Partnerships between Your IRA LLC And Disqualified Persons
One common misconception among IRA investors is that your IRA, or IRA LLC, is absolutely forbidden from interacting with any disqualified person on any deal.
While it’s true your IRA/IRA LLC cannot “transact” with a disqualified person or entity, your IRA entity may enter into a transaction with a disqualified person as distinct partners to the deal.
Think of it as a negotiation table at a car dealership. On one side of the table, you have a buyer, and the other is the seller. Your IRA/IRA LLC may never sit across the table from a disqualified person. But it may sit on the same side of the table to a transaction.
While partnerships are completely legal, there are some important things to remember before entering into a partnership agreement.
First, if the IRA/IRA LLC is partnering with a disqualified person using an LLC or other business entity; in other words, the partners are buying ownership in business entity for the purposes of some investment, the business entity must be newly established, meaning your IRA and the disqualified person are going in at the same time as the first members of the LLC.
Second, the ownership percentage among disqualified members must remain consistent throughout the life of the investment; in other words, one disqualified partner may not buy out the other, nor may a disqualified person “buy-in” after the entity has been funded; as this would be a transaction between disqualified parties. Third, all income and expenses must be split along those lines of ownership; such would be the case in a capital call, or additional funding request, made by the IRA LLC to the members.
In most cases, an LLC, LP, or other structure will be used when forming this sort of partnership. There are generally no special rules as to how this should differ from a personal partnership, but its best to consult with your legal and or financial team to ensure the partnership structure is set up correctly and the operating agreement supports the PT rules found in IRC § 4975.
Below are two examples of partnerships between IRA’s and disqualified persons.
Partnership Scenario (1)
- Susan decides to enter into a partnership with her son Bill. Bill is a successful real estate investor and has an exciting new deal in the works. His plans are to pool his and his mother’s IRA funds into his existing company “Bill Flips, LLC”. Unfortunately, an investment in Bill Flips, LLC would be prohibited as the investment made in the company is essentially a purchase of equity from a disqualified entity.
- In this same scenario, Bill establishes a brand-new LLC for the exclusive purpose of this deal. Bill creates a new entity named Bills JV LLC and both partners invest in the company. Because there is no “owner” of the newly created LLC, Susan’s IRA is allowed to purchase the vacant units alongside Bill. It’s important to note however, that depending on the ownership percentage of the new partnership – and – that Bill is a disqualified person, his role in Bill Flips JV may be limited. Therefore, it’s recommended to first speak with a competent legal consultant prior to entering into a partnership with a disqualified person.
Partnership Scenario (2)
Jeff and his brother Tom decided to form a partnership for the purpose of lending to real estate developers. Jeff utilized his IRA account, Tom used personal funds. In need of additional capital, Jeff and Tom decide to allow their father to invest some personal capital into the partnership. Jeff’s IRA and Tom personally each owned 35 per cent of the partnership, leaving their father with a 30 per cent ownership. While no single person owns 50% of the partnership, the combined ownership by disqualified persons is over 50% (Jeff IRA 35% + Jeff’s Father 30% = 60%) making this entity disqualified from transacting with any other disqualified entity or person. For example, this partnership may lend to developers, as long as the developer is not disqualified.
Remember (!) The IRA prohibited transaction rules will follow the money, regardless of direct or indirect ownership. Therefore it is important you take care to ensure that no disqualified person is receiving immediate personal benefit from the IRA or IRA LLC’s investment in a partnership.