I’ve long advocated the use of IRA’s to expand one’s business interests. The issue is that there is a VERY fine line dividing what can and cannot be done- in a legal sense.
I started my first self-directed IRA (SDIRA) some 35 years ago. SDIRA’s allow (actually require) the account owners to control the investments and make decisions as to how the money should be invested. But, one needs a custodian or IRA trustee to have this process approved. This trustee/custodian maintains the assets, records the transactions, files the properly completed IRS reports, and issue client statements. The actual assets can be stocks, bonds, or mutual funds, pretty much what a conventional IRA can house.
One should know that you cannot use these funds for life insurance, collectibles (art, rugs, antiques, metals [other than gold bullion], gems, stamps, coins [except US treasury coins]), alcoholic beverages, and some tangible personal property (property than can be moved). So, that means investing your IRA funds to purchase a rental property or to buy stock in a private corporation are perfectly legitimate.
Moreover, you can’t involve family members, your fiduciary, or any entity for which you own or control more than 50% – and that uses the IRS definition of control group. You can’t use those assets to sell your existing business to an IRA, or use the vacation property you purchased with the IRA for your own use. You also can’t make improvements with your own funds to improve the property (that would be an “excess contribution”, according to the IRS).
So, you could use your IRA to purchase stock in a corporation you plan to run. (Notice- you do not yet own that company!!!) Yes, that does mean you can provide the start-up funds. Before you jump up and down for joy, recognize that you better have a good plan- because your retirement can go up in smoke if you don’t make your company a success.
Moreover, you better not plan to borrow additional funds to run your corporation. You see, most entities demand personal guarantees (or recourse) from principals, as a protection should the loan fail to be repaid (default). This is exactly how Lawrence Peek and Darrell Fleck just found themselves in very expensive, very hot waters.
They each employed $ 309K from their IRA’s to buy 50% share in a corporation. But, that new corporation actually acquired a $ 1.1 million entity, with part of that money being a promissory note for $ 200K with personal guarantees (PG) by Peek and Fleck (secured with their homes).
The Tax Court (Docket Nos. 5951-11, 6481-11) decided that this was a prohibited action. Yes, the personal guarantees did not involve the IRA’s, but they were considered by the IRS to be indirect extensions of credit. It is illegal to have any direct or indirect lending of money (or an extension of credit) between a retirement plan and insiders. That’s exactly what the IRS decided the PG were, and invalidated the concept that the IRA was invested in the company- and, thus, was subject to personal taxation laws.
The good thing for Peck and Fleek- the statute of limitation did not permit the IRS to assess taxes, penalties, and interest for all the years involved in this entity. But, the IRS did impose some $ 467 K in capital gains taxes (they sold the business in 2006)- plus penalties and interest.
So, make sure you have good advice before you proceed down this track with Self-Directed IRA’s. (We are available, of course 🙂 .)
One less thing for me to worry about. All I need is to purchase a home with an IRA that I cannot do work on with a loan from something else. I can see how you could double dip this way, but getting a different kind of loan, not based on the tied-up IRA? Something is wrong with this picture.
Ann Mullen recently posted..Inbound Marketing Tip #4: Combating Bad Reviews on Yelp!
This is one of the ways that the top 5% do get extra benefits, Ann.
But, for example, if one of the firms you are working with was to be looking to grow, and YOU believed in it fully, this would be a way to invest in that entity and profit. The odds are you would do better than the stock market investments…
Will share. Always impressed with the diversity of your knowledge and understanding.
Alessa:
This actually is something you and your family should consider. (That is based upon what I read about your business and family.)
You should investigate it further.
Thanks for the visit and the comment.
This is a wonderful article, Roy, but I have to tell you I laughed out loud at the image of someone trying to use their funds for booze. What’s your retirement plan? Oh to wake up and drink. I have one drink a day for my retirement health…I start in the morning drink all day. I know that’s not the point of your post, but the list of things you can’t use your funds with is fairly amusing. Stability V. instability
Lisa recently posted..Strange Moon by Lisa Brandel
Um, Lisa.
If you were to invest in caseloads of semi-precious wine and store them properly, you could, indeed, make a small fortune. Of course, that leaves out the bottom 95% of us, but, then, again, most of those folks don’t invest in corporations, either…
But, yes, that would be illegal for an IRA… 🙂
I like your article Roy,it’s very teaching,now what do you think of a self-directed precious metals IRA?
Wouldn’t it be a good idea to buy some gold and silver and benefit from intrinsic value over time?
Josh @ Precious Metals IRA recently posted..Why is Gold an Inflation Hedge ?
I don’t think buying silver or gold are great for an IRA, unless one has lots of time to watch the prices and make the profits as the prices gyrate. If one does- you bet.
I think the IRA vehicles are best left for investments that one needs to adjust no more than 4 times a year. But, as I said, for those who have the time (and that usually is when one is DRAWING from an IRA because they are retired), then, by all means, it makes great sense.
My head is spinning by all the rules and regulations! I can see why people would need help wading through all the legal issues.
Suerae Stein recently posted..Fab Fotos – Ferns!
Suerae:
There are lots of ways to handle the choices. One, which is what most of us do, is to do nothing. Just make our wages, pay our mortgages, and then compute the taxes. Others, look for ways to protect themselves in their senior years- looking for special investments, new companies etc.
The choice is ours- to risk being confused and making tough decisions or to play it simple and get little, if any, benefit.
It’s not the best system- but we do get to make our own choices.
Thanks for making it clear to everyone that there is that choice!
Why is it so complicated? Honestly, as an individual, it would be impossible without a tax adviser. What a maze!
MuMuGB recently posted..Trying Too Hard
Well, Muriel, it’s only complicated if you want to minimize the amount of taxes you pay and get the most benefits. Otherwise, you can just do simple math…