3 Devastating Checkbook IRA Mistakes | Think Realty
InsightInvesting Strategies

3 Devastating Checkbook IRA Mistakes

Case Study: A Misused Checkbook IRA Painfully Derails Investor’s Retirement.

When a Phoenix engineer started flipping real estate after the 2008 housing crash, his first few flips netted him about $126,000. Things were off to a great start. However, due to a serious mistake, the engineer made when he set up his flipping business using a Checkbook LLC, he ended up on the hook for truly obscene taxes that could – and should – have been completely avoided.

Here’s a brief summary of the three big devastating checkbook IRA mistakes:

  1. He had too many things going on in his business structure. Tax Court called the investor’s three business entities a “tangle.” He used the businesses somewhat interchangeably to do flips, buy and hold mineral rights, and transfer properties among the businesses. One of those businesses the investor owned wholly by himself. This last was a big part of why he ended up under IRS scrutiny and eventually lost his case and his retirement account.
  2. He claimed travel and home-office expenses that alerted the IRS to a potential problem. While claiming the wrong types of deductions on your business and personal taxes will not necessarily destroy your IRA, it’s a good way to get the IRS’s attention so they can find the bad decisions you made that will destroy it. Our investor claimed unusually high, round numbers for travel and home-office expenses, common red flags to the IRS.
  3. The Big One: He did not confirm that his checkbook LLC was set up properly or that he was using it correctly. Our investor said in Tax Court that the checkbook-LLC “promoter,” who sold him the checkbook LLC at an event and later set things up for him, told him only that he could use the structure to write checks out of his tax-advantaged IRA funds. Unfortunately, the business entities were set up incorrectly and the investor did not understand how to use them anyway. He committed multiple prohibited transactions, which ultimately terminated his entire $230,000 self-directed IRA.

TAKEAWAY LESSON: If you are going to use complicated business structures in your self-directed IRA, make sure that they are set up correctly and that you use them correctly. Tax Court does not care if you meant to commit a prohibited transaction or not. They’ll fine you either way.


CHECKBOOK LLC: Checkbook LLCs allow “checkbook control,” which means if an IRA owns a checkbook LLC, the owner of that IRA has complete signing authority over the retirement funds in the retirement account. This is important if you use investing strategies like flipping or buying at auction that require you to make fast or immediate payments.

PROHIBITED TRANSACTION: When a self-directed IRA does something prohibited by the IRS. Examples include investing with someone who is related to you or borrowing money from the retirement account and purchasing ineligible investments such as life insurance.