If you are receiving a fee for assisting someone else’s company in raising money, then you must operate within the confines of securities laws. These laws provide three different ways in which one may legally raise money for another company for a fee. You can’t get a “commission” or “bonus” or anything of value for bringing an investor to another company or person unless you fit into one of these three categories:
Broker Dealer License
First, if you are licensed and are registered with an SEC registered broker dealer, you may receive commissions and other forms of compensation for raising money in public or private offerings (e.g. private placements). The newest form of registration from FINRA is designed to license and regulate those who operate as “investment bankers,” called a “Series 79 license.” This license allows a holder to collect commissions and other fees for raising funds for an offering of equity (e.g. stock) or debt (e.g. notes or bonds). In addition to passing the licensing test, you’ll need to associate with a broker dealer.
Second, if you take a limited role in the raising of funds and are paid a flat or hourly fee, as opposed to commissions based on funds raised, you may be able to be paid a finder’s fee for introducing investors to others. A finder’s fee can only be paid to a finder so long as:
- The finder isn’t involved in negotiations of the securities being sold.
- The finder doesn’t discuss the details of the securities.
- The finder isn’t paid based on money raised (e.g. no commission).
- The finder doesn’t perform “finding” services on a regular basis.
In sum, a finder’s fee may be paid but only to someone who makes introductions of potential investors, and the fee amount must be based on some factor other than compensation relating the persons or amount of securities sold to those introduced by the finder.
Director or Officer of Offering Company
Third, you may be able to assist in raising funds for another if you are an Officer or Director of the company whom you are raising money for. The SEC promulgated Rule 3a4-1 which is a Safe Harbor from enforcement and allows someone who serves as a paid Director or Officer to assist in selling the company’s securities. There are many ways to qualify under this Rule but the most common is to meet the following criteria:
- Be paid as a Director or Officer by salary or other criteria that is not linked to sales of securities made (e.g. be the CFO or Treasurer and offer financial consulting advice in addition to working with potential investors).
- Can’t be associated with a Broker Dealer and cannot have a prior SEC disciplinary history.
- Should stay on with the company following closing of the offering so as to show your purpose as a Director or Officer was not just for raising funds.
- Takes a passive and restrictive role in selling the securities and refers to the CEO or President for details and negotiations.
Failure to comply with the securities laws can result in civil and criminal action. In addition, investors who can claim a failure to comply with the laws outlined above are able to rescind their investment and can subject the company’s founders and the person soliciting the investment with personal liability for any losses.
When it comes to transferring property, such as rental properties into LLCs or your personal residence into a Trust, it can be confusing understanding whether you should use a quitclaim deed or a warranty deed. Here is a brief description of each type of deed and when they should be used.
Warranty Deed – A warranty deed transfers ownership and explicitly promises the buyer that the transferor has clear title to the property, meaning it is free of liens or claims of ownership. The terms of a warranty deed should state that the transferor “warrants” and conveys the property. The warranty deed may make other promises as well, to address particular problems with the transaction. But generally, the use of the word “warrant” means that seller/transferor guarantees the new owner as to clear title. Because the seller “warrants” clear title under a warranty deed, it is a preferred method of title transfer and should be used by real estate investors and property owners as the default method of transferring title. When transferring title from your own name to your LLC or Trust, the use of a warranty deed typically allows the title insurance you bought when you acquired the property to remain in effect.
Quitclaim Deed – A quitclaim deed transfers whatever ownership interest a person has in a property. It makes no guarantees about the extent of the person’s interest. If you are buying a property from a third-party, you would never want to use a quitclaim deed because they aren’t making any guarantee as to whether they own it or not, or if they have clear title. It would be like paying someone on the street for a set of keys to a car. Who knows whether they own the car or not? You gave them money for it, and if they do own it, you just bought it. But, if they don’t own it, then you’re out of luck and you’ll have to resolve the ownership issue with the person who legally owns it. There are limited situations where a quitclaim deed is used. In some instances, a quitclaim deed is used when the buyer and seller are aware of legal issues or defects to title, so the seller transfers their interest and the new buyer has to resolve the title issues. Another situation, perhaps more common, arises in states that have a transfer tax. For example, some states will exempt transfer taxes on the transfer of title from the owner to their own LLC, but only if it is by quitclaim deed (e.g. Tennessee). When transferring title to your own LLC, we generally aren’t worried about title issues, so the savings on transfer taxes make the quitclaim deed a better option.
Most states don’t have a transfer tax, but to make matters more complicated, some states use the term “grant deed”, California being one of the most prominent. The reality is that a grant deed can be used as a quitclaim deed OR a warranty deed. It essentially depends on the verbiage used inside the terms of the deed itself. If you see words like “warrant” and “convey,” then you probably have a warranty deed. Bottom line: Make sure that you look at the language used in the deed itself. Don’t think that because you have a grant deed you have all of the benefits of a warranty deed.
Our Recommendation – Always double check the local state and county laws regarding the type of deed to use when transferring property, and what the different types of deeds actually provide. HOWEVER, as a general rule of thumb, we recommend the warranty deed when transferring property to yourself, your trust, or your own company because we want to make sure that the Title Policy and all of its benefits transfer to the Grantee of your deed.
The Retirement Improvements and Savings Enhancements Act (“RISE Act“) has drastic changes and provisions that effect self-directed IRA investors. From mandatory third-party valuations on all retirement account investment transactions to changing the 50% disqualified company rule to 10%, the bill has some significant changes that will negatively affect your ability to self-direct your account. There are some favorable provisions for IRA owners, however, the negatives greatly outweigh the positives.
