A common question for someone considering the formation of a Checkbook IRA LLC is: “What is the best state to form the LLC in?”
It’s a good question, and one that merits some consideration before putting a plan in place and starting to invest. It’s also a question for which there is no one good answer.
The needs of each investor will vary based on their own location, what types of investments they intend to make, where investments will be located, and if a personal move across state lines may be on the horizon.
Let’s take some time to evaluate a few of the key factors that may help determine which state is best for an IRA LLC.
The Purpose of the LLC
The primary purpose of the LLC component of an IRA LLC is to put the IRA account holder in control of their IRA funds. The LLC is configured in a special way so that the IRA can be the member with ownership equity, and the IRA account holder can act as a non-owner manager.
As a result, the investment activities of the LLC fall under the tax umbrella of the IRA, but can be administered by the account holder. This is why the structure is said to provide checkbook control.
This level of control can be achieved with a LLC formed under the laws of any state. (add spacing between paragraphs)
So why don’t we always use the state with the simplest filing requirements and the lowest formation and annual maintenance fees?
A secondary purpose of the LLC is to provide asset protection for the IRA and the IRA account holder. LLC stands for Limited Liability Company, and the laws of all states afford varying degrees of legal insulation to protect LLC owners from lawsuits against the entity.
In that case, would it make sense to form the LLC in a state with very strong LLC protections like Delaware?
For an investor with operations in Delaware or in multiple states, this might make sense. For an investor looking to hold a rental property in Colorado, however, that Delaware LLC will not do much good in a lawsuit unless it has also registered in or formed a subsidiary in Colorado.
Nexus, Nexus, Nexus
Typically, the most important consideration for the formation of an IRA LLC is business nexus. Where will the investments be taking place, and do those investments classify as having business nexus with the state?
Owning income-producing property or lending to residential homeowners are activities that will generally be considered to produce nexus. In a case where nexus exists, an LLC must have a registration footprint in that state in order to be compliant with state law for operating in the state.
This registration also grants the LLC legal standing with the state, so the LLC can pursue and defend matters before the courts.
Operating in a state where nexus exists without having the appropriate registration can result in administrative penalties as well as loss of the liability protections afforded to LLC entities.
Registration can be accomplished by forming the LLC in that state, or registering as a foreign entity to do business in another state if the LLC is initially formed elsewhere.
Many investments made with a checkbook IRA don’t create nexus. These activities are generally perceived as asset holdings, and do not necessarily require state registration.
Examples might include:
- Conventional financial products like stocks or funds
- Private placements, real estate syndications, and other investments that consist of purchasing ownership in another legal entity
- Stock of privately held corporations
- Foreign real estate
- Precious metals
- Raw land held for appreciation only
- Lending to commercial borrowers (depending on the state)
When no nexus exists the question then becomes: “How simple is it to setup and maintain a LLC in your state of residence?” Establishing a LLC in your home state is generally simple and gives you the option to act at the registered agent for the LLC — being a physical in-state address for delivery of a court summons or other official notice.
Some states have more complex filing and annual reporting requirements, or particularly high annual re-registration fees for LLC entities. In this case, if you are not doing business in the state, it may be advantageous to register elsewhere.
Asset Protection Focus
For an investor with a large portfolio and an investment strategy that creates nexus in multiple states, forming the master IRA-owned LLC in Delaware, then having foreign entity registration or land trusts where the Delaware LLC is the grantor/beneficiary in individual states where properties are held could be worth the cost of setting up and maintaining such a structure.
For most investors, such a strategy would be overkill. Forming the LLC in the primary state where investments creating nexus will take place, then obtaining quality landlord and liability insurance for that LLC is likely more than sufficient and more cost effective.
When a portfolio is unlikely to create nexus or liability exposure, simplicity of operation and minimal maintenance become primary considerations. Often times forming a LLC in your home state will be the easiest bet, unless you live in a handful of states with requirements for complex annual filings or high fees.
Massachusetts, Tennessee, Nevada, and California are some states where “somewhere else” may be a good answer.
Missouri is a great state for LLC formation in these cases. The filing process is quick and simple. No personal information needs to be in the public record, so there is a layer of anonymity.
There is no state required annual report or filing fee. If you’re not a resident of Missouri, you simply need to hire a 3rd party to act as registered agent and provide an in-state address for official notices.
That can be done for as little as $50 per year. Compare that to annual filings in Massachusetts of $500 or Nevada at $425 and Missouri becomes a pretty easy decision.
Your investment portfolio may change over time. We speak with a lot of investors who may be starting out with alternative assets and only thinking about a few non-nexus investments like a private note fund or real estate syndication.
As their portfolio grows, however, they have an intention of adding some directly owned rental property into the mix.
If you live in Kentucky and plan to invest locally in the future, it may make more sense to form a LLC in Kentucky than a lower cost option like Missouri, even though annual operating costs in Kentucky will be $140 more per year initially.
While it is beneficial to spend some time evaluating the best state in which to setup your IRA owned LLC, don’t get caught in an endless game of “what if?”
Life changes. Investment goals change. The more you network, the broader your investment options become.
It may be that in the future you need to modify your IRA LLC structure and extend to or move to another state. Such actions are generally not too burdensome in terms of paperwork or expense. In a future article, we’ll discuss how to alter an IRA LLC as circumstances change.