Investing in real estate can be expensive. For many investors who want to diversify their retirement savings into assets such as rental property, access to capital can be a barrier.

We’re often asked whether it’s possible to combine IRA and personal funds in a joint venture. The concept is promoted on the internet as being possible, and is supported by many self-directed IRA custodians.

But is this strategy really safe, and is it a good idea? Let’s take a deeper look.

Prohibited Transactions and Disqualified Parties

One of the first principals of investing with a self-directed IRA or 401(k) plan is avoiding prohibited transactions as defined in IRC section 4975.

Prohibited transactions occur when there’s any direct or indirect transaction or provision of benefit between a retirement plan and a disqualified party.

Disqualified parties include the IRA account holder, their spouse, lineal family such as parents, grandparents, children and grandchildren, the spouse of a descendant, or an entity such as a business or trust where such a disqualified party has control.

Certain fiduciaries such as investment advisors are also disqualified.

So something like personally lending money to your IRA would be a prohibited transaction that would have severe tax consequences for the IRA.

But What About a Joint Venture?

When some in the self-directed IRA industry speak about the possibility of combining personal and IRA funds, it is generally in the context of a joint venture, where each party is separately and distinctly entering into a transaction.

The idea is that no transaction or benefit is occurring if:

• Both parties enter into a transaction jointly at the point of inception. One party could not complete a transaction and then sell or transfer interest to the other party, as that would create a transaction between the parties.
• The equity participation in the venture is locked in based on the initial funding. If an IRA provided 60% and an individual provided 40%, then all future expenses and income are allocated on this 60/40 basis.
• Neither party can ever buy the other party out.

In such a rigid framework, one could argue that each party to the transaction is separate and distinct, and there are no transactions between the IRA and the disqualified party.

What About Indirect Benefit?

A concern we have always voiced in this context is the risk of indirect benefit.

What if either party is enabled to participate in a transaction that it might not have been able to otherwise because of the presence of the other party? Would this not constitute a benefit?

If one side of the venture was bringing 90% of the capital and the other just 10% there is a real concern. Could that 10% partner, whether the IRA or the IRA account holder, have executed the transaction on a stand-alone basis?

Most probably not. It would be a reasonable argument that the transaction was only available to that minority participant via to the ability to partner, and that could be considered an indirect benefit.

There could also be risk if an IRA and a disqualified party were combining resources simply to be used as a down payment, and then obtaining mortgage financing. The likelihood in such an arrangement that either party could have done the transaction alone is relatively slim.

In a 50/50 split or something close to that, this issue of access becomes less murky perhaps, but not exactly clear.

Take the example of a $200K property purchase. An IRA with $100K available would have the opportunity to purchase the property with the use of a non-recourse mortgage.

It could therefore be argued that it was possible for the IRA to engage in the transaction without access to the personal funds, and the decision to joint-venture was an option, not a requirement. Under those circumstances, there’s no benefit occurring in the form of access to an otherwise inaccessible opportunity.

But would the IRS agree?

What We Don’t Know Equals Risk

The interpretation of tax attorneys and commentary on the internet are one thing. There are certainly some logical arguments that would lead one to believe it may be possible in some circumstances to partner with your IRA.

But these arguments are just theory. Actual language in the tax code, or existing case law are an entirely different matter. A reasonable amount of certainty can be determined from these sources.

The reality is, there is no clear guidance in the code or tax courts on this topic. As such, any transaction of this nature would be somewhat of a voyage into the unknown. In dealing with the IRS, unknown territory is risky territory.

Are You Prepared to Fight?

At the end of the day, the risk of any aggressive transaction with a self-directed IRA is that the IRS may question what you have been doing in an audit. It’s your obligation to prove that your actions with your IRA are in compliance with the relevant laws.

While you may prevail, simply the act of defending your IRA can be a long, stressful, and expensive process.

Are There Better Options?

Our stance on this topic is that you probably should not enter into a joint venture with your IRA. In some circumstances it may be okay, but at what level of risk?

The purpose of a self-directed IRA is to grow your retirement savings. When there are so many ways this can be done that don’t introduce the risk of significant tax penalties, why go there?

Our experts are standing by to help you make the most of your self-directed retirement savings. Give us a call to further discuss your options and get the answers you need »