Can You Invest With a 50/50 Business Partner Using a Self-Directed IRA?
The short answer is yes, potentially. A Self-Directed IRA can generally invest alongside an unrelated business partner, even when the IRA account holder and that partner own another business together on a 50/50 basis.
However, there are important restrictions under Internal Revenue Code (IRC) Section 4975 that investors need to understand before moving forward.
The key questions are whether the business partner is a disqualified person, whether the IRA is investing in an existing business owned by the account holder, and whether the transaction provides an improper personal benefit.
Let’s look at how these rules work.
What Does IRC 4975 Say About Business Partners?
IRC Section 4975 establishes the rules governing prohibited transactions involving retirement accounts, including Self-Directed IRAs.
Under IRC §4975(e)(2), certain individuals and entities are considered disqualified persons and are restricted from engaging in transactions with an IRA.
These generally include:
- The IRA owner when acting as a fiduciary over the account.
- The IRA owner’s spouse.
- The IRA owner’s parents, grandparents, children, grandchildren, and spouses of descendants.
- Individuals or entities providing services to the IRA.
- Businesses in which disqualified persons own 50% or more, directly or indirectly, under the applicable ownership rules.
- Certain other individuals and business relationships specifically identified in the statute.
Here is an important distinction: An unrelated business partner does not automatically become a disqualified person simply because that individual and the IRA owner share ownership of a business.
IRC §4975(e)(2)(I) also addresses certain partners and joint venturers owning 10% or more of specified disqualified entities or persons. But this provision does not create a blanket prohibition against investing alongside every unrelated business partner.
The complete relationship and investment structure must be evaluated.
Can My Self-Directed IRA Invest Alongside My 50/50 Business Partner?
Potentially, yes.
Consider this example:
John and David are unrelated individuals who own an operating business together. Each owns 50%.
John has a Self-Directed IRA and wants to purchase investment real estate alongside David.
John’s IRA will provide 50% of the investment capital, and David will contribute the remaining 50% personally.
Assuming David is not otherwise a disqualified person, the investment is independent of their existing business, and the arrangement does not improperly benefit John personally, the co-investment may be permissible.
The IRA must hold its investment interest directly, and its share of expenses and income must be properly allocated.
For example:
- John’s Self-Directed IRA contributes $100,000.
- David personally contributes $100,000.
- Together, they acquire a $200,000 investment property.
- The IRA owns a 50% interest, and David owns the remaining 50%.
If the investment is structured appropriately, rental income and expenses would generally be allocated according to the respective ownership interests.
John cannot personally receive the IRA’s share of rental income or use the IRA-owned property for personal purposes.
The fact that John and David own a separate business together does not, by itself, prohibit the investment.
What if the IRA Owner Already Owns 50% of the Business?
This is a very different situation.
Suppose John personally owns 50% of ABC Investments LLC, while David owns the remaining 50%.
John now wants to use his Self-Directed IRA to purchase an ownership interest in ABC Investments LLC or lend money to that company.
Under IRC §4975(e)(2)(G), a business that is 50% or more owned by disqualified persons is itself generally a disqualified person.
Because John personally owns 50% of ABC Investments LLC, the company would ordinarily be a disqualified entity with respect to John’s IRA.
Consequently, the IRA generally cannot purchase an ownership interest from that company or make a loan to it.
The important point: The 50% ownership threshold matters when determining whether the company is disqualified, even though the unrelated business partner may not be personally disqualified.
Investors should also understand that reducing ownership below 50% does not automatically make an investment permissible. Other prohibited transaction rules, including those involving conflicts of interest and personal benefits, may still apply.
What Does the Department of Labor Say?
The Department of Labor addressed a related issue in Advisory Opinion 2000-10A, commonly referred to as the Adler opinion, issued July 27, 2000.
The case involved an IRA owner who wanted to invest IRA funds in a partnership where the account holder and certain relatives were already investors.
The Department concluded that the IRA’s purchase of a partnership interest would not automatically constitute a prohibited sale or exchange under IRC §4975(c)(1)(A), based on the specific facts presented.
However, the Department cautioned that the investment could still violate prohibited transaction rules if it benefited the IRA owner personally or created a conflict of interest.
This distinction is especially important when evaluating investments involving business partners.
An IRA investment cannot be used to rescue an account holder’s personal investment, provide necessary financing for a personal obligation, or otherwise improperly benefit the account holder.
The Department also noted that merely receiving an incidental benefit does not automatically create a prohibited transaction.
Source: Department of Labor Advisory Opinion 2000-10A
What Are Examples of Permissible and Prohibited Investments?
The following examples illustrate how the rules may apply.
