvy investors can consider the loss harvesting strategy if appropriate for their particular situation. As with all cryptocurrency transactions, good record keeping is paramount. It is especially critical to have accurate records to substantiate your losses if you are repurchasing the same crypto. Good and accurate records are the best tool in defending your position to the IRS, should the IRS take a position and disallow your claimed losses.

Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2021 Artaev at Law PLLC. All rights reserved.

Can a Self-Directed IRA (“SDIRA”) Invest in Cryptocurrency and NFTs?

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Self-directed IRAs (“SDIRAs”) can be a powerful investment tool when used the right way. Instead of relying on a bank or brokerage to hold and invest your retirement accounts, the SDIRA gives you direct control over what to invest in for your retirement. Best of all, the SDIRA is not limited to the traditional stock and bond market portfolios. Savvy and knowledgable investors willing to take on high levels of risk can direct their tax-advantaged savings into private companies, debt portfolios, real estate, and other non-traditional assets. While the personalized control and expanded investment opportunities may sound great, SDIRAs are subject to complex tax rules and other pitfalls, including extreme volatility and investment risk. The government rules and regulations ensure that individuals are not abusing the tax advantaged status of their retirement accounts. The Internal Revenue Code (“IRC”) governs what retirement accounts (including SDIRAs) can and cannot invest in.

What about cryptocurrency like Bitcoin? Can an SDIRA invest in cryptocurrency? Yes. In general, the IRC prohibits any IRAs (including self-directed ones) from owning life insurance, S-Corporation stock, and collectables. 26 USC 408. The term “collectable” includes art, antiques, collectable stamps, coins, alcoholic beverages, and “any other tangible personal property” specified by the IRS. Pursuant to Notice 2014-21, the IRS considers cryptocurrency to be intangible property for the purpose of taxation. This means it is treated the same as stocks or bonds – if you sell at a profit, you are paying capital gains tax. Note that cryptocurrency is not treated the same as cash – this also means that if you are paying for a product with Bitcoin, it is a taxable event. For the purposes of an SDIRA and retirement investment, you can certainly buy and hold (or HODL) cryptocurrency. Or sell it for a gain – the tax consequences are the same as they would be with a stock or bond portfolio (depending on whether you have a 401k or Roth-type setup). Remember that any profits that an SDIRA makes go right back into the SDIRA and may only be withdrawn for the benefit of the individual under certain conditions (like being 59 and a half years old) to retain the tax advantage. With cryptocurrency, it is critical to set up an SDIRA-owned LLC to establish and own the cryptowallet in conjunction with a bank account. The LLC structure allows the SDIRA beneficiary to act as a manager and direct investments right from the bank account rather than going back to the SDIRA custodian and waiting for an approval of a particular transaction. However, remember that the manager cannot receive compensation or commingle personal and SDIRA assets, accounts, or cryptowallets.

What about non-fungible tokens or NFTs? Can an SDIRA invest in those? Maybe. NFTs are digital property that exist only online, but unlike “traditional code,” NFTs are unique and cannot be copied. More accurately, they can be copied (like a print of the Mona Lisa can be copied), but there can be only one original. In that sense, they are like real-world property and their non-fungibility creates scarcity, and theoretically value. Although NFTs are based on the Ethereum blockchain (and Ethereum is a cryptocurrency like Bitcoin), cryptocurrency and NFTs are not necessarily treated the same way. As explained above, the IRS treats cryptocurrency the same as intangible property for the purposes of taxation – meaning like stocks, bonds, and mutual funds. Section 408 of the Internal Revenue Code prohibits any IRA from investing in art, antiques, collectable stamps, coins, alcoholic beverages, and “any other tangible personal property” specified by the IRS. 26 USC 408. Will the IRS treat NFTs like cryptocurrency and therefore permitted SDIRA investments? Or will NFTs be treated like restricted collectables?

The IRS has not issued guidance on this matter. Some commentators (including the top search result on Google as of the writing of this article) have concluded that the IRS treats NFTs as collectibles and therefore they subject to a “higher minimum gains tax rate of 28%.” This is simply not true. While the IRS certainly treats NFTs as taxable property, it remains uncertain exactly how the IRS will tax these digital assets.

