DISCLAIMER: This topic is extremely complex, I am neither CPA nor attorney, and the views presented are my lay views and should not be construed as advice. You should consult a professional regarding your specific situation. If you are such a professional, please feel free to chime in!
When I invest, my goal is to keep the maximum amount of my money that I can legally keep. I was recently presented with an investment opportunity to consider, and I've reread the rules regarding self-directed retirement accounts. Here are my thoughts:
1. The rules against self-dealing mean that you cannot buy and run a company with your self-directed funds. [I am not considering ROBS in this post.]
2. Because IRAs and Roths were designed for passive investing, active profits are considered "unrelated." This has two implications:
2.1 Profits generated by a business for "non-passive" activities may be subject to Unrelated Business Tax Income (UBTI), which is taxed at Trust rates, currently 37% above $9150. Ouch!
2.2 Profits generated by passive real estate activity may be subject to Unrelated Debt Financed Income (UDFI). The percentage of income associated with debt (the debt to total basis ratio) is subject to taxation at Trust rates. Ouch again!
3. In a liquidity event, the tax on gain is subject to the usual rules for capital gains and losses.
4. In my humble opinion, regular IRAs are subject to double taxation when used to invest. After-tax profits in the IRA are then subject to ordinary income tax rates upon withdrawal, whereas after-tax profits in a Roth can be withdrawn tax free.
So, to maximize your return:
1. Find an equity investment
2. Where all returns are considered passive income
3. The investment is funded without debt
4. And use a self-directed Roth IRA.
Quick example: in the 65% debt-financed passive investment opportunity I am considering, my self-directed Roth should generate a 26.1% IRR, compared to 21.76% if I were to invest using non-tax-sheltered funds. Still worth doing. BUT, if this opportunity were debt free, my IRR would be 32.7%.
I occasionally advise developers on financing options for their projects, so I am curious how many other investors have Roth IRAs and an interest in these types of opportunities. Please let me know. [Second disclaimer: I do not know of any opportunities at this time, and I am not licensed to sell these opportunities, so this is market research only!.]
Using a self-directed IRA or Roth for maximum tax advantage
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by an intermediary from The Johns Hopkins University
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