In the case of some of the more popular Self-Directed IRA investments, such as private equity, hedge funds, venture capital, real estate, private placements, and private stock, being an accredited investor or qualified purchaser may determine whether your Self-Directed IRA would be permitted to invest in the deal. This article will explore how the qualified purchase and accredited investor rules work and then apply how those rules could impact the type of investments that an investor could potentially make with a Self-Directed IRA.
Who is a Qualified Purchaser?
In general, certain investments will require an investor to either be a qualified purchaser or an accredited investor. For example, an investor who satisfies the qualified purchaser or accredited investor rules would be able to invest in certain investments that are not registered with the SEC. These rules are aimed to protect investors from more sophisticated and illiquid investments into non-publicly traded securities, such as an interest in a private equity fund not listed on a public exchange.
A qualified purchaser is basically a person or a family business that holds investments with a value exceeding $5 million. However, the investments that go towards determining the $5 million value cannot include a primary residence, nor property used in the normal conduct of business. Moreover, it is common for an individual or entity who is a qualified purchaser to hold $25 million or more in assets under the qualified purchaser exemption rules. Additionally, a trust can also be a qualified purchaser status if it has assets with a value of $5 million or more and is owned by at least two close members of a familial unit.
The Benefit of Being a Qualified Purchaser
Under the 1940 Investment Company Act, privately held corporations or trusts engaged in the business of pooling capital from investor in securities. The primary advantage of of marketing a fund only to qualified purchasers is that the fund would be exempt from regulation under the “40 Act.” Hence, any investment company that are solely targeting qualified purchaser investors would be exempt from tedious regulation under the 40 Act.
Qualified Purchasers and The Investment Company Act of 1940
Privately held capital firms are considered investment companies under the 1940 Investment Company Act (“the ‘40 Act”) rules when they seek to raise capital from the public where qualified purchasers are not the only owners of their outstanding securities.
The ‘40 Act considers qualified purchasers to be those who meet the criteria outlined above. This, in turn, means funds selling only to qualified purchasers are exempt from regulation under the ’40 Act. In other words, investment companies are not required to observe certain SEC requirements when they choose to work exclusively with qualified purchasers. Thus, the primary advantage of being a qualified purchaser is one would have the ability to invest in a diverse and wide range of investments that are far broader than those investments available to accredited investors.
What is an Accredited Investor?
Under Rule 501(a) of the Securities Act of 1933, an accredited investor is one who has a net worth exceeding $1 million dollars, individually or jointly as a married couple. The $1 million amount excludes one’s primary residence. Additionally, one can satisfy the accredited investor rules if one has earned at least $200,000 ($300,000 if married filing jointly) in income for two consecutive years immediately prior to the year in question where accreditation is sought. Additionally, an individual can be deemed an accredited investor by having a FINRA Series 7, Series 65, or Series 82 financial securities license
The primary benefit of satisfying the accredited investor rules is that one can invest in most investment funds and private placements. That is because funds that are offering for sale unregistered securities, such as private equity funds, private placements, real estate funds, are allowed to sell only to accredited investors, who according to the SEC are in a better financial position to handle the risk associated with a non-publicly traded investment.
Read More: Can My Self-Directed IRA be an Accredited Investor?
Interplay Between Qualified Purchaser & Accredited Investor Rules
In general, all qualified purchasers will satisfy the accredited investor rules, but not all accredited investors will satisfy the qualified purchaser rules. The reason is because a qualified purchaser must have at least $5 million in net worth, excluding a primary residence, which is higher than the $1million threshold for an accredited investor. Furthermore, being a qualified purchaser will offer an investor even greater investment optionality than an accredited investor. For example, certain large and highly successful investment funds will only allow qualifying purchaser investors and will not open the fund to accredited investors.
Self-Directed IRA & Qualified Purchasers/Accredited Investors
Since an IRA is a retirement account and not a natural person, the SEC will look to the IRA owner to determine whether the IRA can make the investment in satisfaction of the qualified purchaser or accredited investor rules. In other words, the IRA itself does not have to have over $1 million in assets to be deemed an accredited investor or over $5million to be a qualified purchaser. The IRA owner would be the one responsible for satisfying the net worth test or the annual income requirement.
Making a Self-Directed IRA Investment as a Qualified Purchaser/Accredited Investor
Now that you hopefully understand the rules and requirements involving in determining whether you are a qualified purchaser or accredited investor, it is important to identify whether the IRA investment into a fund or private placement could be subject to tax.
In general, when it comes to using a Self-Directed IRA to make investments, in almost all cases, all income and gains would be exempt from federal income tax. This is because an IRA is exempt from tax pursuant to Internal Revenue Code Section 408. Furthermore, IRC 512 exempts most forms of investment income generated by an IRA from taxation. Some examples of exempt types of income include interest from loans, dividends, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate.
However, a tax known as the unrelated business taxable income (UBTI) tax can, in limited circumstances, trigger up to a 37% income tax on an IRA in the following limited investment scenarios:
- Income from the operations of an active trade or business – i.e. a restaurant, gas station, store, etc.
- Business income generated via a passthrough entity, such as an LLC or partnership.
- Using a nonrecourse loan to purchase a property (in the case of an IRA)
- Using margin on a stock purchase
In the case of an accredited investor or qualified purchaser making a Self-Directed IRA investment into an investment fund, if the fund will be using leverage or investing in businesses operating via a passthrough entity, such as an LLC, the income from the fund could be subject to the UBTI tax when allocated to the IRA investor.
The IRA Financial Qualified Purchaser/Accredited Investor Difference
IRA Financial “literally” wrote the book on the Self-Directed IRA. Our founder, Adam Bergman, Esq, has written 8 books on self-directed retirement plans and over the last 15+ years has helped over 24,000 clients invest over $3.2 billion in alternative assets.
IRA Financial is one of the only Self-Directed IRA providers that can help a qualified purchaser or accredited investor navigate the UBTI rules and customize the investment in the most tax efficient manner, whether it involves using a C Corporation blocker, foreign blocker corporation, re-structuring the investment, or applying various tax optimization strategies, IRA Financial is the leading provider for sophisticated qualified purchaser or accredited investors seeking to make a Self-Directed IRA investment.
