Mat Sorensen


December 17, 2013

Crowdfunding will soon become one of the most utilized methods of raising capital for small businesses, investment ventures, and start-ups. The concept of Crowdfunding is to loosen the restrictive securities laws so that new or existing companies can raise small sums of money from large groups of people. If you’re unfamiliar with Crowdfunding, check out my prior blog article on the subject here.

Self directed IRA investors will likely be a significant investor group in Crowdfunding offerings as much of the nation’s wealth (and available investment capital) is held in IRAs. Before deciding to invest your IRA into a Crowdfunding offering, self directed IRA investors should consider the following issues and factors.

  1. Will Your IRA Have to Pay UBIT Tax? Many Crowdfunding offerings will generate UBIT tax for the IRA owners of the company. UBIT tax applies to income received by an IRA that is not passive. IRC 511, IRS Publication 598. For example, if my IRA invests into a new tech start-up LLC, then the profits received by the IRA will likely be subject to UBIT tax since the tech company LLC is not a passive business. Also, if my IRA invests into a Crowfuding company that flips real estate the profits my IRA receives will also likely be subject to UBIT tax.Passive income received by an IRA, on the other and, is exempt from UBIT tax. IRC 512. If the Crowdfunding Company is a c-corporation, then there is no UBIT tax as c-corporation dividends to an IRA are exempt from UBIT tax.  Also, rental real estate income, royalty income, and interest income are exempt from UBIT tax.a
  2. An IRA Cannot Buy S-Corporation Shares. An IRA cannot buy stock in an s-corporation as an IRA does not qualify as an s-corporation shareholder. As a result, you cannot use your IRA to invest in an offering of s-corporation shares.
  3. Are You or Your Family Members Involved in the Crowdfunding Company? If you or your family members are owners or part of management in the company raising funds, then it may be a prohibited transaction for your IRA to invest into the Crowdfunding offering. The prohibited transaction rules apply to all IRA investments and essentially create restrictions on investments into companies where the IRA owner or family members of the IRA owner are involved. IRC 4975.
  4. Have Crowdfunding Rules Been Complied With? A Crowdfunding offering must include certain disclosure documents and financial records to prospective investors. Also, the transaction must be conducted through an SEC registered Funding Portal who serves as an escrow/transaction agent for the offering. And lastly, the Crowdfuding rules restrict how much someone may invest from all sources of their funds (personal and IRA). The amount that may be invested annually ranges from $2,000 to $100,000 per person and depends on the IRA owner’s annual income and/or Net Worth. This is an annual collective number for all Crowdfunding offerings and the IRA owner’s personal investments and their IRA investments are combined to reach the maximum limits.
  5. When Do You Need To Take Distributions? Most Crowdfunding offerings will restrict the investors from selling their interest for a certain period of time. Consequently, IRA investors in a Crowdfunding offerings need to plan for the long haul and should not invest into a Crowdfunding offering if they are planning or are required to take distributions from the sums being invested.
  6. Adequate Due Diligence. And last, but certainly not least, have you conducted adequate due diligence on the Crowdfunding offering? Do you understand how the company makes money (or plans to)? What are their operating expenses? What is the experience of the persons running the company? Do you understand the industry the company is in? Do the documents you received match up with what you have been told that peaked your interest in the offering?  I have previously prepared a due diligence top ten list that you can refer to here if you don’t know where to start.

Crowdfunding will become a significant investment option for self directed IRA owners. As a result, self directed IRA owners need to properly analyze the investment options for their IRA prior to executing investments.

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