Example 1: Investing Alongside an Unrelated Business Partner
An IRA owner and an unrelated business partner want to purchase an investment property together.
The IRA contributes its share of the purchase price, and the partner contributes personal funds.
Generally permissible: Provided the partner is not otherwise disqualified, the structure does not create prohibited personal benefits or conflicts, and the investment complies with applicable IRA rules.
Example 2: Investing IRA Funds Into a Company Already Owned 50% by the Account Holder
An IRA owner personally owns 50% of an LLC and wants the IRA to purchase an interest directly from the company.
Generally prohibited: The company is ordinarily a disqualified entity under IRC §4975(e)(2)(G).
Example 3: Lending IRA Funds to an Unrelated Business Partner
An IRA owner wants to direct their Self-Directed IRA to lend money to an unrelated business partner.
Potentially permissible: If the partner is not otherwise disqualified and the loan does not directly or indirectly benefit the IRA owner, the transaction may be allowed.
However, if the proceeds are used to support a company owned by the IRA owner or satisfy an obligation of that owner, the arrangement could create a prohibited transaction.
Example 4: Using IRA Funds to Support a Struggling Personal Business
An IRA owner wants to contribute IRA funds to a business in which they already have a substantial personal financial interest.
High risk or prohibited: If the business is a disqualified entity, direct transactions are generally prohibited. Even if it is not technically disqualified, using IRA assets to protect or enhance a personal investment may constitute prohibited self-dealing.
What Happens if an IRA Engages in a Prohibited Transaction?
The consequences can be significant.
According to the IRS, when an IRA owner or beneficiary engages in a prohibited transaction involving their IRA, the account generally ceases to be an IRA as of January 1 of the year in which the prohibited transaction occurs.
The account is treated as distributing its entire fair market value as of that date.
This can result in:
- Federal income taxes on the taxable distribution.
- Potential state income taxes.
- A possible 10% early distribution tax if the account holder is under age 59½ and no exception applies.
- Loss of the account’s tax-advantaged status.
Different excise-tax consequences may apply to prohibited transactions involving other disqualified persons.
For these reasons, understanding the rules before investing is essential.
Source: IRS – Retirement Topics: Prohibited Transactions
Frequently Asked Questions About Investing With Business Partners
Is my 50/50 business partner automatically a disqualified person?
No. An unrelated individual is not automatically disqualified merely because they own 50% of a separate business with the IRA holder. Additional relationships, services, fiduciary roles, and transaction details must be considered.
Can my Self-Directed IRA and my business partner buy real estate together?
Potentially, yes. An IRA may co-invest with an unrelated, non-disqualified person if the transaction is properly structured and does not create prohibited benefits or conflicts of interest.
Can I invest my IRA into a business that I already own 50% of personally?
Generally, no. A business owned 50% or more by the IRA owner is ordinarily a disqualified entity under IRC §4975(e)(2)(G). Transactions between the IRA and that entity are subject to the prohibited transaction restrictions.
Can my IRA lend money to my business partner?
Potentially, provided the partner is not a disqualified person and the loan does not directly or indirectly benefit the IRA owner or another disqualified person.
Does owning less than 50% of a business make an IRA investment automatically permissible?
No. The 50% ownership test is only one part of the prohibited transaction analysis. Conflicts of interest, personal benefits, indirect transactions, and other relationships must also be evaluated.
The Bottom Line: Know the Difference Between a Business Partner and a Disqualified Person
Self-Directed IRAs offer investors access to alternative assets, including real estate, private placements, promissory notes, and private businesses.
Investing alongside another person can be a useful strategy, but an existing business relationship deserves careful consideration.
Remember these important points:
- An unrelated 50/50 business partner is not automatically a disqualified person.
- A business owned 50% or more by the IRA holder is ordinarily a disqualified entity.
- Co-investments may be permissible when properly structured.
- IRA assets cannot be used to improperly benefit the account holder personally.
- Every proposed investment should be reviewed based on its specific facts and circumstances.
At uDirect IRA Services, we believe informed investors make better decisions.
Our role is to provide education and administrative services that help account holders understand the possibilities and responsibilities of Self-Directed IRA investing.
Interested in exploring alternative investments through your retirement account?
Visit www.uDirectIRA.com or call us at (866) 447-6598 to learn more about Self-Directed IRAs and how to get started.
Disclaimer: uDirect IRA Services provides administrative services and educational information. We do not provide legal, tax, or investment advice, and we do not determine whether a particular investment is appropriate or free from prohibited transaction concerns. Consult a qualified tax or legal professional familiar with IRC §4975 before entering into transactions involving business partners or related entities.