At its core an NFT is code. Cryptocurrency is also code, which the IRS expressly treats like “property” for the purpose of taxation. It follows that NFTs are also “property” for the purpose of taxes. But what kind of property? Are NFTs always considered art or collectibles? Or are they cryptocurrency and can be owned by an SDIRA? What about NFTs that represent virtual real estate in “worlds” like Decentraland, Cryptovoxels, Somnium Space, Sandbox? What if the NFT is an avatar, a name, a virtual outfit? There are several possible ways for the IRS to treat NFTs:

  • One, the IRS can take a pragmatic approach and tax them in accordance with what they would represent in the real world. Some NFTs have real-world counterparts – for example, Forbes reported that a digital collectible startup called Ethernity is set to auction limited edition real world baseball bats that include an NFT counterpart. Nike also patented something called “CryptoKicks,” which presumably will tie real sneakers to some sort of digital authentication certificate. If an NFT represents art, then it is treated like art for tax purposes. If an NFT is a trading card, then it is treated like a collectible. If the NFT represents virtual real estate, it is treated and taxed like real estate (which raises a whole different set of questions).
  • Two, the IRS can take a simple approach and classify NFTs as “property” that is treated exactly like cryptocurrency regardless of what the NFT “represents.” This second approach avoids litigation over what how a particular NFT should be taxed – for example, is an in-game avatar “art”? The second approach also would give SDIRA investors the flexibility to invest in virtual assets, including virtual real estate.

Finally, is the IRS really going after unreported cryptocurrency and NFT transactions? Absolutely. In 2020, the IRS established the Office of Fraud Enforcement and announced in 2021 that a special investigative team was conducting “Operation Hidden Treasure” to identify individuals who failed to report cryptocurrency (and presumably NFT assets).

Investing in cryptocurrency and NFTs is a hot trend in 2021. Although these digital assets may “exist” only as part of the virtual blockchain, the IRS considers them very real and very taxable. This is a constantly changing and developing area, so it is especially critical to consult a tax and legal professional before making any investment decisions. As I pointed out in my earlier post about SDIRAs, even if you are right, you may still end up litigating against the IRS in Tax Court.

More questions? Thinking about investing in cryptocurrency or NFTs? Funding your retirement through an SDIRA? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2021 Artaev at Law PLLC. All rights reserved.

What Should You Know Before Buying Into a Business? 5 Key Considerations for the Informed Investor.

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Buying into a business can be an exciting next step in your career and present uncapped opportunities for growth. It can be especially lucrative from a financial perspective, as well as the professional allure of working for yourself. For example, if you are a doctor working for a clinic, you may be given an opportunity to buy into as a partner. Or, as an employee you may be presented with an option agreement that lets you purchase a membership stake in your employer. Note that this discussion is limited to privately held companies – if you are buying stock in a publicly-traded company (or receiving stock options as part of your compensation) or otherwise investing in an SEC-registered security, you may encounter different issues.

Here are 5 key considerations when faced with a (private) buy-in opportunity:

1. Retain an attorney to represent you. Buy-in options often come from a boss or trusted partner with whom you have an existing relationship. You may even be friends outside of work, which may make you reluctant to involve an attorney. However, you owe it to yourself to treat this as a business deal – because it is a business deal – and it is better to get professional advice now, rather than try to undo something years down the road. There are countless court cases that develop from one person trusting the other too much, people taking advantage of each other, or even a fundamental miscommunication or difference in expectations.

2. Review the operating agreement or the bylaws of the business. As part of your fundamental due diligence, you must ask for the basic formation documents. For a corporation, the foundational document is called the bylaws and for a limited liability company (LLC) the document is called the operating agreement. This document describes the rights and obligations of members, distributions, voting, buy-sell rights, mandatory offers to sell in situations like death, divorce, or insolvency of a member, and other important provisions. Be especially careful if you are buying a minority stake, which does not give you voting control If the company is governed by a majority vote and one person owns the majority, it is effectively at the control of that majority shareholder. Make sure you know what your rights are as a minority shareholder before you invest – you certainly want to avoid a situation where you are “frozen out” or otherwise oppressed, with no remedy other than potentially going to court.

