Five Partnering Strategies to Help Your IRA Funds Go Farther
Estimated reading time: 7 minutes
There’s no greater feeling than when a promising investment opportunity comes your way. However, many self-directed IRA (SDIRA) holders often find alternative assets such as real estate or private equity that are just outside of their price range.
Thankfully, there’s an investment strategy that not only boosts your buying power but has the potential to mitigate risk as well: partnering.
Partnering your SDIRA allows you to leverage your existing funds by investing with others. If you choose to partner, you’ll be able to join forces to create a larger pool of financial resources. Many investors use partnering to purchase real estate investments, though this strategy can be used to fund any IRA-qualified investment.
Partnering allows investors to pool resources and purchase investments that might be outside their budget alone.
Your SDIRA can partner with anyone, even disqualified persons, on a new transaction. However, once you begin the partnership, you must avoid any prohibited transactions with disqualified persons.
You can partner your SDIRA with other IRAs, non-IRA funds, or even a mixture of the two.
Why Do Investors Partner Their SDIRA?
Partnering can be an invaluable strategy. It allows investors to take advantage of their collective purchasing power and meet minimum investment limits often found in private equity investments.
Some gather family or friends to pool resources to invest in an expensive property. Others partner not due to a lack of funds, but to mitigate risk, or to bring other valued perspectives into a project.
How Do I Partner an SDIRA?
You can partner your SDIRA funds with anyone on a new transaction. You can partner your SDIRA with your spouse’s IRA, your parent’s retirement funds, or your child’s accounts. You can even partner your SDIRA with your own non-retirement funds. And of course, you can partner with friends or anyone else you want to invest with.
One question that often comes up when considering partnering with a spouse or family member is the issue of partnering with a disqualified person.
You can partner your IRA with a disqualified person in order to purchase an investment property because the purchase is a new transaction. You can even partner your funds again later to purchase a different property as this second purchase would constitute a new transaction.
That said, once you begin your partnership, you must avoid any prohibited transactions with disqualified persons.
Developing a complete understanding of how to partner your SDIRA can open a host of investment options and allow you to grow your retirement portfolio in exciting ways.
Five Strategies for Partnering Your SDIRA
1. Partner Your SDIRA With Another IRA
Partnering your funds with someone else’s IRA is a popular partnering strategy. You can partner with another SDIRA or a traditional IRA at a brokerage.
2. Partner Your SDIRA With Non-IRA Funds
You have the option to partner your SDIRA with non-IRA funds. This can be another retirement account you own, cash, or even someone else’s non-IRA funds.
3. Partner Your SDIRA With a Mixture of IRA and Non-IRA Funds
Because you can partner your SDIRA with another IRA and non-IRA funds at the same time, partnering is the ultimate flexible investment strategy to leverage your retirement funds. Here is an example:
You can partner $200,000 from your SDIRA, $50,000 from your personal funds, and $120,000 from your spouse’s SDIRA. Instead of only being able to invest $200,000 in a new asset, your partnering strategy allows you to purchase a higher-price investment for $370,000.
This strategy leverages everyone’s investment and provides each partner with greater investment opportunities. While there may be practical limitations to having lots of partners, you are not limited to two funding sources when you partner your SDIRA.
4. Partner With a Lender to Leverage Your SDIRA
Sometimes you may not have another set of funds to partner with, but you still want to invest your SDIRA in an expensive investment like real estate. In this case, you can partner with a lender.
In this scenario, your SDIRA makes the down payment on a property, and your SDIRA partners with a lender who uses a non-recourse loan to finance the balance of the property.
Unlike a traditional mortgage, a non-recourse loan is not secured by the SDIRA holders’ credit. Instead, the loan is secured only by the asset the loan finances. It is named a non-recourse loan because the lender has no other recourse or ability to seize other assets if the borrower defaults on payments.
In this partnering strategy, the loan is made to the IRA rather than the IRA holder. Thus, the lender can seize only the collateral (the property), not the funds held in the IRA itself. It is also important to remember that this type of loan must be repaid through the IRA.
5. Use an LLC to Partner Your SDIRA With Other Sources of Funds
When you partner two or more funding sources, a partnership is created. This type of partnership does not require any business filings, but it does create a partnership structure for the investment.
Some people choose to use a multi-member LLC to structure their partnering agreement. This structure allows you to create an operating agreement clearly outlining each partner’s ownership percentage.
Creating a multi-member LLC can also have benefits for partners because it can provide asset protection. An LLC also makes it easy to break up the ownership and cash flow by percentage. When the LLC is dissolved, the profits are then divided proportionally by ownership to the SDIRA and the accounts it was partnered with.
Three Things to Remember When Partnering your SDIRA
1. Partnering Does Not Combine Partnered Funds Into a Single Account or IRA
When you partner funds, you do not combine accounts. When your SDIRA is partnered with your spouse’s IRA, the accounts remain individually-owned IRAs and the funds are not commingled. The amount each partner contributes determines the percentage of ownership.
2. Partnering Requires Proportional Allocation of Expenses and Income
One important thing to remember is that each partner owns a certain percentage of the investment. This ownership percentage determines how the proceeds and expenses for the investment are allocated.
You might see the idea of dividing funds based on a proportionate allocation of the ownership called pro rata. This is simply the Latin term for proportional allocation.
In this arrangement, each partner’s account pays expenses for the asset in proportion to their ownership. By the same token, each partner’s account receives income or distributions proportional to their owners as well.
Here’s an example of how proportionate allocation works for both expenses and income:
You partner your SDIRA with your sister’s SDIRA to purchase a $200,000 investment property. Your SDIRA contributes $120,000, so it constitutes 60% ownership. Your sister’s SDIRA contributes $80,000, so it constitutes 40% ownership.
Because funds must be divided pro rata, when property taxes of $1000 come due on the property, your SDIRA will pay $600 (60%) and your sister’s SDIRA will pay $400 (40%). When rental income comes in, your SDIRA will receive 60% of the rental income, and your sister’s SDIRA will receive 40% of the rental income.
It’s always important to remember to keep enough in your accounts to pay expenses based on the proportional allocation of your ownership. All repairs, improvements, and other expenses must be paid out of the partnered SDIRAs.
3. Partnering May Have Tax Implications
Whether you use a multi-member LLC or not to structure your partnering agreement, you will need to file a partnership tax return. SDIRAs do not owe taxes, but if you are partnered with a non-IRA funding source, the partner may owe taxes.
Even if you are only partnered with another SDIRA and your SDIRAs do not owe taxes, when the IRS sees the investment, they may not know you are using an SDIRA. Filing a partnership return helps you keep the IRS informed and can help avoid penalties.
Partnering Your SDIRA Can Leverage Alternative Investments
The world of alternative assets is full of possibilities. An SDIRA opens the door to investments outside of traditional options such as stocks, bonds, and mutual funds.
Thanks to partnering, you are not limited by the funds available in your SDIRA. Partnering opens up tax-advantaged opportunities to leverage your retirement portfolio in new and exciting ways.
As always, when self-directing your account, it is important to do your due diligence. Make sure you carefully vet anyone you choose to partner your SDIRA with. It is often a good idea to speak with your legal and financial advisors to ensure you are making an informed, responsible choice.
Create a strategy to help your retirement investments go farther with partnering, and experience the power of investing your way. If you already have an Entrust SDIRA, check out our partnering page to learn more strategies and discover how to start partnering your funds.
If you don't have an SDIRA yet, download our account guide to discover the different account types Entrust offers.