The good news is that you can you use a Self-Directed IRA or other self-directed retirement plan (e. g. 401k) and invest it in a new or existing business or franchise. You can’t put money into a business that you already own, but you can put money into any other business. You can use your retirement funds without being taxed on the funds (except where an IRA is used to own the LLC – see below). The use of the funds would be considered an investment, not a withdrawal. This means that there are no early-withdrawal taxes or penalties. However, there are some plans and structures that work better than others for this purposes. These are examined below.
Have you been wondering if your IRA can invest in C Corporation stock? Maybe you’re looking to diversify your retirement portfolio beyond traditional stocks and bonds? Well, you’re in the right place because today I’m going to break down everything you need to know about IRAs and C Corp investments.
Yes, an IRA can own C Corporation stock. But there’s a lot more you should know about this investment strategy before you jump in.
The Basics: What Investments Can Your IRA Hold?
Before we get into C Corps in particular, let’s talk about the different kinds of investments that can be made in an IRA.
- Traditional investments: Stocks, bonds, mutual funds, ETFs
- Alternative investments: Real estate, private company stock, precious metals, cryptocurrency
- Private equity: Including C Corporation stock, LLC interests, and partnership interests
Many people don’t realize that IRAs can hold such a wide variety of assets. According to the content from Accuplan Benefits Services, while most Americans are aware they can invest in conventional options like stocks and bonds, alternative investments make up only a small portion of retirement accounts
Can Your IRA Invest in C Corporation Stock?
Yes, you can own C Corporation stock in your IRA, whether it’s traded on the stock market or held privately. An important benefit of having a self-directed IRA is that it lets you invest in private companies, such as C Corporations.
However, there’s an important distinction to make: While your IRA can own C Corp stock, it cannot own S Corporation stock. This limitation isn’t due to IRA rules but rather to S Corporation shareholder restrictions under IRS code section 1361.
Why Use a C Corporation with Your Self-Directed IRA?
According to TheMoneyKnowHow, there are some big benefits to using a C Corporation that is owned by a self-directed IRA:
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Access to retirement funds: If you don’t have sufficient funds outside of retirement accounts, you can tap into your retirement money for business investments.
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Avoidance of UBTI (Unrelated Business Taxable Income): Unlike with an LLC owned by an IRA, a C Corporation structure helps you avoid UBTI tax issues. This is because a C Corp is taxed as a separate entity, so the IRA’s ownership status doesn’t affect the tax treatment at the corporate level.
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Tax benefits on distributions: Dividends distributed from the C Corporation to the IRA are not taxable when received because the IRA is a tax-exempt structure.
Restrictions and Limitations to Be Aware Of
While an IRA can own C Corp stock, there are important restrictions you need to understand:
1. Self-Directed IRA Requirement
To invest in private company stock, you must have a self-directed IRA. Regular IRAs offered by traditional investment companies typically limit your investments to their platform options, which rarely include private company investments.
2. Prohibited Transactions
The IRS has strict rules about “prohibited transactions” with your IRA. These include:
- Self-dealing: You cannot use your IRA to invest in businesses where you or certain family members (disqualified persons) have substantial ownership.
- Ownership limitations: If you want to invest in a company you’re connected to, your total ownership (including family members) must be less than 50%.
- Management restrictions: If you are a managing member, you should ensure you are a less than 10% interest owner.
- Compensation restrictions: A C Corporation owned by your self-directed IRA cannot pay you a salary or other compensation.
3. Prohibited Investments
Your IRA also cannot invest in:
- S Corporations
- Collectibles (art, antiques, etc.)
- Life insurance
- Certain precious metals
- Personal property for your own use
Advantages of Investing in Private Companies with Your IRA
When done correctly, investing in private companies through your IRA offers several advantages:
1. Tax Advantages
Your investments grow either tax-deferred (Traditional IRA) or tax-free (Roth IRA), just like with conventional investments.
2. Portfolio Diversification
By investing in private companies, you can diversify beyond paper assets, which helps mitigate risk to your retirement funds.
3. Growth Potential
Private companies, especially startups, often have tremendous growth potential. As Accuplan points out, compared to buying shares in a listed company, your return on investment can be higher since there’s more room for company growth.
4. Business Agility
A private company is usually more nimble than a public company and can quickly change direction if market conditions shift.
Risks of Private Company Investments in Your IRA
Be aware of these risks before investing your retirement funds in private companies:
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Limited Liquidity: Private company investments can be difficult to sell when you need cash.
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Limited SEC Oversight: Private companies have fewer reporting requirements, making thorough research crucial.
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Higher Volatility: Private company investments typically come with greater volatility and risk of business failure.
Step-by-Step: How to Invest in C Corp Stock with Your IRA
If you’ve decided this investment strategy is right for you, here’s how to proceed:
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Set up a self-directed IRA with a custodian that specializes in alternative investments.
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Fund your self-directed IRA either through a new contribution (subject to annual limits) or by transferring/rolling over funds from an existing retirement account.
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Find the private company you want to invest in. Remember it cannot be controlled or owned by you, your spouse, descendants, or certain other disqualified persons.
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Ask your custodian to make the investment. Be sure to specify the details of the transaction, including purchase price and number of shares if investing in a corporation.
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Verify the transaction has been performed correctly.
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Maintain proper valuation reporting. The private company’s management should provide the fair market valuation on an annual basis for tax reporting purposes.
