Partnering with your Self-Directed IRA

Here is an article that our friends at New Direction IRA wrote for us a while back…

Many people don’t know that an IRA (or Roth, I-401k, HSA) can partner with other investors or, with care, the IRA holder.  There are several ways to do this, some easier than others.  The question frequently asked is “if an IRA holder cannot have a transaction with his/her IRA, how is it they can purchase an asset together, isn’t that co-mingling of funds?”  The answer to that question is that they can partner, each with their distinct and defined share of the investment.   Neither funds nor equity may not shift back and forth between the IRA and the IRA holder within the investment as that would be co-mingling and violate the rules.

Why do people partner?  Sometimes the IRA is not big enough to purchase an asset and wants to join other investors.  Sometimes an investment will be put together and structured to include IRAs as investors.   Most frequently we’ve seen partnering happening in real estate transactions and private lending by using self-directed IRAs.

The various partnering combinations seen are:

  1. IRA partners with arms length cash investor (easy)
  2. IRA partners with arms length IRA investor  (somewhat easy)
  3. IRA partners with close family member* cash  (more difficult)
  4. IRA partners with IRA holder (can be complicated)
  5. IRA partners with IRA of close family member (can be complicated)
  6. IRA partners with Roth IRA belonging to the same person  (the most difficult)

What are the important differences in these six combinations?  Combinations #1 and #2 are easier because they involve people or IRAs that belong to two unrelated people.

There is a lot of flexibility in #1 because the arms length cash investor can handle the funds of the partnership and does not have to worry about shifts in equity or money between him/her and the IRA.

In #2, since they are both IRAs, neither of the IRA holders can handle the funds of the asset and must use a third party.  Since IRAs have contribution limits, if the partnership runs out of money there may have trouble in the event of a cash shortfall and the IRAs may not rely on the IRA holders to bail them out.  The good news is that if one of the IRAs has sufficient cash, that cash can go in and bail out the investment without violating any rules.

Combinations #3, 4 and 5 are the same.  No partner can handle the money, no partner can pay the expenses of the other partner in the event of a cash shortfall and there can be absolutely no shift in the cash or equity balance between the partners.

What about #6?  Why is that so difficult?  Well, when you partner your traditional IRA with your Roth IRA, everything stated in the paragraph above applies plus, because the aggregate contribution to BOTH IRAs cannot exceed the current 2011 $5,000 limit.  You have less ability to contribute.  An additional burden placed on this partnership is that you may not always qualify for a Roth IRA because you make too much money.  In this case, as in all the combinations above, you must have earned income in order to make a contribution.  If you make only $5,000 for the tax year, your contribution may be only $5,000.

Other investments in which partnering works, and probably the easiset of all, are in private lending.  Without going into how these deals are structured it’s enough to say that “arms length” lending of money, either as a first or second deed of trust, can include all of the combinations described above in #1 through 6 without issue.

Here are some examples of partnered investments:

Example #1

Lloyd and Bruce each have a self-directed IRA and live next door to each other.  On their street is a property on the market and which they think is a good deal.  They don’t have cash individually but they have IRAs that can manage the purchase.  The IRAs turn it into a rental property and engage a property manager because neither Lloyd nor Bruce can handle the money.  They decide to do a cosmetic remodel at a cost of $12,000 and sell the property within the first two years.  Both Lloyd and Bruce are over 50 and therefore can contribute $6,000 each over a two year period thus having another $24,000 available for the remodel.

Example #2

The McCarthy family members have $200,000 collectively in their self-directed IRA accounts.  Although each of the four IRAs has only $50,000, together they are able to lend the money as a first deed of trust on the purchase of a rental property by an unrelated third party.  They negotiate the terms of the note; obtain title insurance, an appraisal, make sure the IRAs are shown as the mortgagees on the hazard insurance and hire an attorney to put together the note and deed of trust.  The borrower pays all of these expenses in addition to a 1 point origination fee.  Mortgage checks are sent directly to the self-directed IRA administrator and tracked using the clients’ on line statements.

In conclusion, consider the power of partnering IRA funds with other IRAs or individuals.  It can be done in real estate purchases with varying degrees of difficulty and done quite easily in private lending of all types.  There is no limit, from an IRS standpoint, on either the terms negotiated by the IRA for lending or the number of IRAs that can participate in an investment.  Consult with your tax and legal advisors when considering any investment in your IRA.  For information on the rules and for self-directed IRA services for this type of IRA investment, visit