3. Do not assume that you will receive distributions just because you are now part owner. As a shareholder or equity owner, you are also sharing in the losses of the business, as well as its gains. Just because you paid $50,000 into the business, you are not guaranteed a return or any profit at all. Again, it is important to understand the operating agreement or bylaws of the business. When are distributions paid? Monthly? Yearly? Who decides how the gross income of the business is allocated? What happens if the business loses money? Are the owners required to contribute additional capital? Can the majority owner issue additional shares and introduce new members?

Additionally, when you buy into a private company, you cannot cash out your investment very easily. Even if an operating agreement or bylaws include a mandatory sale clause, there is a matter of determining the sale price and the company may very well not have the assets to buy out your shares, even if you try to sell them back. Further, private companies restrict the ability of its owners to sell their shares to third parties or on the open market. In other words, an investment in a privately-held company is an investment for the long-haul, and you should be financially and psychologically prepared for that fact.

4. Get familiar with your new tax status and obligations. If you were a W-2 employee, your tax situation is relatively simple. But if you switch to partnership status, suddenly you will be responsible for paying your own taxes (quarterly), calculating the right amount of self-employment tax, and setting aside sufficient funds for future tax obligations. You will likely receive a new document from the business – a K-1 form – which will change the way you do taxes. Also, any retirement contributions (401k, IRA, etc.) will need to be reassessed in light of your new partnership status. It may be a good time to consult with an accountant as well.

5. Take the time to do your due diligence. Because you are likely dealing with a familiar person when buying in, you may feel pressure to act quickly or forgo asking the tough questions. Again, this is a business deal and a significant financial obligation that you are assuming. Just because your boss assures you that “this is a great opportunity and we will be millionaires” does not make it so. In addition to reviewing the business forms, you should ask for and review (with your lawyer and/or accountant) the financial documents like profit and loss statements, assets and liabilities, projections, and the business plan. After all, you would not buy a house without an inspection and a walkthrough, nor would you buy a car without test driving it first. Even if you think you know the business from working there as an employee, ownership is a different game and it is in your best interest to gather as much information as you can before making a significant financial investment.

Business ownership presents an exciting opportunity. As long as you are proceeding patiently and consulting outside professionals, you will be able to make a fully informed decision. And remember, even if presented with an option to buy-in, it does not mean you have to take it now or even take it at all. It is called an “option” because it optional and should be exercised only if it is in your best interest.

More questions? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.


© 2021 Artaev at Law PLLC. All rights reserved.

What is a Self-Directed IRA and Is It Legal in Michigan? 5 Essentials to Know Before Taking Control of Your Retirement Accounts.

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You may have seen YouTube videos or advertisements touting the merits of the self-directed IRA (“SDIRA”) as a “magic” way to leverage your retirement accounts and outperform the stock market by investing in private companies, real estate, gold, and even cryptocurrency. SDIRAs are perfectly legal when done right and for the right reasons, but unfortunately there is nothing “magic” about them. Nor are they appropriate for everyone. They are a sophisticated investment tool for persons who want to diversify their retirement account holdings and invest in something other than the stock market or mutual funds. It also gives the beneficiary (or owner) direct control over the investments, rather than relying on a bank or investment firm like Merrill Lynch to choose what stocks to buy. An SDIRA can invest traditional securities like stocks and bonds, and also in rental properties, precious metals, and yes, even cryptocurrency.

As an IRA, the SDIRA enjoys certain tax benefits (similar to a traditional IRA or 401k). There is also a self-directed Roth option. Federal law has a complicated set of rules and restrictions for SDIRAs because of the potential for abuse by SDIRA owners, and the IRS field manual and policies contain detailed instructions regarding various schemes and situations to spot the prohibited transactions. Violating these rules has significant tax consequences – an illegal transaction effectively distributes all assets of your retirement account early, with retroactive capital gains liability and penalties.

