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Category: Entity Investments in Your IRA

What Are Private Entities?

Posted on by Quest Trust Company
Estimated reading time: 3 minutes

Are private entities the same as private companies? How do private entities gain funding? 

If you’re curious about what exactly a private entity is and what makes them different from public companies, then this article is for you.

You may already know that private entities are privately owned businesses, but there’s a lot more to them than that. Continue reading to learn how private entities work and what makes them different from private companies.

What is a Private Entity?

There are a few groups that can be considered a private entity in the business world. A partnership, corporation, individual, nonprofit organization, company, or any organized group that is not government-affiliated can be considered a private entity.

Because private entities are not publicly traded companies, they do not have public stock offerings on Nasdaq, American Stock Exchange, or the New York Stock Exchange. They do offer private shares to investors who can trade among themselves.

This means that they do not need to meet the Securities and Exchange Commission’s (SEC) strict filing requirements that public companies do. That means their shares are less liquid, and their valuations are harder to determine.

How Do They Work?

A private entity relies on a small group of chosen investors in order to grow and fund their business. This could be employees, colleagues, friends, family, or even large institutional investors. Interested parties are able to support the private entity in order to help the company grow.

Once it reaches a certain size, a private company may eventually decide to go public. This means they are able to have an IPO or initial public offering of stock shares on a public exchange. However, many private companies prefer to remain private to maintain family ownership or avoid the high costs of an IPO.

It is also possible for a public company to go private if a large investor buys out the majority of the stock shares and removes them from public exchanges.

Private Companies vs. Private Entities

The difference between a private entity and a private company is that a private entity is not determined based on the Companies Act of 2013. Instead, they are determined by ownership and holding. Sole proprietorships and partnerships are examples of private entities.

A sole proprietorship is a small business that is owned by an individual. They are the easiest way to organize a company in the U.S. They are set up to create a financial structure that makes the owner and company itself the same person for legal purposes.

All private companies are private entities, but not all private entities are private companies that are registered under the Companies Act of 2013.

How Do Private Entities Trade Stocks?

Shareholders of private companies receive dividends and profits from their stocks, just like public companies. However, there are some major differences that exist. Buyers and sellers of private shares must set their own prices and negotiate sales themselves. 

It can be difficult to figure out the worth of private shares since they aren’t traded often. Plus, no set price exists for the shares. They do not need to report trades to the SEC. This means privately-owned companies tend to be subject to fewer government regulations than publicly traded companies.

However, there is also a greater risk when becoming a shareholder of a private entity. 

Make the Most of Your Small Business

Now that you know the facts about private entities, you may be wondering how to start one of your own. There is a lot to consider when becoming a sole proprietor or private entity, including how to save for your future retirement.

To learn more about how to get started investing with a self-directed IRA, schedule a 1-on-1 consultation with an IRA Specialist by clicking HERE. Just because you own your own business doesn’t mean you can start saving now.

Characteristics of the best IRA custodian

Posted on by Quest Trust Company
Estimated reading time: 3 minutes

The internal revenue service (IRS) decree holds that Individual Retirement Accounts (IRAs) should have a custodian. The custodian is a financial institution that holds the account’s investments just for preservation. The custodian also ensures that all the government and IRS regulations are honored accordingly. While custodians are very easy to find, the problem is how to make the best choice. First, you have to decide the type of IRA you need and the type of investments you need to make with it. 

Traditional vs. Roth IRA 

Both accounts allow the money to grow free of income tax. The difference between the two is: 

  • In Traditional IRA, a tax deduction is made on the contributions from that year; this defers any tax payments until withdrawals are made years later. 
  • Whereas for Roth IRA, there is no tax break on the amount of money invested. In a nutshell, there are no taxes owed on the amount earned. 

Self-directed IRA

Whether Traditional or Roth, as an investor, you can choose to have your custodian manage the investments for you entirely or be self-directed. 

A self-directed IRA allows for expanded investment options. Although the name self-directed makes it seem like the owner has all the control, that’s not how it is. A Self-directed IRA will allow you to move away from the traditional publicly traded assets and utilize your money for alternative assets: Real Estate, Private companies. 

With this in mind, an investor, whether self-directed or not, would want to get the best custodian. 

The following are characteristics of the best IRA custodian. 