Most Important Provisions
The bill sponsor is Sen. Ron Wyden (D-OR) who is the Ranking Member of the Senate Finance Committee and the Joint Committee on Taxation. Here’s a quick run-down of the most troublesome provisions that apply to self-directed IRA investors:
- Valuation Purchase/Sale Requirement. Mandatory Valuation Requirement for Private IRA (non-public stock market) Transactions: The new proposal seeks to require gifting valuation rules and standards for IRA transactions. This rule will force IRA owners to get a valuation before making any private investment. This valuation would include real estate, private company (e.g. LLC, LP, corporation), and note investments. The gifting valuation rules were created to value gifts where no value is set between a buyer and seller. mandating those same rules on actual transactions between an IRA and another unrelated party is unrealistic and unnecessary to establish actual fair market value.
- 50% Rule is Reduced to a New 10% Rule: Changes the 50% rule that states a company is a disqualified person to an IRA when it is owned 50% or more by disqualified persons (e.g. IRA owner and certain family). The new rule makes a company disqualified when owned 10% or more by disqualified persons.
- Roth IRAs Capped at $5M: Roth IRAs will be capped at $5M. Any amount over $5M must be distributed from the Roth IRA.
- Eliminate Roth Conversions: Traditional IRA funds cannot be converted to Roth IRA funds. Roth IRAs will be allowed only if the account owner makes initial Roth IRA contributions and only when they meet the Roth IRA contribution limits, which restricts high-income earners.
- Require RMD for Roth IRAs: Roth IRAs are currently not subject to required minimum distribution (“RMD”) rules because the amounts distributed do not result in tax. This rule will change and RMD will apply to Roth IRAs when the account holder reaches age 70 ½.
These proposals will have drastic impacts on self-directed IRA investors. The valuation requirement is perhaps the most dramatic as it will require valuations before an IRA can buy an asset and before it can sell an asset. Not only will this cause administrative issues and increased costs, but it will undoubtedly replace the ability of an IRA buyer or an IRA seller from transacting their IRA at the price and value they determine to represent the actual current fair market value of their investments.
I have written a detailed analysis of the bill which I plan to share with the Senate Finance Committee and the Joint Committee on Taxation. I welcome your input as a self-directed IRA investor and plan to advocate for common-sense rules that help self-directed investors take control of their retirement. My draft bill analysis can be accessed at the link below. Please send your comments to firstname.lastname@example.org.
The prohibited transaction rules applicable to self directed IRAs prohibit not what your IRA can invest into but WHO your IRA may engage in a transaction with. For example, the prohibited transaction rules restrict my IRA from buying a rental property from my father. This is not because rental properties are prohibited to my IRA but because my father is prohibited by law from transaction with my IRA. My self directed IRA could buy a rental property from a third party seller whom I have no family or other business relationship with since there is nothing wrong in buying the rental property the question is just who am I buying it from. Congress decided to restrict investments with certain persons who could potentially collude with the IRA owner to unfairly avoid taxes. As a result, transactions with certain family members and business partners of an IRA owner are prohibited. The consequence for engaging in a prohibited transaction can be drastic (e.g. no longer have an IRA, penalties and taxes on distribution) so IRA owners must avoid them in all situations.
The prohibited transaction rules therefore provide the greatest restriction on using self directed IRA funds and must be understood by self directed IRA investors. These rules are found in IRC 4975 and state that a prohibited transaction occurs when an IRA engages in a transaction (e.g. buy, sell) with a disqualified person. The question immediately arises, who is a disqualified person to my IRA?
Categories of Persons Disqualified to Your SDIRA
There are essentially four categories of disqualified persons to your IRA and they are as follows.
- IRA Owner. The IRA owner is disqualified to his/her own IRA as the fiduciary making decisions for the account. IRC 4975(e)(2)(A), Harris v. Commissioner, 76 T.C.M. 748 (U.S. Tax Ct. 1994).
- Certain Family Members. Disqualified family members include the IRA owner’s spouse, children, spouses of children, grandchildren and their spouses, and the IRA owner’s parents and grandparents. Family member who are NOT disqualified persons are siblings (e.g. brothers and sisters), aunts and uncles, cousins, nieces and nephews, and parent in-laws (e.g. spouses parents). IRC 4975 (e)(2)(F), IRC 4975 (e)(6).
- Company Owned 50% or More by IRA Owner or Certain Family Members. Any Company that is owned 50% or more by the IRA Owner or Certain Family Members outlined above are disqualified to the IRA. For example, an LLC owned 30% by the IRA owner, 30% by the IRA owner’s spouse, and 40% by an un-related partner is a disqualified company to the IRA (owned 50% or more by disqualified persons) and any transaction between the IRA and the company would be a prohibited transaction. IRC 4975 (e)(2)(G).
- Key Persons in Company Owned 50% or More by IRA Owner or Certain Family Members. Any person who is a 10% or more owner of a company owned 50% or more by disqualified persons (e.g. number 3 above) or any person who is an officer, director, or manager of a disqualified company (owned 50% or more by disqualified persons) is also disqualified. For example, if my wife and I own 60% of a company and if Julie is an officer of that company then Julies is a disqualified person to my IRA. Additionally, if Julie was a 15% or more owner of the company she would also be prohibited to my IRA.
When you are dealing with unrelated persons (not related as family or as business partners) the prohibited transaction rules do not need to be analyzed but once family members or business partners are involved in any part of the transaction, the IRA owner must ensure that the prohibited transaction rules are not being violated.