It goes without saying that you should hire an experienced professional to advise you on the SDIRA structure. Not all attorneys and accountants are knowledgeable and experienced in this area, so make sure you are talking to the right person. While there is a lot to know about SDIRAs and books have been written on the subject, here are 5 essentials to know if you are thinking about taking control of your retirement investments.

1. An SDIRA is not a source of start-up capital for your small business. One common misconception is that an SDIRA can fund a transition from “corporate America” to “small business owner.” That is not the case – the IRS rules prohibit related-party transactions. For example, you cannot use the SDIRA to invest in a used-car dealership and then you work at the dealership and draw a salary, commissions, or some other compensation personally. Nor can you use the SDIRA to loan money to your business, even if the transaction is commercially reasonable, papered, and your business pays market interest on the loan.

2. An SDIRA cannot buy real property from you or your family, or for you or your family to live in or use. Another misconception is that since real estate is a common SDIRA investment, you can transfer your mortgage to the SDIRA and basically pay interest to your retirement account on your house. Or, that the SDIRA can invest in rental or vacation property that your kids can use during winter break. Self-dealing with the SDIRA is prohibited. You cannot sell property from your own self to the SDIRA. Nor can you personally benefit from the SDIRA’s ownership of property, such as for example staying at the property or letting your kids use it during vacation.

3. Using a corporate entity as a conduit for investing is a good idea, but it must be set up in the right way. A common structure for investing is to create an LLC or corporation for the SDIRA to own 100% – which then can then create its own bank account, own property as the LLC, and protect the SDIRA and its owner from liability. For example, if the investment is a rental property and a tenant is injured, the tenant would be limited to suing the LLC (and the property insurance would pay), instead of the entire IRA or the IRA owner personally. That is not to say that the IRA is somehow immune from bad investments, creditors, or losses. Rather, the IRA/LLC structure allows to compartmentalize and limit liability to certain assets. Another important thing about the LLC structure is that a normal operating agreement does not work for an LLC that will be owned by an SDIRA. Special provisions are necessary to comply with IRS rules, as well as certain restrictions that preclude prohibited transactions and self-dealing. The custodian for the SDIRA will likely require a review of such an operating agreement before creating an SDIRA.

4. A special SDIRA custodian needs to be involved to create and administer the SDIRA. Not all banks or investment companies handle SDIRAs. This is not because there is something illegal about them – rather, self-directed investments are more expensive to administer and require more direct oversight than a traditional mutual fund, index fund, stock, or bond investment. Special SDIRA custodians that meet certain federal criteria exist to serve as administrators for these accounts. Because of the higher involvement, they usually charge higher administrative fees. They also will require documents (like the operating agreement or corporate bylaws if you are using a corporate entity structure). Some may even require an opinion letter from an attorney or qualified financial advisor attesting to the legality of a structure before they open your account. And, to the frustration of some, the custodian cannot give financial or legal advice to their clients.

5. Even if you do everything right, you may still be audited or end up in tax court. The IRS has spent a lot of time and resources litigating SDIRA cases and structures. They have lost some cases and won others. The bottom line is that unless you want to invest tens of thousands of dollars into making precedent and trailblazing new law in the area, conservative investing is your best bet. Simple is better. The golden rule is this: passive investments are ok, active investments are prohibited. So long as you stick to a conservative investing approach, do not commingle personal and SDIRA business interests, and treat the SDIRA as an investment opportunity for your retirement account, you will be in good shape. However, there are no guarantees that you will not have to defend your structure in tax court, and the more entities, companies, and investors are involved, the higher the risk.

In sum, SDIRAs are out there and make it possible to leverage your retirement assets into self-directed investments. Real estate, privately-held businesses, precious metals, and even debt portfolios are all potential avenues to receive greater-than-market returns for your retirement account. Or, it is also a great way to lose your entire nest egg if you invest in the wrong venture. Even when making a prudent investment, it is critical to do it right and act only with the counsel of experienced attorneys, accountants, or financial advisors. This is not a simple area and is rife with potential pitfalls and hazards. Use caution.

More questions? Thinking about funding your retirement through an SDIRA? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.


© 2021 Artaev at Law PLLC. All rights reserved.

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