Many investors want to know whether retirement funds can be used to buy a business. According to David Moore of IRA Advantage, the answer is often yes, but only when the transaction is structured correctly from the start.
The rules governing retirement accounts have remained largely unchanged since they were introduced in the mid-1970s. Despite that, self-directed retirement accounts are still widely misunderstood. The confusion does not usually come from what retirement accounts are allowed to invest in. It comes from how the transaction is structured and who benefits from it.
Why Structure Matters When Buying a Business with Retirement Funds
When evaluating whether a business can be purchased with an IRA or 401k, David focuses on two primary issues.
The first is the type of retirement account involved and what the investor wants to do with it. The second is who the transaction is between or for the benefit of.
Answering these questions determines whether the investment is allowed and which structure should be used.
Investment Only or Active Involvement
The most important distinction is whether the business is being purchased strictly as an investment or whether the investor plans to work in the business.
Both options are permitted under retirement account rules, but they require completely different structures. Using the wrong structure can lead to a prohibited transaction.
What IRAs and 401k Plans Can Invest In
David explains that retirement accounts offer broad investment flexibility.
An IRA can invest in nearly anything other than collectibles, life insurance contracts, or certain restricted stock subscriptions. A 401k plan can invest in anything other than collectibles.
The asset itself is rarely the problem. The risk arises when transactions involve disqualified parties or provide improper benefits.
Understanding Disqualified Parties
Disqualified parties play a central role in retirement account compliance.
They include lineal ascendants and descendants, their spouses, and any legal entity that is owned or controlled by one of those individuals.
When reviewing a potential transaction, David always looks at what is being purchased and who the transaction benefits. This analysis determines whether the structure complies with retirement account rules.
Using Multiple Retirement Accounts in One Investment
Different retirement accounts can be combined into a single investment. Traditional IRAs, SEP IRAs, and inherited beneficiary IRAs can all be used together.
Each account type requires its own custodial structure. These accounts are also considered disqualified parties to one another, which increases complexity. Combining accounts is allowed, but it must be done carefully to avoid compliance issues.
Understanding the source of funds is essential before moving forward.
Buying a Business as a Passive Investment with a Self-Directed IRA
If the goal is to buy a business strictly as an investment, a self-directed IRA may be an appropriate option.
With a basic self-directed IRA, funds are moved from one custodian to another. The trust company, for the benefit of the IRA, becomes the owner of the business investment. The investor directs the custodian to make the investment.
This structure works best for transactions that are not time-sensitive and do not require frequent or immediate action.
Checkbook IRA and IRA LLC Structures
For investors who want greater control over the transaction, a checkbook IRA may be used. This structure is also referred to as an IRA LLC or a Checkbook Advantage IRA.
In this arrangement, an IRA-specific limited liability company sits between the trust company and the investment. The trust company invests into the LLC. The IRA owns the LLC. The investor serves as the manager of the LLC.
As manager, the investor has the authority to negotiate and execute the purchase of the business in the LLC’s name. This allows faster execution while maintaining retirement account ownership.
This structure is limited to passive investments.
Why You Cannot Work in a Business Owned by an IRA
If a business is purchased using an IRA or an IRA LLC, the investor cannot work in that business in any capacity.
Working in the business would be considered a prohibited transaction. When a prohibited transaction occurs, all funds in the account are treated as distributed as of the first day of the year in which the violation took place.
This result can trigger significant taxes and penalties, making compliance critical.
When a Rollover Strategy Is Required
If the investor intends to work in the business, an IRA-based structure is not allowed. In that situation, a rollover business startup is required.
This strategy combines a 401k plan with a C corporation.
How a Rollover Business Startup Works
The process begins by establishing a new 401k plan. Eligible retirement funds are then rolled into that plan.
Unfortunately, inherited beneficiary IRAs and Roth IRAs cannot be rolled into a 401k plan. However, there are other eligible retirement accounts that may be transferred.
Once the funds are in the 401k plan, the plan purchases stock in a newly formed C corporation. The corporation then uses those funds to acquire the business.
Because the business is owned by the retirement plan through the corporation, the investor may work for that corporation. Clients are also required to personally own at least 5 percent of the corporation.
Choosing the Correct Path from the Beginning
Problems most often arise when investors focus only on whether a business can be purchased, without fully considering how they plan to be involved.
A passive investment may be structured using a self-directed IRA or a checkbook IRA. Whereas active involvement requires a rollover strategy using a 401k plan and a C corporation. These structures are not interchangeable, and choosing the wrong one can result in a prohibited transaction with serious tax consequences. So it is crucial to fully consider what role you to take in your investment before starting any kind of serious planning.
If you are thinking about investing your retirement funds into a business and want guidance on which structure fits your situation, contact IRA Advantage to speak with an expert today.
The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 800-475-1031.