An Experienced Custodian – The best custodian for your self-directed IRA is a financial institution with significant experience in offering that service. Also, a custodian that focuses its efforts on providing self-directed IRA custodial services is more likely to serve your needs.  

Smooth Account Set-up – The process of setting up an IRA with a traditional custodian should be as brief and quick as setting up a self-directed IRA. Quest Trust Company, for example, provides easy downloads for new account information packages and forms on its website. 

Low-fees – Cost is one of the essential factors in business because it determines the total amount of profit expected. The most common fees for a custodian are the annual account maintenance fees, commissions, and loads for the mutual funds. All custodians do not charge the same. For example, maintenance fees are not a must. And if you are thinking of investing in mutual funds, it would be better to look for a custodian offering no-loads. 

Wide Selection – It would be best to have a more excellent variety of investment options, especially the individual stocks and bonds. 

Customer Service – It is imperative to have a knowledgeable person answering your calls and emails. It is very frustrating to receive incomplete or confusing information about your accounts. Therefore, while looking for a custodian, always vet the customer service. 

No Restrictions – As an investor, you must get a custodian that doesn’t limit your investment options. 

Education – Even if you are an experienced investor, you can benefit from an IRA custodian who provides you with educational opportunities. It would be wise to look for custodians who have relevant educational materials on their websites, such as in-person courses, live webinars, and overall educational resources.

Consolidation Savvy – For people having multiple IRA accounts, most custodians advise consolidation of the accounts into one single fund. Therefore it will be advisable to get a custodian who thoroughly understands the rules regarding consolidation.

After considering all of these characteristics, you should be able to make an informed decision about choosing the best custodian to help you set up and maintain your Self-directed IRA. 

At Quest Trust Company, we offer self-directed IRA accounts that place the customer at the heart of the decision-making process. Contact us today to discover how our expert staff can ease the administrative burden and help you to make the investment that is right for you.

Using A Self-Directed IRA To Move Beyond Stocks And Mutual Funds

Posted on by questadmin

Estimated reading time: 2 minutesSetting up a new self-directed IRA with a custodian such as Quest Trust Company can be one of the best ways to retirement planning efforts to a host of new investing options. With a self-directed IRA you be able to move beyond investments in stocks and mutual funds, and explore asset classes that might be a much better fit to your investing personality and needs.

First things first – there’s not necessarily anything wrong with incorporating stocks and mutual funds into your retirement portfolio. These types of investments can be a great cornerstone for many individuals’ retirement portfolios.

The potential issues arise in that there are other individuals who want additional options – options to target other investing markets and potentially secure a much higher level of return for themselves. Let’s take a closer look at the self-directed IRA.

Real Estate. There are a variety of methods through which you can invest in real estate with your self-directed IRA. The most accessible type of real estate investment is probably the single family home. These may be the easiest real estate investments to manage yourself (assuming that you don’t want to incur the expenses of an outside professional).

But you can also use your self-directed IRA to invest in multifamily properties, farmland, commercial real estate, undeveloped land, or any other type of real estate interests that a non-retirement account investor has available to them.

Private Investments. The IRS rules governing IRAs also authorize account holders to invest in non-public assets such as private equity and private debt instruments. Depending on the nature of the investment, you may need to meet the definition of a “qualified investor”, but even non-qualified individuals can still make other types of nonpublic investments, including loans and mortgages.

One of the biggest challenges may simply be acquainting yourself with being able to find these types of opportunities. This is one area of investing in which the Internet can provide you with a great deal of useful information. A number of different private investment exchanges and clearing houses have come online in the past few years, and these can help you find suitable private investment opportunities for your self-directed IRA.

These types of non-stock investments are sometimes unfamiliar to retirement savers, so always be sure to do your research and understand the risks of any investment fully before committing any funds.

Steps For Rolling Over Existing Accounts Into A Self-Directed IRA

Posted on by questadmin

Estimated reading time: 3 minutesAs people work their way through one or more careers, and have several (if not dozens) of jobs, they can easily accumulate multiple retirement accounts. They generally come in the form of 401(k) accounts at past employers, traditional IRAs, Roth IRAs, and perhaps even employer pension plans (although this last type of benefit is becoming increasingly rare).

