Would it be a prohibited transaction if I only owned 25% of the entity???

Question:

I’ve just finished reading a 102 page pdf document which contained articles authored by you concerning Self-Directed IRAs.

I’m confused as to whether or not my particular circumstance would fall under the prohibited transaction category.

I’m employed by XYZ Company, a manager of commercial real estate assets.

XYZ Holdings is under contract to acquire a 50 unit student housing asset in Austin, TX for $4.65 million.  With closing costs and renovation costs, the total costs of the transaction are $5.0 million.  We are financing the acquisition with a $3.75 million loan from KeyBank, and raising the remaining $1.25 million through a friends and family private placement equity raise.

The loan from ABC Bank is an 18 month bridge loan which is full recourse to me and my partner.  However, once we implement some improvements to the asset and increase the net cash flow generated by the property, we will refinance into a non-recourse permanent loan.

As compensation for finding this transaction and sponsoring the deal, my partner and I will receive 25% of the ownership in the entity which owns the asset.  The equity investors who invest the $1.25 million of equity will receive the remaining 75% of ownership in the entity which owns the asset.

XYZ Management Company will manage the asset at some point in the future, but not initially.  I’m technically an employee of XYZ Management Company, but not an owner of XYZ Management Company.

I would like to invest an existing traditional IRA of mine, which has a balance of approximately $160,000, as a portion of the $1.25 million of required equity capital, thus giving me a limited partner position in the ownership entity, in addition to my sponsorship promote equity position.

Is the proposed IRA investment acceptable, or would this be considered a prohibited transaction?

Thank you for your assistance on this issue.

Answer:

Unfortunately, this would be a prohibited transaction.  You cannot use your IRA for your personal benefit now, and clearly having your IRA invest in a  project that you receive a 25% personal interest in would violate the rules.  The goal of the prohibited transaction rules overall is to make sure that transactions in your IRA are on an arms-length basis.  We would love to assist you with your self-directed IRA needs if you identify an investment that fits within the parameters of the law.  Good luck with your project, and have a great day!

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