James Hitt, CEO of American IRA, a national provider of Self Directed IRAs, offers an expert opinion on owning a business within self-directed IRAs. With the latest National Association of Realtors housing statistics showing a monthly increase in home sales of 4% and an overall yearly increase in home sales of 12.2%. It is not surprising that investors are forming businesses and purchasing real estate within those businesses.
Mr. Hitt reports “You can run a small business within your self directed IRA without having to worry about taking a chunk of your profits out of it every year to pay income taxes. Further you can buy and sell property as much as you want, within your small business, and you won’t have to worry about capital gains taxes.”
How It Works
While most people don’t realize that IRAs aren’t just restricted to stocks, bonds, annuities, CDs and mutual funds, when they think about the mechanics of it, it’s obvious that they can own a business in their IRA. After all, what is stock ownership but ownership of a fractional interest in a business? Owning a whole business in an IRA, then, is no different than owning all the stock of the business in the IRA. In fact, they can invest their IRA assets in nearly anything they can conceive, as long as it is not expressly prohibited by law. As of 2011, the list of prohibited investments is fairly narrow: They cannot invest directly in collectibles, art, rugs, antiques, metals other than gold, silver and palladium bullion, gems, stamps, coins (except certain U.S.-minted coins), alcoholic beverages, and a few other tangible items related to personal property.
They can also use a Roth IRA to own a business. This means that provided they abide by certain rules, they can operate their business income and capital gains tax free for as long as they live!
That said, if they want to use their IRA assets to start or acquire a business they plan to operate themselves– including a small business that engages in buying and selling any of the above items, there are a couple of things they need to do differently.
Mr. Hitt, interjects, “It is important that you abide by prohibited transaction rules.
When you own a business in a retirement account, you can’t treat it the same way as you do the other entities they control. For example, you can’t have the company in your IRA hire your company to clean the air ducts, even if you pay market rates. Nor can you hire your wife or her company to manage the property. In fact, your IRA cannot buy from, sell to, lend money to or borrow from any of your ascendants, descendants, nor their spouses, nor any entities they control. The same applies to your financial experts and attorneys and their businesses. IRS rules require you to keep a strict arms-length relationship between your, your family, and any businesses or entities you control.”
Watch Their Cash Flows
Remember that they can only contribute a maximum of $5,000 to an IRA in any given year. That limit is increased to $6,000 for those over age 50, but that is still a very narrow window for the infusion of new capital. If their business needs additional capital, they will have to fund everything above that number from existing IRA assets. They may be able to roll over contributions to that particular IRA account from other IRA or 401(k) assets. However, they cannot contribute more than $5,000 in new money, plus allowable catch-up contributions, in any given year.
Additionally, they cannot take money out of the business for their own use until they reach the age of 59½. If they do, their distributions will be subject to income taxes and penalties as they would be for any other IRA account. They must reinvest any earnings back into the IRA until they reach age 59½.
Don’t Pledge the IRA as Collateral for a Loan
This can be a problem for IRA owners whose IRA businesses need to raise capital, for whatever reason. Once the available rollover options and new money contributions are exhausted, then the IRA will have to borrow the money from some other source. However, the only loans IRAs are allowed are non-recourse loans: The bank or lender can have no claim on any assets, in the event of default, that are outside of the IRA.
Don’t Make Personal Use of IRA-Owned Property
They cannot use their IRA or property within it for their own personal enjoyment. For example, if their IRA has a real estate investment company inside it, and it owns a vacation property, they cannot stay in that property themselves, even for a night, and even if they pay fair market rates to the IRA for the use of the property.
Mr. Hitt provides further insight, “It is important that you build a team of experts to assist you in the areas that you are not familiar with. The rules governing self-directed IRAs are complex. Not every administrator understands the ins and outs of this very specialized area of financial planning. It is critical to get advice from a qualified expert who has experience specifically with self-directed IRAs, and who understands and follows the various court precedents, revenue rulings and other factors unique to this kind of investing.”
About: American IRA, LLC was established in 2004 by James C. Hitt in Asheville, NC.
The mission of American IRA is to provide the highest level of customer service in the self directed retirement industry. Mr. Hitt and his team have grown the company to over $250 million in assets under administration by educating the public that their self-directed IRA account can invest in a variety of assets such as real estate, private lending, limited liability companies, precious metals and much more!
To learn more about American IRA, LLC and self-directed IRAs/self-directed Solo 401(k)s, please contact our office at 1-866-7500-IRA(472).