Unfortunately, it can often become quite an administrative burden to manage so many different accounts. For some individuals it can be challenging enough trying to come up with the time to review the monthly or quarterly statements from a single retirement account. Trying to do so for a half-dozen or more accounts can quickly become nearly impossible.

The best way to clear up this administrative nightmare is to roll over all of your existing accounts, including accounts from prior employers, into a single self-directed IRA. Here are the steps for doing so.

1. Identify Your Target Account.
If you don’t currently have a self-directed IRA, then you’ll need to set one up before you go any further. Requesting a rollover from a prior 401(k) or a current IRA, but not having a target account in place, can result in the other plan administrator sending you a check for your account balance. If you don’t deposit this check quickly enough, the IRS may consider it a taxable distribution, and the cost to you could be significant.

The better path forward is to have your self-directed IRA already in place, and request that your current custodian or plan administrator send your rollover proceeds directly to the new account.

2. Contact Your Prior and Current Account Administrators. Once you have a self-directed IRA set up, it’s time to contact each of your current and prior account custodians and administrators. When attempting a rollover of a 401(k) from a prior employer, you may need to begin the process by contacting the employer first; and if you don’t know where to begin, start with the HR or benefits department.

Have all the information regarding your new account ready to give the prior administrators, and be prepared to follow-up if the rollover doesn’t occur within the timeframe they specify. Some plans will give you the choice of liquidating your account and doing a rollover of the proceeds, or rolling over the investment positions themselves, while other plans will automatically liquidate your investments and do a rollover of cash. If you have the choice, make sure to do your research on what’s best for you.

3. Consider Your Next Investment Steps. As you may already know, self-directed IRAs provide significantly more investment options than traditional IRAs or 401(k)s, so it might seem a little overwhelming. You can use a self-directed IRA to invest in real estate, certain types of precious metals, private companies, private mortgages, and many other investment classes that almost certainly weren’t available with your prior retirement plans.

Exploring investment possibilities while the rollovers are occurring will give you the confidence to proceed with your retirement investing plan once the rollover funds are in your new account.

Selecting Your First Real Estate Investment For Your Self-Directed IRA

Posted on by questadmin

Estimated reading time: 3 minutesLet’s say that like many individuals who are setting up their first self-directed IRA, perhaps drawn to the offerings of custodians such as Quest Trust Company because of the investment flexibility that such an account gives, you’re interested in using your new account to invest in real estate.

What are the next steps? How do you go about choosing your first real estate investment for your self-directed IRA?
What’s Your Prior Experience? When it comes to any new investment, there’s always some degree of learning as you go. But if you have very little or no experience with owning or managing real estate, then you may want to consider a more straightforward property for your first self-directed IRA investment.

What’s Your Investment Budget? Another key consideration is going to be the size of the investment budget for your first property. The more money you have available, the more options you’ll have.

As you formulate your budget, be sure to take into account the fact that any expenses for maintaining the property you buy must also come from within your self-directed IRA. This might be new contributions you are able to make each tax year, but these are subject to the annual contribution limits. Plan to either have your real estate generate enough income to pay for these expenses, or to incorporate other assets into your account in order to cover the real estate carrying costs.

What’s Your Current Portfolio Composition? Regardless of your preferred investment type, you always need to take care to avoid having too much of your portfolio committed to a single asset class. If you already have exposure to real estate in your portfolio (perhaps through banking stocks or REITs), then you want to factor that into your new investment considerations.

What’s the Purpose of the Real Estate Investment? Are you considering this real estate investment solely for potential gains, or do you have other goals in mind? For example, some people use their self-directed IRAs to purchase vacation or other properties that they intend to use themselves once they reach retirement age.

As you consider these types of investments, remember that the IRS regulations prohibiting self-dealing, meaning that you cannot use (nor can anyone in your family use) the property you buy until you take a distribution of it from your account during retirement (or face significant penalties if you take that distribution prior to retirement).

Start Small. Many first-time investors find that the best way to become more familiar with investing in real estate is to start small. This might be a single-family home, or even a condominium. Having a small investment in real estate can give you the opportunity to learn more first-hand, without over-committing your retirement portfolio to this type of asset.

Even though real estate is a fairly unique investment asset, it’s still subject to traditional financial analysis. Make sure you familiarize yourself with the local and broader real estate environment before making your first investment with your self-directed IRA.

