Business IRA Investing Secrets – Just What Can You Invest in?
Many IRA investors are not aware of their allowable investments outside of real estate, but along with our previously mentioned investment options, the IRS also permits many types of business investments.
Some options available to you as a self-directed IRA investor are limited liability companies, limited partnerships, general interest, joint ventures and C-Corps (not to be confused with S-Corps). Many of these can be good investments because your liability is protected, but some types of partnerships do not offer that security, as we will reveal below.
Limited Partnership Interest – How much liability does an IRA have?
Your IRA operates as a limited partner in a business. Limited means you acknowledge that your investment and possible loss is limited to your $10,000. A limited partner (your IRA) teams up with a general partner, thereby boosting the investment amount in a business without your being directly involved in the management of it.
For example, if you invest $10,000 dollars in a limited partnership, then $10,000 is the maximum amount you could lose on this particular investment. Buying a business with IRA funds is as risky as any start-up, and we have seen less overall loss with real estate investments than start-ups over the years. Consult your tax advisor before deciding to become a limited partner, as you will need to know in advance if your partnership will be subject to unrelated tax income (UBIT) in the type of business you want to invest in.
Key Video Highlights
[0:10 Terry presents the Self Directed IRA Handbook; which is made available to all new clients of Sunwest Trust.]
[0:45 Terry introduces 5 different types of business that you can use with your IRA.]
[1:13 Prefer less risk? A Limited Partnership interest means that you’re liable only for losses up to the amount that you have put in.]
[1:53 Terry talks about a C-corp; the same type as big traded companies on the New York Stock Exchange.]
[2:31 What makes a C-corp unique? The profits from the corporation are taxed at a corporate level.]
[2:38 Terry explains a “rollover to start a business”, and why Sunwest Trust does not allow it.]
[3:11 Another reason to use a C-corp is when you would like to invest in the business of a qualified friend.]
C corporations – When can an IRA invest in a Corporation?
These are corporations that are taxed at a corporate level — separately from their owners. (An S-corporation is not, so it is not an allowable IRA investment.) Traded companies on the New York Stock Exchange would fall under this category.
You can invest in non-disqualified parties’ startups, and as with the limited liability partnership, your liability is limited to your investment amount. Any dividends earned are paid directly into your IRA account, so they are taxed-deferred or tax-free.
Beware, however, of what’s known as “Rollovers as Business Start-Ups” (ROBS). The argument for it is that if you use your IRA money to form a C corporation which pays its own taxes, the IRS will turn a blind eye. The dividends will flow through to the IRA (if the C corporation pays dividends), and then your profit will be tax-deferred or tax-free. In a 2010 study of ROBS plans, the IRS discovered that “while some of the ROBS were successful, many of the companies in the sample had gone out of business within the first 3 years of operation, experiencing significant monetary loss, bankruptcy, personal and business liens, or had their corporate status dissolved by the Secretary of State (voluntarily or involuntarily).” This is why Sunwest does not recommend ROBS.
If you are still interested in ROBS, be aware that the Form 5500 series filing requirement does not apply to ROBS plans – because the ROBS plan owns the business, not the owner(s), the owner(s) cannot claim the “assets less than $250,000” exemption each year.
General interest partnerships – Can an IRA invest in a partnership?
These are very similar to limited partnerships, but they are a much riskier choice for the self-directed IRA investor – you can potentially lose more than your original investment. As a general partner, your IRA could be tapped for more money, and your IRA is also equally liable for the debts of the business. We recommend that you stay away from this type of investment.
Joint Ventures – Can I Use my IRA to start a business?
This works when you team up with another investor (a qualified party, possibly another IRA) and purchase a piece of real estate or something that can be sold at a profit within a few months or years. The profits are shared pro rata with the original investment, for example, if you put up 50 percent of the original cost, you get 50 percent of the profit.
A common investment choice for joint ventures is real estate, whereby a piece of land is cleared, developed or simply held before being sold at a profit.
Two clients each used $25,000 from their IRA to purchase a dressage horse that cost $50,000. After training, such a horse can be sold for as much as $70,000 to $100,000. ~ Laurie Bachelder, principal and chief compliance officer with Nua Advisors
Limited Liability Companies (LLCs) – Can I use my IRA to invest in an LLC?
Single member and multi-member LLCs are a popular IRA investment choice because as with most of the IRA allowable investments mentioned above, your liability is limited to the amount of the initial investment. It is straightforward to set up and is the most recommend outlay in this list of allowable business IRA investments.
“Eric Gilkesson, 38, of Atlanta, used his self-directed IRA in 2006 to make a total investment of $95,000 in Signature Channels LLC (now Thanks Again LLC), a rewards program company … His initial 3 percent investment has ballooned to about $300,000.” ~ bankrate.com
An LLC’s income flows through to the owners of the single-member and multi-member LLCs, but the profits are shared according to the shared ownership interest.
As with all IRA investments, these five allowable investments with your self-directed IRA can be profitable as long as you know what you are doing and have good advice from an experienced investor and a tax specialist. Remember that using any of the above investment vehicles to profit your IRA does not allow you to maneuver around the restricted/prohibited investments or the disqualified parties restrictions. You must still adhere to those Internal Revenue Codes.
