How to Get More Funding for Investments while Teaching Your Children about Money

By Elsie Dudukovich0 Comments

After the time spent studying listings and checking out addresses, you feel like you could recite the details of every house listed in the county with as much accuracy and certainty as your football team’s current roster.  During the 16th open house you’ve been to in the last two months, you find The One.  Out of everything you’ve seen this property by far stands out as a potentially great rental opportunity for a self-directed IRA.    

There’s just one small detail: the asking price is more than you currently have in your IRA and you don’t think a counteroffer is going to get the price down enough for your funds to cover it.

At this point, you think of a few options.  You could always walk away for now and check back in a few months.  After all, it’s been a buyer’s market in your area and it’s not unreasonable to consider a seller finding it more appealing to work with a buyer who’s basically offering cash in hand. The IRA could also take on debt financing through a nonrecourse loan to cover the difference. 

These are both possible options, but there others to consider.  One such example is partnering.  The IRS does not allow a self-directed IRA to buy, sell, or in some other way transact with a disqualified individual.  According to the Internal Revenue Code Section 4975, a disqualified individual is summarized as the following:
  • Fiduciaries (which in the case of a self-directed IRA includes the IRA owner).
  • The following family members of the IRA owner:
    • Spouse;
    • Parents;
    • Grandparents and Great-Grandparents;
    • Children (and their spouses);
    • Grandchildren and Great-Grandchildren (and their spouses).
  • Service providers of the IRA (e.g., IRA custodian, CPA, financial planner).
  • An entity (such as a corporation, partnership, limited liability company, trust or estate) of which 50% or more is owned directly or indirectly or held by a fiduciary or service provider; also a partner which holds 10% of a joint venture of such entity.
However, when it comes to partnering, individuals who would normally be considered disqualified according to the IRS are permitted to share ownership of the asset using undivided interest.  This means the asset would be titled to reflect each holder of the asset along with their percentage of ownership.  Since the ownership is split between different parties, any funds moving to or from the asset must be split according to the percentage of ownership.  This also means any expenses related to the asset must be paid by each owner according to their percentage of ownership and any income generated by an asset or proceeds of sale of the asset must go back to each owner according to the percentage of ownership as well.
Let’s take a look at an example:

After a little negotiation, you know you have enough in your IRA to cover 80 percent of the property, along with 80 percent of any of the closing fees and inspection expenses.  Going forward, you know you could transfer additional funds from your IRA at another custodian to help cover 80 percent of renovations, repairs, and other expenses such as property taxes.  When the time comes, you’ll make sure 80 percent of any rental income goes back into your IRA and, if you ever feel like selling the property, 80 percent of the proceeds of the sale would go back to your IRA as well.

 This part is pretty straightforward; but the next question is who could you partner with to pick up the remaining 20 percent?

Compatible investment partners
In this example, you need someone you can depend on to maintain their 20 percent share of the investment.  It’s good to remember in the case of alternative assets, it might be in your best interest to consider if this is a person or group you can work with long term.  You and your investment partner will need to make a variety of decisions together for the life of this investment.   

That said, you are open to seek out people who would be considered disqualified under other circumstances.  To increase the benefit of the investment, these individuals could also open a self-directed IRA account – based on their eligibility and goals – and gain the tax advantages of their account when it comes to any investment profits.

Your spouse and children may come together to open their own self-directed IRA accounts, if necessary transferring funds from  another custodian to fund the remaining percentage of ownership, and as a  group you could use undivided interest to hold the asset. 

Let’s say you decide to pursue owning the house with your IRA, and your spouse decides to open an account to invest in the remaining ownership.  The titling would look like this:
  • Equity Trust Company Custodian FBO John Doe 80% Undivided Interest and Equity Trust Company Custodian FBO Jane Doe 20% Undivided Interest
Another option to consider is making it a family event and using this property as an opportunity to help your child learn about investing as well as getting his retirement savings started.   If you helped your 17-year-old son open an IRA now that he has an after-school job providing earned income to contribute to the account, he could take on a percentage of ownership as well when you purchase the property.  If you, your spouse, and your son all came together as a family to invest in this property, the titling would look like this:
  • Equity Trust Company Custodian FBO John Doe 80% Undivided Interest, Equity Trust Company Custodian FBO Jane Doe 19% Undivided Interest, and Equity Trust Company Custodian FBO Robert Doe 1% Undivided Interest
As you can see, partnering can be a powerful tool in your investing strategy toolbox.  It can be a way to take advantage of opportunities previously out of reach for your IRA alone.  But more than that, this is a way to get the whole family involved in investing and creating a financial legacy for your children beyond making them your IRA’s beneficiaries.

We invite you to contact our Senior Account Executives to discuss how you can help your family take advantage of a self-directed IRA.