Is A Self-Directed IRA More Powerful Than Your 401(k) At Work?

Posted on by questadmin

Estimated reading time: 2 minutesMost individual retirement savers have a wide range of opportunities and account options to help them save. Quite often it comes down to two basic choices; a 401(k) plan that’s offered by your employer, and an IRA that you set up with the custodian of your choice.

But some people don’t realize that there are actually some significant differences when it comes to choosing that IRA custodian. Traditional custodians such as discount brokers, banks and credit unions offer an artificially restricted set of investment options that you can choose from. Self-directed IRA custodians allow the full range of investment choices that are permitted under the relevant IRS regulations.

For many, the main choice is between a 401(k) at work and an IRA, possibly a self-directed IRA with a custodian such as Quest Trust Company. It’s certainly possible to use both accounts, but if you have to choose between them, here are some factors to consider.

Investment Options. We mentioned it above, but this is possibly the biggest difference between a self-directed IRA and a 401(k). You can use your self-directed IRA to invest in real estate, private companies, precious metals, issue private debt, and more. At the other end of the spectrum, your employer-sponsored 401(k) will only provide you with a limited set of options. In fact, many 401(k) plans only offer a relatively small range of mutual fund choices, and you won’t even be able to invest in publicly traded stocks.

For many, having the broadest range of investment options is the most important factor in deciding between accounts, and their self-directed IRA is the clear winner.

Contribution Limits. It’s true that your annual contribution limit for a 401(k) that’s offered by your employer is likely to be higher than that for a self-directed IRA. For 2021, the contribution limit for the IRA is $6,000 (plus an additional $1,000 for individuals age 50 and older).

Employer Matching. Employer matching of your contributions to your 401(k) can be valuable, but make sure you understand the limitations and restrictions that may apply. For example, some employers only provide a match for investments that goes directly into company stock. While this might seem like a great opportunity to earn “free money” in your account, be sure that your company stock is a suitable investment for your portfolio, and that you don’t become too heavily weighted in at particular investment. Furthermore, many employers have done away with work or reduced their match programs.

You can still leverage the value of the higher contribution limits for 401(k) plans by simply prioritizing the first $6,000 (or $7,000) of your retirement savings toward your self-directed IRA, then contributing any additional amounts you have available to your 401(k). Remember that when you stop working for that employer you can always roll over your 401(k) into your self-directed IRA.

Entity Investments in Your IRA – Advantages, Cautions and Legal Considerations

Posted on by questadmin

Estimated reading time: 5 minutesThis article is part of a series of articles discussing some issues arising when investing your IRA into an entity, such as a limited liability company, corporation, limited partnership, or trust.  Other articles in this series include prohibited transactions and disqualified person, unrelated business income (UBI) and unrelated debt-financed income (UDFI) as it relates to entity investments, the plan asset regulations and other regulations which may apply, and formation and management issues, including the “checkbook control” LLC which has become so popular in the self-directed IRA industry.

There are advantages, cautions, and legal considerations when investing in an entity within your IRA.  Advantages of having your IRA own an entity include:

1)         Your IRA’s funds may be held in the entity’s name at a local bank.  This can be an advantage when getting cashier’s checks for the foreclosure or tax lien auction, paying earnest money or option fees, or paying contractors who prefer local checks, among other things.

2)         Certain types of investments, such as real estate closings or investments at foreclosure auctions, may in some circumstances be easier to facilitate through an entity.

3)         Investing your IRA’s funds through an entity may give your IRA some asset protection.  Always check with local legal counsel!

4)         In certain limited circumstances, you may be able to act as a manager, director or officer of your IRA-owned entity without compensation.

5)         If the entity’s shares are all that the IRA owns, administration fees may be lower.

6)         If the director, officer or manager is a trusted friend, you may more easily control what happens with your IRA’s funds.

Cautions when investing your IRA through an entity include:

1)         Check with your CPA or tax advisor on the local, state and federal tax implications of the entity you want your IRA to invest in.

2)         Select competent legal counsel to guide you who is familiar with the restrictions imposed by the Internal Revenue Code, including the prohibited transaction rules of Section 4975, as well as the plan asset regulations.  Otherwise, you may inadvertently engage in a prohibited transaction.  Make sure that the investment in the entity is not prohibited in itself and also that the company is not structured in a way that the operations of the company will lead to a prohibited transaction.

