Can I Use My IRA to Invest in a Startup?
Investment in private companies offers enormous growth potential and diversifies your portfolio, but they carry certain risks – and must abide by IRS regulations when investing in startups.
Recently, using your IRA to invest in private startups has never been simpler! Keep reading to discover more!
Self-directed IRAs give you full control of your retirement account, but require greater investment expertise than standard IRAs. To avoid violating IRS guidelines and jeopardizing its tax-deferred growth potential.
Many startup companies are turning to self-directed IRAs for capital. Companies like Facebook, Staples, Sealy Mattress Company, Domino’s Pizza and PayPal are examples of successful startups which have sold shares or units into these accounts.
Self-directed IRAs allow investors to invest in real estate, precious metals (provided they meet IRS purity standards), and foreign currency. Investment in startup companies that you own or operate would be considered an illegal transaction and result in UBIT income for your IRA; however, ROBS (Rollover to C Corporation or ROBS – Opens in new tab) provides another means of starting up new businesses using your IRA without breaching IRS rules.
Qualified Small Business Stock
The US tax code offers investors an attractive incentive for investing in small businesses: Qualified Small Business Stock (QSBS). Investors who meet certain requirements of QSBS companies can exempt up to $10M of gains incurred when investing.
Key components to consider in issuing US C corporation shares are that it must have aggregate gross assets of $50 million or less prior and immediately post-issuance of shares and that it be engaged in an approved trade or business (including certain technologies sectors, but excluding some services businesses like hotels and banks).
Founders and early employees who receive restricted stock from startups should consider making an 83(b) election to meet the five-year holding period requirement more quickly. Before proceeding with this strategy, however, seek expert tax advice as changing vesting dates may render an election invalid and thus disobey QSBS requirements.
Investment options abound for startup companies via self-directed IRA or Solo 401(k), yet some considerations should be kept in mind before taking this route.
Investment in illiquid assets such as startup shares can impact your required minimum distribution (RMD). Your RMD is calculated based on the total value of your IRA holdings, which could include investments such as startup shares.
Notably, it’s essential to remember that you can only do one indirect rollover in any one year if you switch IRA accounts – this means if funds move between types, you must wait 60 days for the IRS to return 20% withheld from your distributions back into your IRA accounts.
An infusion of IRA money from outside investors can often provide startups with just what they need for growth, yet caution must be exercised in ensuring such transactions comply with prohibited transaction rules and that equity rather than debt or loan investments are made by their IRA owner. Failing to do this could result in a taxable distribution to the owner as well as possible audit by the IRS.
Many investors were unaware they could use their retirement accounts to invest in startups or private companies until recently; now that more people know, the odds of success may have increased but potential payoff remains strong.
Taxes play an essential role when investing in startups, so it is crucial that investors understand the rules before proceeding. For instance, investing a qualified revocable trust or limited liability company into any business owned by you may violate self-dealing rules; similarly you cannot invest any funds from an IRA into businesses owned by disqualified persons such as spouses, children, parents, fiduciaries and more.
Similar to dividends or payments from startup investments, dividends or payments from startups will generally be taxed at ordinary income rates according to their security type (equity, SAFE or debt). Furthermore, startup expenses should generally be depreciated over multiple years as capital costs.