When looking for ways to finance the purchase of a business, your individual retirement account assets are a source of funding that allow you to lock in tax-deferred, or tax-free, capital gains as your business increases in value. As an added benefit, you may not need to cash in on the investments in your IRA for many years and can allow the business sufficient time to grow to its fullest potential. A self-directed IRA is the key to this process, allowing you greater choice with your investments.
A self-directed IRA has an independent trustee who makes purchases of investments and holds them in the name of the IRA account for the owner. The self-directed trustee also handles the reporting and paperwork requirements and makes sure your IRA stays in compliance with Internal Revenue Service regulations to retain its tax-advantaged status. The trustee is prohibited from purchasing collectibles, but most other types of investments are allowed.
Fund the IRA
Although you can make yearly contributions to your self-directed IRA, it would take considerable time to accumulate the funds necessary to purchase a business by doing this. You can use money from an existing IRA to purchase a business by having your self-directed IRA trustee initiate a trustee-to-trustee transfer of these funds to your self-directed account. You will pay no taxes or penalties with trustee-to-trustee transfers.
Make the Purchase
Once your funds are in place, instruct your self-directed IRA trustee to make the purchase. The trustee will handle the details of transferring funds, as well as setting up the legal ownership of the business in the name of the IRA account. You must do your own research on the business, determining that it is a good investment, as the trustee's primary function is to maintain the tax compliance and tax-advantaged status of your account.
Your IRA cannot own a business that is set up as an S corporation or a general partnership. In addition, your parents, children and spouse cannot invest in your business with a self-directed IRA, but friends and business associates can. You cannot be a key employee of the business and the primary owner of that business. If you work for the business, someone else must have controlling interest and be able to fire you. Your IRA-owned business may also be responsible for paying unrelated business income tax. Any income that the business owns is subject to this tax, while capital gains and appreciation on the business maintain their tax-advantaged status.
Get legal advice before you try to use your IRA to fund a business that you are involved in. The IRS takes an extremely dim view of taxpayers who use their retirement accounts for their immediate economic benefit. If you cross any of its rules with a self-directed IRA, you could find the account invalidated and face hefty penalties.