If you are familiar with IRAs, you probably have a good idea of the IRS rules and regulations that govern retirement accounts—especially if you self-direct. You understand your retirement plan must avoid dealings with disqualified persons or run the risk of taxation, penalization, or even disqualification. However, you may not know that your IRA can partner funds with disqualified persons to invest.
Who are disqualified persons?
The most important aspect of investing with retirement funds is to have a firm grasp of whom the disqualified persons are that your account cannot deal with. These people would be you and your spouse, your lineal ascendants (parents, grandparents, their spouses) and lineal descendants (children, grandchildren, and their spouses). The disqualified list also includes any other person or entity that is connected with your self-directed IRA such as fiduciaries, managers, advisors, or anyone providing service to the account. Additionally, any corporation, partnership, trust, or estate in which disqualified persons have a 50 percent or greater interest is not allowed to transact with your IRA.
Partnering with disqualified persons
With that being said, there is one transaction wherein your IRA can interact with a disqualified person and that is partnering funds to invest. While many rules imposed by the IRS may frustrate us to no end, this is one allowance we can thank them for. Partnering funds allows those with smaller funds in IRAs to participate in investing by pooling funds with another. It also provides the chance to invest in more lucrative assets than your IRA can acquire on its own. And while your IRA can partner with anyone, there is a certain comfort in partnering with someone you know and trust, like your mom or grandfather.
The reason you’re able to partner funds with a disqualified person is fairly simple, when you think about it. Your IRA is meant to benefit you only upon retirement and not before. So, if you have real estate in your IRA, such as a vacation rental, you and any disqualified person are not permitted to enjoy a relaxing week—or even one night—in that property. That would be considered a current benefit, which is a prohibited transaction. But, partnering funds to invest is a bit different in that your IRA and its partner are purchasing an asset together—and ownership of that asset belongs to your account and the person or entity your IRA partners with. The partner does not benefit from your IRA’s portion of the investment.
Ownership is assigned according to the buy-in of each party. Income and expenses are distributed accordingly. For example, if your IRA purchases 60 percent of the asset and the partner purchases 40 percent, your IRA would receive 60 percent of the income and be responsible for the same share of expenses.
So, if you’ve got your eyes on an asset that your IRA can’t afford on its own go ahead and see if your mother or your brother wants to pool funds to invest. Your IRA can even partner with your personal funds, allowing you to build tax-sheltered income in your IRA as well as accruing income on the portion of the asset you personally own!