QUESTION ON Using A Self-Directed IRA to Invest in Business
Hello. I have a small business that I would like to invest additional monies in. One of the sources is a simple IRA being managed by my financial institution. I was advised that I could set up a self-directed IRA to invest that money in the business. As an S-Corp, would that be possible? And how would I go about doing such a thing through my CPA, attorney, financial institution or all of the above? Also, how long would something like that take? Thank you!
– Bryan Stone, TX
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The stock of an S corp may not be held by a self-directed IRA. Alternatively, it may be possible for a self-directed IRA to make a loan to an S corp. BUT, if the loan is made to an S corp (or any other entity) that is owned 50% or more by you or a “disqualified person” as defined by the IRS, this would be considered a “prohibited transaction.” The penalty for such a prohibited transaction would be a determination by the IRS that the IRA has been fully distributed and the imposition of taxes on the value of the IRA.
One workaround might be to have the self-directed IRA make a loan to someone you trust — someone who does not fit the definition of a “disqualified person”–who would then make a loan to your S corp. Disqualified persons include but are not limited to your “spouse, ancestor, lineal descendant and any spouse of a lineal descendant.” For a full definition of the term “disqualified person”, see Section 4975 of the Internal Revenue Code ( http://uscode.house.gov/download/pls/26C43.txt ). This can be a risky approach, however, because if the transaction is handled improperly, or if it could be argued that the transaction involves the fiduciary’s indirect benefit or conflict of interest, it could be found to be a prohibited transaction regardless of whether or not the loan was made to a disqualified person.
Another solution might be to apply for an exemption–that’s right, an exemption–which would allow your self-directed IRA to make a loan to your S corp. Not too many advisors know this, but there is a provision in the Internal Revenue Code that gives the Secretary of Labor the power to grant exemptions to the prohibited transactions rule (see Section 4975(c)(2) of the Internal Revenue Code)–and the Secretary has issued both blanket exemptions and individual exemptions numerous times. For more information, you can contact the Department of Labor or visit the DOL Web site at http://www.dol.gov .
You should seek out the assistance of a tax or financial advisor who is knowledgeable in this area. If you do decide to go with a self-directed IRA, the time it will take to set up will depend on the financial institution and/or brokerage firm. Do not be surprised, however, if the whole process (setting up the self-directed IRA and having the funds transferred from the old account to the new one) takes 4-6 weeks.
Best of luck!
Recommended Resources on Self Directed IRA:
- The Real Smart IRA and Guide to Alternative Investments
- Surprisingly Simple: LLC vs. S-Corp vs. C-Corp Explained in 100 Pages or Less
- Nolo’s Quick LLC: All You Need to Know About Limited Liability Companies
- Form Your Own Limited Liability Company
- How to Use LLC to Invest Funds From a Self Directed IRA
- How a Corporation Can Elect to be an S Corporation
- How to Set Salary of Partners in S Corporation
- How to Reduce Capital Gains Tax of a C Corporation
- Forming an LLC and Electing to be Taxed as an “S” Corp