Self-Directed Retirement Plans for Alternative Asset Investing

Private Entities: Self-Directed IRA’s and 401(k)’s are free to invest in privately-held business entities just as they are free to buy stock in publicly-traded companies. Each opportunity, of course, must be evaluated on its own merits. The IRA Holder, as fiduciary of the IRA account, is held to the “prudent business person” standard. Accordingly, sound judgment must be exercised when considering an investment in a private entity.

Investment strategies include making a loan to or acquiring an equity stake in the given private enterprise. Representatives of a closely held company will typically present the prospective investor with a Private Placement Memorandum detailing the terms of the  business opportunity as well as the potential risks and anticipated returns for the investor. The entity will typically be structured as either a partnership, limited liability company, corporation or non-traded REIT.

It is important to recognize and understand the various tax issues that may apply to the particular type of entity that an IRA is considering investing in. Income realized from pass-through entities (such as Partnerships and LLC’s) that produce or sell goods or services may be subject to Unrelated Business Taxable Income (UBTI) even though the IRA is considered a tax-exempt organization. Income to the IRA from a C-corporation is realized as dividends, so is generally not subject to UBIT. This is because the C-corporation is taxed at the entity level and dividend income is exempt from UBTI (as it is with publicly held corporations like IBM). Your tax advisor can provide valuable insights into the potential tax consequences.

Private Equity: Today’s private equity funds can be compared to the syndications of the 1980’s, save for the tax advantages that were eliminated in 1986. With IRA’s and 401(k)’s, however, the tax-deferred or tax-free returns are ever present, making this investment alternative very attractive to IRA Self-Directors. Some funds are structured to offer debt instruments as the investment vehicle with a stated rate of return (e.g.- 8% per annum). Others offer equity positions where the potential returns are commensurate with the greater risks.

Sponsors of various funds raise capital to exploit a variety of unique opportunities including distressed properties, defaulted commercial or residential mortgages and myriad other situations where having cash available translates into purchasing power to exploit steep price discounts. As with other private entities, the funds are typically pooled in a limited partnership, private REIT or limited liability company structure. Some of the pools are blind; they offer generous returns on investment and participate in the most advantageous opportunities unearthed by the given fund’s management team. Others are more asset class-specific like multi-family projects or commercial loan acquisitions.  

Additional Guidance:

Instruction Letter Documents Required Prior to Funding Private Placements