3)         All fees for the formation of the entity and for the preparation of any necessary tax returns as well as any taxes due must be paid from funds belonging to the IRA.

4)         Unless the entity is taxable itself, to the extent it owns debt-financed property or operates as a business, unrelated business income tax (UBIT) may attach to the profits from the entity.  Remember, there is no distinction between general and limited partners.

5)         Your third party administrator generally does not review the formation document or the by-laws, operating agreement or partnership agreement.  The nature of a self-directed IRA is that the IRA holder is responsible for the contents of the agreement, and usually must read and approve the subscription agreement and operating or partnership agreement prior to the administrator signing.  Typically, the only review that is undertaken is to make sure that the ownership of the asset is correctly listed in the name of the IRA.  Also, bear in mind that the administrator does not review any investment for compliance with IRS guidelines, so the IRA holder and his or her advisers should be very familiar with any restrictions.

Other things for you and your legal counsel to consider include:

1)         You should review the entity agreements to make sure that an IRA or qualified plan is permitted to be a shareholder, member or partner.  The agreement should specify the voting procedure for shares held by an IRA or qualified plan.

2)         There should be no transfer or buy-sell restrictions that would restrict the shares if the IRA is distributed either because the IRA holder dies or because the shares are distributed as part of a Required Minimum Distribution (RMD), or if the IRA holder decides to move the shares to a different custodian or administrator.

3)         The IRA holder and other related disqualified persons generally cannot receive compensation from the company.

4)         Depending on the ownership percentage by the IRA and other disqualified persons, it may be a prohibited transaction to fund additional capital calls.  If so, only the amount of the initial commitment can be funded.  Many administrators or custodians have restrictions on future capital calls.  The concern is that if the IRA and other disqualified persons fund more than 50% of the entity the entity will become a disqualified person to the owning IRA and future capital contributions might be considered a “transfer to, or use by or for the benefit of, a disqualified person of the income or assets of the plan” in violation of Internal Revenue Code §4975(c)(1)(D).

5)         If the IRA holder is or may soon be subject to required minimum distributions, either the IRA holder must have sufficient resources left in the subscribing IRA or other traditional IRA’s to cover the RMD, unless there will be guaranteed sufficient distributions from the entity to fund the RMD.  Otherwise, shares of the entity may have to be distributed.  This would cause significant difficulties both for the IRA holder and for the entity.

6)         Because of the limited review by the custodian or administrator of the formation documents and the investment, the IRA holder and his or her advisor should do the normal due diligence on the company, including investigating all of the principals involved reviewing the financial strength of the company, verifying with the Secretary of State that the company is in good standing, and checking with the Securities and Exchange Commission , the Better Business Bureau and any other governmental or non-governmental agency to see if any complaints have been filed against the company.  The IRA holder is 100% responsible for evaluating the company and the investment.

Entity Investments in Your IRA – Prohibited Transactions and Disqualified Persons

Posted on by questadmin

Estimated reading time: 5 minutesThis article is part of a series of articles discussing some issues arising when investing your IRA into an entity, such as a limited liability company, corporation, limited partnership, or trust.  Other articles in this series include advantages and cautions when making entity investments, unrelated business income (UBI) and unrelated debt-financed income (UDFI) as it relates to entity investments, the plan asset regulations and other regulations which may apply, and formation and management issues, including the “checkbook control” LLC which has become so popular in the self-directed IRA industry.

As with any self-directed IRA investment, when investing your IRA in an entity you must know what transactions are prohibited and who is disqualified from doing business with your IRA or benefiting from your IRA’s investments. The general rule, as defined in Internal Revenue Code (“IRC”) Section 4975(c)(1), is that a “prohibited transaction” means any direct or indirect –

A)       Saleor exchange, or leasing, of any property between a plan and a disqualified person;

B)        Lending of money or other extension of credit between a plan and a disqualified person;

C)        Furnishing of goods, services, or facilities between a plan and a disqualified person;

D)        Transfer to, or use by or for the benefit of, a disqualified person of the income or assets of the plan;

E)        Act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or

F)         Receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

Essentially, the prohibited transaction rules are intended to discourage disqualified persons from dealing with the assets of the plan in a self-dealing manner, either directly or indirectly. The assets of a plan are to be invested in a manner which benefits the plan itself and not the IRA holder (other than as a beneficiary of the IRA) or any other disqualified person.  Investment transactions are supposed to be on an arms length basis.  There are various exceptions and class exemptions to the prohibited transaction rules, but unless you know of a specific exception, the wisest course is to stay away from a transaction involving one of the above situations.

