Imagine an investment opportunity arises but you don’t have enough liquid funds to act on it. Instead of letting it go by, your IRA can be an oasis of funds that enables you to invest. In fact, nearly every investment with which you can make money outside your IRA, you can make money with inside it—everything but collectibles and life insurance.
All you need is a self-directed IRA (SDIRA) provider like New Direction IRA (NDIRA) to provide bookkeeping and administration for the account. Then, your IRA can invest in private equity, issue loans, buy real estate, metals and more. The challenge up to this point—as you may have noticed—is finding an IRA provider that will service alternative assets. Companies like NDIRA are specialists with these asset types and have made these investments easy.
The opportunity is available for your IRA to provide start-up costs for companies, buy into growing entities, purchase existing businesses, buy and rent commercial space and much more.
Let’s look at a few purchase structures commonly used to invest in businesses.
Outright Purchase – You can buy an existing business outright with your retirement account. In this structure, you will agree on a sale price for the business and direct the IRA provider to send funds from your IRA to buy the business. After that, you may supply the brain power and make decisions regarding the business, however you cannot provide services or perform any sweat equity for the business. So even though you are the owner and decision maker at the business, you can’t, for example, be there 40+ hours a week performing a job, like many business owners are.
Loans – In this structure, you and the company you’re investing in will determine the amount and terms of the loan and sign a promissory note together. Your IRA earns money on the interest rate and points you assign to the loan. This is an advantage unique to notes as you will have a fixed return in an agreed upon amount of time. Your borrowers can be companies and/or people with whom you feel comfortable.
Note that the company you invest your IRA in cannot be owned or controlled by a disqualified person (lineal ascendants and descendants, spouse and certain fiduciaries).
Private Equity/Stock – Some companies derive investment capital not only through loans, but also by offering equity or stock. Via these private placements, your IRA can invest in private companies and earn a percentage of their profits based on how much equity you have. Equity can be expressed as either shares of stock in a company or as an ownership percentage.
The hallmark of private equity asset is that the return on the investment can be directly tied to the performance of the company.
Convertible Notes – Convertible notes act as a sort of hybrid between loans and equity. This structure requires a loan to be issued initially with an option at some point in the future for the lender to convert that loan to an ownership share (stock). The flexibility of this structure appeals to many investors and businesses.
One final thing to consider when you buy equity with your IRA is Unrelated Business Income Tax, or UBIT. Originally created to keep nonprofits and for-profit businesses in fair competition, this tax also covers retirement accounts as they typically possess tax-advantaged statuses. It is not a penalty; it is simply a cost of doing business. For IRAs, a form 990-T is used to calculate profit or loss and if UBIT needs to be paid.
Like all businesses, those owned by IRAs must pay business taxes. This tax can be handled at the company level before profits are paid to the IRA and in that case, UBIT would not be assessed to the IRA. Or, the company may be able to pay profits to the IRA before business taxes, and the IRA would be subject to UBIT, which would be assessed at trust rates. Note that interest derived from loans made by an IRA are not assessed UBIT.
If you participate in ongoing businesses, you may need to deal with UBIT but it need not deter you from good investment opportunities. An SDIRA provider like New Direction IRA can help you navigate UBIT.