Private Company or Business Investment
In this IRA Financial post, we’ll detail what you need to know if you want to use an IRA to buy or invest in a private company or business. With a Self-Directed IRA or checkbook IRA structure, you can invest in almost any type of asset you wish. This includes a private company or business.
IRS Prohibited Transaction Rules
The IRS (Internal Revenue Service) and the Internal Revenue Code (IRC) don’t describe what a Self-Directed IRA can invest in. However, it describes what assets a Self-Directed IRA cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain type of transactions. These include life insurance, collectibles, or transactions directly or indirectly involving or benefiting a “disqualified person.”
Essentially, a “disqualified person” is the IRA holder and any of his or her lineal descendants. It also includes entities such persons control.
How the Self-Directed IRA Works
The main advantage of using a Self-Directed IRA for a private company or business investment is that you can invest in assets you understand. Additionally, you can defer taxes on the income or gains of investments.
As long as you or a disqualified person has no personal involvement in the company or business directly or indirectly, the Self-Directed IRA will likely be able to make the investment without triggering the Prohibited Transaction Rules.
Generally, you have two options when using an IRA for a private company or business investment.
Private Company or Business Investment Options
With the custodian controlled Self-Directed IRA, a special IRA custodian will serve as the custodian of the IRA and allow you to make alternative asset investments. This includes a private business or a private company. The IRA custodian will then invest the IRA funds at the sole direction of the client. The IRA holds the investment in the name of the IRA custodian. An example is Financial Trust Company FBO John Doe IRA. The IRA custodian is responsible for making all payments regarding the IRA investment, including paying expenses.
With a Self-Directed IRA with “checkbook control,” investing in a private company or business is as simple as writing a check. With a Self-Directed IRA with checkbook control, a special purpose limited liability company (LLC) is established. The IRA owns the LLC and the manager is you, the IRA holder.
As a result, you can make real estate investment decisions on behalf of your IRA without an IRA custodian. With a Self-Directed IRA LLC with Checkbook Control, you can make a private company or business investment by writing a check. All you IRA funds will be in a local bank in the name of the IRA LLC.
So all you have to do to make the real estate transaction is write a check straight from the IRA LLC bank account or simply wire the funds from the IRA LLC bank account.
The UBTI Self-Directed IRA Rules
When it comes to using IRA or 401(k) plan funds to invest in a private company or business, other than the prohibited transaction rules, there’s an additional issue to address. This is whether the transaction will trigger a tax known as the Unrelated Business Taxable Income tax (UBIT or UBTI). If the UBTI tax is triggered, an IRA investment into a private business or company can be subject to a tax as high as 37%.
Under the Self-Directed IRA UBTI rules, if the private company or business is operates through a passthrough entity, like an LLC or partnership, the income by the private company or business that’s allocated to the IRA will likely trigger the UBTI tax if it exceeds $1,000 for the year.
Whereas, if the private company or business was operated as a C corporation, the UBTI tax will not apply as the C corporation is blocking the application of the UBTI tax. As a result, when you use your IRA to invest in public stocks, such as Apple or Google, the UBTI tax does not apply. This is because almost all public companies are C corporations.