Note that the last two restrictions listed above (E and F) apply to a special class of disqualified persons who are also fiduciaries.  These two provisions are designed to ensure that the fiduciary does not participate in a transaction in which he or she may have a conflict of interest.  At least in the context of a self-directed IRA, the IRA holder is considered to be a fiduciary of the plan.  Other fiduciaries may include officers, directors and managers of entities owned by IRA’s.  Fiduciaries of retirement plans owe a duty of undivided loyalty to the plans for which they act.  The prohibitions are therefore imposed on fiduciaries to deter them from exercising the authority, control, or responsibility which makes them fiduciaries when they have interests which may conflict with the interests of the plans for which they act.  Any action taken where there is a conflict of interest which may affect the best judgment of the fiduciary is likely to be a prohibited transaction.

All prohibited transactions involve a plan and a disqualified person.  There are nine different classes of disqualified persons.  They are:

1)         A fiduciary, which is defined to include any person who – exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets; renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so; or has any discretionary authority or discretionary responsibility in the administration of such plan.

Note that this definition of a fiduciary is much broader than in traditional trust law, and at least with a self-directed IRA includes the IRA holder who exercises control over the management or disposition of its assets.

2)         A person providing services to the plan.  This can include attorneys, CPA’s and your third party administrator.

3)         An employer any of whose employees are covered by the plan.

4)         An employee organization any of whose members are covered by the plan.

5)         An owner, direct or indirect, of 50 percent or more of the voting power of stock in a corporation, the profits or capital interest in a partnership, or the beneficial interest in a trust or other unincorporated enterprise which is an employer or employee organization described above.

6)         A member of the family of any of the above individuals, which is defined to include only a spouse, ancestor, lineal descendant and any spouse of a lineal descendant.

Caution:  Although other members of the family are not disqualified persons (for example, brothers, sisters, aunts, uncles, step-children), dealing with close family members may still be a prohibited transaction because of the indirect rule.  For example, in the IRS Audit Manual it states:  “Included within the concept of indirect benefit to a fiduciary is a benefit to someone in whom the fiduciary has an interest that would affect his/her fiduciary judgement (sic).  An example would be the retention by the fiduciary of his/her son to provide administrative services to the plan for a fee.”  This is true even though the son’s provision of services to the plan may be exempt under the “reasonable compensation” exception.

7)         A corporation, partnership, trust, or estate owned 50% or more, directly or indirectly, by the first 5 types of disqualified persons described above.  Note that indirect ownership may include ownership by certain related parties such as spouses.

8)         An officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person who is an employer or employee organization, the owner of 50% or more of an employer or employee organization, or a corporation, partnership, trust, or estate which is itself a disqualified person.

9)         A 10 percent or more (in capital or profits) partner or joint venturer of a person who is an employer or employee organization, the owner of 50% or more of an employer or employee organization, or a corporation, partnership, trust, or estate which is itself a disqualified person.

As I always say, “Don’t mess with the IRS, because they have what it takes to take what you have!” A Quest Trust Company self-directed IRA is an excellent tool to help your retirement savings grow, often at rates far exceeding those of ordinary IRA’s.  Knowing these rules is a critical step in learning to use your self-directed IRA in a way that will safely lead to vastly improved retirement wealth.

Entity Investments in Your IRA – Who Cares About the Plan Asset Regulations?

Posted on by questadmin

Estimated reading time: 5 minutesThis article is part of a series of articles discussing some issues arising when investing your IRA into an entity, such as a limited liability company, corporation, limited partnership, or trust.  In this article we discuss the plan asset regulations and how they may impact your investment in an entity.