- Single member and multi-member LLCs are a popular IRA investment choice
- Avoid investing in businesses that do not protect your liability.
- Beware of rollovers as business start-ups (ROBS).
- An IRA can invest in a C-corporation, but not an S-corporation.
Summary of Recommended Resources:
Full Video Transcript
Hi, my name is Terry White. Thank you for joining us this afternoon. We’re going to go back and look at some of the information from the Self-Directed IRA Handbook. If you haven’t heard of it before, this is a book that we make available to all of our new clients; if you’re interested in it, feel free to email me or call our office, and if you’re a potential client of Sunwest Trust, we’d be happy to mail this to you. It gives you a lot of great information. In the past, we’ve talked about what you cannot invest in with your self-directed IRA, and then we touched a little bit on real estate last time. Now it’s time to talk about the things that you can invest in!
So today I want to talk about LLCs, limited partnerships, C corporations, general partnerships, and joint ventures. I want you to understand right up front I am not a lawyer. I am not giving legal advice. I am just telling you what I know from 30 years of business experience and has invested in some of these different types of vehicles. I am going to leave LLCs for last because that’s probably the most widely used one. The first thing I want to talk about is a limited partnership interest. Now, typically you see limited partnership interest in real estate, but it could be for any type of investment, really. You have limited partners, meaning that they’re limited in the amount of liability they accept, and you have a general partner.
So typically your IRA is going to be a limited partner in this type of situation, and so you are limited to losing only what you’ve invested. So if you invest $10,000, the most you can lose is $10,000. That’s what a limited partnership is. You’ve got a general partner, but typically your IRA is going to be a limited partner.
The next thing is a C corp—a corporation that the IRS looks at as a C corp. There are also S corps, which you cannot invest in with your IRA. All of your big companies that trade on the New York Stock Exchange are C corps. And what that means is that the income that they generate —the profit that they make from whatever they do – is taxed at a corporate level, and then they can choose whether or not to pay dividends. That dividend income would come into your IRA and, because it’s in an IRA, will be either taxed-deferred or tax-free. But the income form the corporation gets taxed at the corporate level.
Beware of ROBS
You may hear about investment vehicles called ROBS, or Rollover to Start a Business. The IRS doesn’t look kindly on those, and we don’t recommend them; if we know that’s what you’re doing, we won’t allow you to do it. But the argument for it is that you form a C corp which pays its own taxes and therefore the IRS might not care because they are getting taxes on the C corp. Then the dividends would flow through to the IRA if there are any and would be tax-deferred or tax-free.
However, you could also have a C Corp if a friend of yours is starting a business and just wants to have you invest in his business. As long as that friend is not a disqualified party, then, yes, your IRA could invest in that C Corp. Again, with a C corp, your maximum liability is what you have paid in. You can’t lose more than what you invested.
The next thing is a general partnership. Now, what’s different than a limited partnership is that in a general partnership, your IRA could be liable for more than what you have invested. So, if you’re a general partner, and there is some loss in a business, the IRA could be looked to in order to come up with more money. So personally I stay away from general partnerships unless it’s one that I am in control of and I feel really confident about. I probably wouldn’t invest my IRA in a general partnership, though I am not saying you can’t. You could, and it’s a perfectly legitimate thing to do. I personally wouldn’t do it because of the potential liability there.
Another possibility to consider is a joint venture investment. Often you see these in real estate, where it’s just an IRA made into a joint venture with an individual who is not a disqualified party, or a joint venture with another IRA that’s not a disqualifier. Together, the two parties buy a piece of real estate and have it developed or fix it up, or just buy it and hold it, whatever they might do; then they share the proceeds pro rata, based on how much each invested in that particular joint venture. So, for instance, if we both put in 50% of the money, then we would share 50% of the profits.
Finally, LLCs. An LLC is just like a partnership, only in an LLC income flows directly through to the owner. If it’s a single-member LLC, it’s called a disregarded entity. All the income flows through to the owner, which in this case would be your IRA. If it’s a multi-member LLC, again, the income flows through to the owners, according to their shared ownership interest. But the liability is limited to what you invested in it. So it’s a great way to protect your liability; as opposed to a general partnership, I would use an LLC. I would probably use an LLC instead of a limited partnership or even a joint venture just because of the ease of setting it up and doing it that way, but that again is a personal opinion.
So those are the five entities that you could use to invest in with your IRA. Again, keep in mind that using those entities does not allow you to get around the disqualified party concerns or the prohibited transaction concerns. So you have to just make sure that even though you’re investing in one of those entities, you can’t be involved with disqualified parties or anything that could create a prohibited transaction.
That was a lot of information, and I hope it was not confusing. Hopefully, it is worthwhile to you, and will at least give you enough information to ask the right questions of your CPA or your tax professional, your attorney. I hope that you stay with us. Come back next week on Tuesday at 2:00, and we’ll have some more great information from this book, Self-Directed IRA Handbook, written by Mat Sorenson. Thank you.