Taxes and Risks of Investing an IRA in a Private Placement

by Leslie McClintock

With most kinds of tax-advantaged retirement accounts, such as 401(k) and 403(b) plans, the investor is limited to a relatively small menu of possible investments, typically consisting of mutual funds and annuities. With individual retirement arrangements (IRAs), however, the investor has a much broader array of investment opportunities to choose from, including individual stocks, bonds, real estate and private equity, subject to certain limits.

Prohibited Transactions

The IRS allows you to invest your IRA in anything you like, with the exception of certain specific prohibited transactions. Generally, you cannot invest your IRA proceeds in entities that you or a close family member controls, you cannot borrow money from your IRA, you cannot live in real estate your IRA purchases, and you cannot invest your IRA in collectibles, alcoholic beverages, art, gems, jewelry, or in some kinds of precious-metals or precious metal-related securities.

Private Placements

When a growing corporation needs to raise capital, but it is not publicly traded on a stock exchange, it has two options: borrow the money via bank financing or by issuing a bond, or issue more stock. If it doesn't want to borrow, and doesn't want to go public, the company may choose to do a private placement, soliciting capital from selected investors. IRAs can invest in private placements -- and even own whole companies intact, provided they do not engage in prohibited transactions.


There is a potential drawback to investing in private placements or in closely held companies which you,as the IRA account holder, do not control. If the company issues a cash dividend distribution, you must reinvest the distribution within the IRA. You cannot take the dividend in cash, or you will pay taxes and penalties on the distribution. For this reason, you will need to set up a corporation or LLC to hold your distributions, and open up a business checking account in the name of the corporation or LLC. This checking account will hold any accumulated dividends until you can profitably reinvest them, thus preventing a distribution problem.

Taxation of IRAs

The tax treatment of IRA accounts that contain private placement equity is the same as for other IRAs: Traditional IRAs grow tax deferred. No taxes are due on dividends or capital gains. Any withdrawals are taxed as ordinary income. Contributions may be tax deductible if the account holder meets specific income requirements. If the account holder does not meet the IRA requirements, he may make non-deductible contributions. The contribution limit is generally $5,000 per year. Those over age 50 can contribute $6,000 per year. Traditional IRA owners must begin taking taxable distributions by April 15th of the year after they turn age 70 1/2. Roth IRA account contributions are not tax deductible, but Roth accounts grow tax free, and no tax is due on income, provided the money has been in the account at least five years. A 10-percent penalty may apply to early withdrawals of earnings, in the case of Roth IRAs, and on the entire withdrawal for traditional IRAs, for account holders under age 59 1/2, except for certain withdrawals made under specific hardship conditions.

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