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Using a Self-Directed IRA to Buy a Rental, Start A Business
By Jason Watson, CPA
Posted February 22, 2020
Since this chapter is about unique or custom entity structures, there’s no better place to talk about self-directed IRAs. What the heck is a self-directed IRA? Just because you make investment choices within your retirement accounts, does not mean they are self-directed. Sure, in a practical sense they are. But a self-directed IRA in the context of this section is about a very specific investment vehicle.
Why would you consider this option? Let’s assume that you want to invest into rental properties (which is a great augmenting retirement strategy by the way.. we are huge fans), but all your money is tied up in an IRA. You are 50 years old, and can’t touch it without penalty. The bank won’t let you borrow against it. You might be hosed.
However, if you set up a self-directed IRA and roll your existing IRA into it, you can have the IRA invest into the rental property. But there is another reason why this might make sense. The S&P 500 index for the past 20 years has returned 9.22%. Not bad. Yet in some situations, rental properties might beat or in some cases, crush, the returns of the stock market. And it creates some diversification within your financial planning.
The other option with a self-directed IRA is to start or purchase a new business. A new business might need cash to invest into equipment, franchise fee, marketing, operational cash, etc.
If you want to expand your horizons into real estate notes, equipment leasing, livestock, private debt and equity placements, and oil and gas you can also use a self-directed IRA. Be careful here. Suitability might be your biggest hurdle. Talk to your financial team (such as The One Call Team) before squandering your life savings on ocean front property in Arizona.
And a 401k may be used as well. A 401k differs slightly from an IRA since it tied to your business. So you get the high contribution limits and no income phase outs of a 401k, and the ability to act as fund manager and purchase assets directly for the benefit of the 401k.
The first step is research businesses who handle self-directed IRAs and ask very pointed questions. Second step is to move your money into the self-directed IRA. Certain businesses provide for this transfer. Then direct your IRA to make an investment into a business. What’s the catch? There’s always a catch. Here are the things to look out for.
No S Corps or Partnerships
The way these entities are structured, business profits are returned to the shareholders. Profits cannot fall into the hands of the IRA account owner. Tainting of retirement dollars is the big thing here. So, your best recourse is a C Corporation or a single-member LLC.
The business cannot invest directly in collectibles, art, rugs, antiques, metals other than gold, silver and palladium bullion, gems, stamps, coins (except certain U.S.-minted coins), alcoholic beverages, and a few other tangible items related to personal property. Ok- there goes half your list for sure. Yup, cross palladium off your list.
In addition, friends, business associates and siblings may invest in the business via a self-directed IRA, but your parents, children or spouse may not. The strict arms-length perspective of the business dealings must be maintained.
Key Employee / Investor
You cannot be the key employee and key investor in the business. Nor can you own a controlling interest of the business. Basically, someone else has to have the right to hire or fire you such as a Board of Directors. The “someone else” is the grey area in all of this, and warrants more discussion.
The net-net of this is that the IRS does not allow you personally to receive money that was slated for retirement (at least without penalty until you are 59.5 years old). There are some other devils in the details, but this is certainly a great option. And Yes, we can help you through the sticky and tightly governed process.
To reiterate, a self-directed IRA or 401k is very cool. It allows you to move money you normally could not use into an account that can now be used to get yourself into a rental or a hot franchise. All without having to find cash elsewhere.
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