Using a C Corporation vs. an LLC with Your IRA
There are two common structures for using your IRA to invest in private companies: through a C Corporation or through an LLC. Here’s a comparison:
C Corporation owned by IRA
- Advantages: Avoids UBTI tax issues; dividends to IRA are not taxable
- Disadvantages: More formalities to maintain (minutes, records); cannot pay IRA owner a salary
LLC owned by IRA
- Advantages: Simpler and less costly to maintain; easier to form
- Disadvantages: Business operations generate UBTI that’s taxed at the IRA level; IRA owner cannot be compensated for running the company
Real-World Example
Let’s say you have $100,000 in your self-directed IRA and you identify a promising private C Corporation that needs investment. You could direct your IRA custodian to purchase shares worth $50,000 in this company.
If the company succeeds and eventually goes public or gets acquired, your IRA would benefit from the increase in value. Any dividends the company pays would go into your IRA tax-free (for Roth) or tax-deferred (for Traditional).
But remember, if you’re personally involved with the company, you need to be careful about ownership percentages and compensation to avoid prohibited transactions.
Tips for Success When Investing in Private Companies
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Conduct thorough due diligence on any private company before investing.
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Diversify your private investments by investing smaller amounts across multiple companies.
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Ask critical questions about licensing, registration, and risk/reward comparisons.
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Understand IRS regulations to avoid potential pitfalls and tax issues.
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Consult with professionals including lawyers, tax advisors, and financial advisors before making these types of investments.
Final Thoughts
Investing in C Corporation stock through your IRA can be a powerful strategy for diversifying your retirement portfolio and potentially achieving higher returns. However, it’s complex territory with significant rules and restrictions that require careful navigation.
I always recommend working with experienced professionals who understand both self-directed IRAs and private business investments before proceeding. The potential benefits can be substantial, but so can the risks if you don’t structure your investments correctly.
Disclaimer: This article is provided for informational and educational purposes only. It is not intended to provide, nor should it be relied upon for legal, investment, accounting, or tax advice. Please consult with professionals specializing in these areas regarding the applicability of this information to your specific situation.
USING AN LLC OWNED BY A SELF-DIRECTED IRA
Under this structure the Self-Directed IRA would form and own a LLC. The LLC would then use the funds from the IRA to purchase or invest in a business.
Advantages. You can access your retirement funds if funds outside of retirement are insufficient. Also using an IRA is less complex and less expensive to establish and operate.
Disadvantages. Using the IRA to own the LLC, the LLC would incur UBTI on the operation of the business and the UBTI would be passed on to the Self-Directed IRA. The taxation of the income at the IRA level would off-set any tax-exempt advantage an IRA would normally have. Note: this tax does NOT apply to LLCs that hold property for investment or rental purposes (except if the level of activity meets the standard of operating a trade or business).
In addition, the owner of the Self-Directed IRA cannot receive any compensation for managing the business. So if a salary is needed by the owner of the Self-Directed, this structure would not meet the Self-Directed IRA owner’s needs. Moreover, even if the owner of the IRA did not receive any compensation, the mere fact of managing the business could give rise to the need to report the transaction as a “listed transaction” and file Form 8886.
USING A C CORPORATION OWNED BY A SELF-DIRECTED IRA
Under this structure, the Self-Directed IRA would form a C corporation instead of a LLC. The IRA would then fund the C Corporation and the Corporation would invest in an existing or new business. A C Corporation is an entity established under state law (just like a LLC) but the major difference is that it is taxable as a separate entity so income earned by the corporation is taxable at the corporate level and taxed again when the income is distributed to the owners (shareholders) of the corporation.
Advantages. You can use your retirement funds if you don’t have enough money outside of retirement to buy or invest in a business, just like with an LLC owned by a Self-Directed IRA. There are two major advantages to this structure. The first is that by virtue of using a C corporation you avoid the UBTI. Since the C Corporation is taxed as a separate entity, the status of the IRA as an owner does not affect the tax treatment at the corporate level. The second is that distributions to the C Corporation as dividends are not taxed by the IRA when they are received because the IRA is a tax-free structure.
Disadvantages. Because of how IRAs work, a Self-Directed IRA owned C corporation still couldn’t pay an IRA owner a salary or any other kind of pay. Such a payment would be a Prohibited Transaction. In addition, a C Corporation has more formalities that must be adhered to than a LLC such as the requirements to create and maintain minutes and other records.
Tips for Investing in a Corporation with a Self-Directed IRA
FAQ
Who can own C Corp stock?
Pros of a C corporation: An unlimited number of shareholders: A corporation taxed under Subchapter C can have an unlimited number of shareholders. No restrictions on ownership: Anyone can own shares, including business entities and non-U. S. citizens.
What investments are not allowed in an IRA?
It seems like the answer options are missing from your query. Some common investments that can’t be kept in an IRA are collectibles (like art, stamps, rugs, antiques, some metals, alcoholic drinks), life insurance, and some types of coins.
Can an IRA own stock?
Almost any type of investment is permissible inside an IRA, including stocks, bonds, mutual funds, annuities, unit investment trusts (UITs), exchange-traded funds (ETFs), and even real estate.
Can I use my IRA to invest in a business?
The use of the assets of an IRA, including a ROTH IRA, to make an investment in a private company can result in what the IRS refers to as a prohibited ….