What are the plan asset regulations and why should you care about them if you are investing your IRA through an entity?  If the plan asset regulations apply to your entity investment, there are two major effects.  First, your IRA is deemed to own not only the equity interest in the entity but also an undivided interest in the underlying assets of the entity for purposes of the prohibited transaction rules of Section 4975.  To see how this works, suppose you want to sell a piece of real estate to your IRA.  Unfortunately, the prohibited transaction rules say you cannot sell any property to your IRA.  So can you form an LLC owned by your IRA and sell the property to that LLC instead?  The answer is no, because under the plan asset regulations selling the property to your IRA-owned LLC is the same as selling it directly to your IRA, which is prohibited.

Second, if the plan asset regulations apply, the officers, directors and managers of an entity may be considered fiduciaries of the investing IRA, which means the prohibited transaction rules apply to them and other disqualified persons related to them.  This is a critical issue and has many implications.  Basically all of the prohibited transaction restrictions which are imposed on the IRA owner now also apply to the managers of the LLC.  As fiduciaries they are responsible for making decisions in the best interests of the IRA as opposed to their own best interests or the interests of parties related to them.  For example, suppose an LLC is formed which is subject to the plan asset regulations.  Because the manager of the LLC is now a fiduciary of the investing IRA, neither the manager nor any other disqualified person related to the manager may sell property to, exchange property with, or lease property from the LLC.

Because of the serious implications of these regulations, when investing your IRA through an entity you should evaluate whether or not they apply.  If you are forming an entity or advising clients as an attorney, knowing when these rules apply is crucial since it may affect how the entity is structured and whether or not you agree to accept retirement plan money.

When do the plan asset regulations apply?  The plan asset regulations apply to any investment which is not a publicly offered security or a mutual fund unless either 1) the entity is an operating company (essentially, a business), which can include a real estate operating company or a venture capital operating company or 2) equity participation in the entity by benefit plan investors is not significant (meaning total retirement plan investors own less than 25% of each class of securities).   This means that the plan asset regulations will apply unless the entity either is running a business (in which case the unrelated business income tax rules apply) or unless all retirement plan investors together own less than 25% of each class of securities.  Even if the entity meets the requirements for an operating company, the regulations still apply if an IRA or a related group of IRA’s own all of the outstanding shares of the entity.

According to an additional set of regulations which stem from the Department of Labor’s Interpretive Bulletin 75-2, even the investment in the entity itself may be a prohibited transaction if a fiduciary (including the IRA owner) causes the plan to invest in an entity and as a result of that investment the fiduciary or another disqualified person derives a current benefit.  For example, if the IRA invests in or retains its investment in an entity and as part of the arrangement it is expected that the entity will hire the fiduciary or a related disqualified person, such arrangement is a prohibited transaction.  Under those same regulations, if a transaction between a disqualified person and an IRA would be a prohibited transaction, then it will ordinarily be a prohibited transaction if the IRA and other disqualified persons collectively have voting control in the entity.

There is no doubt that this is a complex topic which is hard to explore in a short article.  In most cases, the plan asset regulations will apply to your IRA’s entity investment.  If so, you should be aware of the following implications:

1)         Your IRA’s assets include a proportionateinterest in each company asset.

2)         Company managers, directors, officers and advisers are likely fiduciaries of the IRA.

3)         Because they are likely fiduciaries, certain compensation and indemnification plans for officers and directors may give rise to prohibited transactions.

4)         Prohibited transactions may result if the company engages in business transactions with disqualified persons, including the company’s managers, directors, officers, advisers and related parties to them.

If you hire an attorney or a company to assist you in setting up an IRA-owned LLC or other entity, including the “checkbook control” LLC, make sure they have a complete understanding of the prohibited transaction rules of Section 4975 and the associated regulations, the plan asset regulations, and the regulations from Department of Labor’s Interpretive Bulletin 75-2.  Sadly, there is a perception that investing an IRA through an entity is somehow a “prohibited transaction washing machine” which will protect the IRA from all the pesky rules of Section 4975.  In fact, the opposite is true, since the additional layers of complexity make it more likely that an inadvertent prohibited transaction may occur.

For those who want to know more, the prohibited transaction rules may be found in Internal Revenue Code (26 U.S.C.) Section 4975.  The regulations for Section 4975 are in 26 C.F.R. 54.4975-6.  The plan asset regulations are in 29 C.F.R. 2510.3-101.  The regulations relating to Department of Labor Interpretive Bulletin 75-2 are found in 29 C.F.R. 2509.75-2.