Know of Companies Looking for Investors? Here’s a Potential Source of Funding
Have you ever considered investing in a startup or privately held company but thought this type of investing was only available to wealthy venture capitalists? Maybe you’re interested in diversifying beyond publicly traded stocks but weren’t sure if it was a possibility.
You may have access to private investments – and the funds to invest – and not even realize it.
It’s possible to use your retirement account to fund a wide variety of investment opportunities, including privately held entities and companies looking for investors.
Accounts that expend your investment potential
Through what’s known as a self-directed IRA, it’s possible to diversify beyond public stocks, bonds, and mutual funds into nearly any investment opportunity. The realm of investment opportunities can include small businesses, private equity, investment platforms, real estate, and more.
Many investors do not realize the IRS only lists a few items that are not permitted in an IRA – mainly collectibles, including artwork, antiques, and alcoholic beverages (this can be found in IRS Publication 590).
Because the investments are in an IRA, there are tax benefits. Any profits are tax-deferred (or, in the case of the Roth IRA, tax-free). In addition, investments in IRAs are not subject to short-term or long-term capital gains taxes.
Before you try to tap into your current 401(k) or IRA, there’s one other important thing to know: to truly take advantage of this investment freedom and self-direct your funds, your retirement or other qualified account must be established through a custodian, such as Equity Trust, that’s equipped to handle this type of investment.
There are a few other rules as well, due to the fact that you’re investing in a tax-advantaged account.
What do Private Entities Look Like?
Here’s a summary of different types of private-entity investments:
|Limited Partnership||A limited business organized by one or more individuals, called general partners, who manage the business and are liable for the debts of the business. Limited partners are investors in the business and are only liable up to the extent of their investment. An IRA may only make investments in an LP as a limited partner.|
|Limited Liability Company (LLC)||A business that is formed by members (which may include individuals, corporations, other LLCs, and foreign entities) who have limited liability for the entity’s debts and obligations.|
|Corporation (C-Corp)||A company owned by shareholders who elect a board of directors. The board of directors determines the direction of the company.|
Private entity investments with a self-directed IRA: real-life examples
Equity Trust clients have used their accounts to invest in a variety of private market opportunities. Here are a few examples of people who invested in companies looking for investors:
- Paul purchased a 19-percent share in a failing Florida self-storage business and, with another investor, made it profitable again
- Mark used his Health Savings Account to participate in an investment on a real estate crowdfunding platform
- Jim of New Jersey used his IRA to invest in a FedEx delivery route franchise
- James used his SEP IRA for a 14-percent share in a land trust which purchased real estate in Florida and sold it for a profit
- Clyde of California used his IRA to invest in a portion of a film production
What to know about self-directed investing
Once your account is open with a self-directed account custodian, there are a few IRS rules to be aware of when using your retirement account to invest in startups and other businesses.
A disqualified individual is anyone up and down your family tree – parents, grandparents, children, and grandchildren. In addition, yourself, as the account holder, and any fiduciaries are considered prohibited. IRS rules state that these individuals cannot be a counter party to your investment.
This is any transaction involving any of the disqualified individuals named above. Your IRA transactions are to be at “arm’s length” – the account is for the purpose of retirement, so any investments in the account should not benefit you personally.
You can find more information in IRS Publication 590.
Other rules related to private entities in an IRA:
Some important rules to remember about investing in an entity within a qualified account:
- If you are purchasing ownership of an existing entity, total ownership of disqualified individuals (including you) cannot be 50 percent or higher
- Internal Revenue Code 4975 prohibits investments where the managing member is more than 10-percent interest owner and disqualified individual
- Your limited partnership or LLC may be subject to Unrelated Business Income Tax (UBIT)
- UBIT is the tax on unrelated business income that comes from an activity not related to the tax-exempt purpose of the organization. IRS Publication 598 provides instruction and details on how to determine if a normally tax-exempt entity/organization is required to claim Unrelated Business Taxable Income.
- You should discuss UBIT situations with your CPA/tax advisor
- You may not invest in stock of a subchapter “S” corporation
- Any earnings from the entity must return to your qualified account
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How to get started investing in private companies in an IRA
To set up a self-directed account, you’ll need to open an account at a self-directed IRA custodian. You can then fund your account by making a contribution or rolling over or transferring another retirement account.
It’s important to note that Equity Trust does not offer investment advice. It’s recommended you do your due diligence before making any investment decision.
Yes. Investments in newly formed private entities, such as limited partnerships, limited liability companies, C corporations or land trusts, are permissible under the Internal Revenue Code, with the exceptions of subchapter S corporations.
Some advantages of self-directed IRAs include:
- Tax-deferred or tax-free profits
- Investment diversity (it is possible to invest in an array of assets in your retirement account)
- Potentially building wealth for future beneficiaries
With a self-directed IRA, your investments are up to you, within the bounds of the IRS rules and guidelines. The IRS does note provide guidance on what investment types are permitted, but dictates only what is NOT permitted. Examples of prohibited IRA investments include collectible (such as artwork, stamps, rugs, antiques and gems), certain coins and life insurance. See IRA Publication 590 for more information about prohibited investments.
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