Your individual retirement account (IRA) can be a partner in a partnership. Usually, that partnership takes the form of limited partnerships.
You can invest in a business using your funds, which will combine with the money in your partners’ IRAs. When the company makes money, your share of the dividends will go into your IRA account. But you first need to ensure that the business partnership in question allows IRAs and conforms to federal and local rules on the issue.
What Is a Limited Partnership?
A limited partnership is a type of private business partnership where one or more general partners assume the majority of liability and control of the business. In contrast, other partners only assume limited liability relative to the investments they make. And in case more capital is needed, the company can bring in more limited partners.
Typically, there are no stocks or stockholders, and limited partners are not taxed at the business level. So, each limited partner will assume their share of business profit and losses and report them on their personal tax returns.
A master limited partnership (MLP) is a hybrid business partnership model that combines the features of limited partnerships and corporations. It differs from the standard limited partnership because it allows you to trade your ownership units on the national stock exchange.
Also, the business must receive at least 90 percent of its revenue from qualifying sources, such as real estate, exploration and oil and gas processing. You can find master limited partnerships lists online if you are interested in investing in existing businesses of such a nature.
Due to the tax advantages offered by limited partnerships, you need to ensure all of your activities are legally sound. Otherwise, you may end up participating in prohibited transactions, which lead to unrelated business income (UBI). That income, which stems from activities unrelated to tax-exempt businesses, may force you to pay taxes you did not anticipate.
Can a Self-Directed IRA Invest in a Partnership?
The self-directed IRA, which enables you to make all the investment decisions, provides the best way to invest in a partnership. Unlike Roth and traditional IRAs, it allows you to select a wider range of investments.
When investing in a limited partnership business, you can combine the funds in your self-directed IRA with funds in similar retirement accounts. These accounts could belong to your friends, spouse and even strangers.
Alternatively, you can co-invest with other retirement account types, such as a Roth IRA, solo 401(k), traditional IRA, etc. In addition, you can partner with your children’s or grandchildren’s self-directed Coverdell Education Savings Account (CESA).
Below are a few tips that can help you out:
- Learn about the tax laws within the locale you intend to invest in.
- If you intend to invest in a partnership, find trustworthy people with similar business interests.
- You must combine your self-directed IRAs to invest in a business.
- Ensure your funds have the right amount to give you the ownership percentage you desire.
- Always keep track of your share of expenses and profits because you must account for them.
- Upon selling a property, you will receive a share of the proceeds. Alternatively, if your business makes money, you can receive returns in the form of dividends.
Are Limited Partnership Distributions Taxed?
The taxes on your distributions depend on the kind of partnership your IRA becomes part of. Generally, the standard limited partnership model offers several tax benefits. But an MLP is usually taxed differently.
An MLP with a UBI of over $1,000 in an IRA is taxable. So, you may end up losing the tax-deferral advantages of an IRA.
That said, becoming a limited partner through an IRA offers several benefits. These include the following:
- As a limited partner, your IRA could get tax deductions if it’s eligible as a limited partner. These may include business equipment depreciation, interest payments on business loans, business expenses, etc.
- You will likely pay lower taxes because your dividends will be taxed at a lower rate since they are considered long-term capital gains.
- Your IRA will also get higher returns because the business it invests in must pay most of its dividends to shareholders to qualify for tax breaks.
Tips for IRA Tax Benefits
An IRA can be a partner in a partnership, and you can make lots of money doing it too. But to enjoy all the tax benefits of an IRA account while owning a business, you must ensure you follow all the IRS rules to the letter.
Don’t make prohibited transactions and keep your UBI under $1,000 if you are part of an MLP. And take advantage of a self-directed IRA limited partnership for its flexibility. You can consult a tax advisor for guidance if you don’t know much about the IRA tax and limited partnership rules.
- TheBalanceSMB: What Is a Limited Partnership?
- CFI: Master Limited Partnership
- IRS: Retirement Topics - Prohibited Transactions
- IRS: Unrelated Business Income Tax
- Trustec: 6 Ways to Partner Your Self-Directed IRA
- Trustec: Partnering to Purchase Real Estate with an IRA
- Profitable Venture: Can Limited Partnership Be Held in an IRA?
- Dividend: Master Limited Partnerships (MLPs), Taxes & Your IRA
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