On Buying S-Corporations In Your Self-Directed IRA

October 9, 2017  --  Episode #283

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Will your self-directed IRA be guilty of a dreaded PROHIBITED TRANSACTION if it buys shares of an S-corporation?  Conventional wisdom – including many self-directed IRA custodians – say YES.  But the law doesn’t say that AT ALL.  What it ACTUALLY says may surprise you.  I’m Bryan Ellis.  This is Episode #283 of Self-Directed Investor Talk.



Hello, self-directed investor nation!  Happy Monday to each and every one of you all across the fruited plane!  I’m thrilled to have you here with me today!

Today’s show is brought to you by the Self-Directed Investor Society over at SelfDirected.org.  If you’re an affluent investor seeking powerful ways to deploy your capital into alternative assets – everything from real estate to Bitcoin to private companies to dairy cattle… yes… I said dairy cattle… then you’ll definitely want to check out the Self-Directed Investor Society over at SelfDirected.org.

Today, my friends, we do a bit of myth busting where self-directed IRA’s and s-corporations are concerned.  In fact, let’s bust it right now:  If you listen to this show with any frequency, you doubtlessly have heard me mention the thing that is, where your self-directed IRA is concerned, like kryptonite, a nuclear blast and a serious case of the black plague all rolled into one.

That thing is, of course, the prohibited transaction… an astoundingly effective way to make a simple, honest mistake and lose 50-100% of your IRA savings.

Well, there’s a wide belief out there that buying shares of an s-corporation in your self-directed IRA is just such a prohibited transaction.  And that, my friends, is false.  But the details on that are important.

Which is why I encourage you to take part in this discussion.  You can reach us by telephone toll-free at 833-SDI-TALK, by email at [email protected] or the best choice of all is to visit the s-corporations page over at selfdirected.org which is, of course, selfdirected.org/scorporation, SelfDirected.org/scorporation.

Ok folks, one thing we know is that the IRS seems to be quite OK with the notion of you buying shares of stock in your IRA.  Particularly the publicly traded variety.  That seems to be what they want you to do, actually.

That alone should give you pause.  But I digress.

Now those publicly traded corporations are what we call C-corporations.  That’s the normal, run-of-the-mill type of corporation.  The way that type of corporation works is when it makes a profit, the corporation first pays taxes on those profits, then distributes whatever is left to shareholders.  Those shareholders then pay taxes on the income again at the personal level.  If you’ve ever heard the term double taxation, that’s what it refers to:  The fact that money is taxed by the government TWICE before corporate shareholders get any of it.  Double taxation is a pretty brutal arrangement, frankly.

And that’s what the other type of corporation – the S-corporation – is designed to overcome.  The big tax difference between conventional C-corporations and S-corporations is that the S-variety totally eliminates the first level of taxes.  So whereas with C-corps, profits are taxed before being distributed, with an S-corporation, that part is eliminated entirely, so that the only taxes being paid are those paid at the individual level by the shareholders.

S-corporations use single-taxation, C-corporations use double taxation.  That’s the deal.

It’s quite a great thing for corporations that can operate that way… big tax savings are definitely possible using that structure.

So why don’t all corporations do that?  The reasons is simple:  The law prohibits it.  There are some requirements like:  The corporation can’t have more than about 100 shareholders.  That alone eliminates consideration for being publicly traded.  The corporation can only have one class of stock.  That eliminates any creative or complex corporate structuring.  There are some other restrictions as well, but the one restriction that matters to us in a big way right now is this one:

By and large, owners of s-corporations must be individuals or estates of individuals.  For you tax wonks out there, I know that the limitations isn’t quite that narrow, but the exceptions aren’t relevant to the discussion right now.

So here’s the question to task yourself:  Is your self-directed IRA or solo 401(k) an individual or an estate of an individual?  Well, no, it’s not.  And that’s why your IRA can’t own shares of an s-corporation.

But that doesn’t mean that doing so is a prohibited transaction which will blow up your IRA.  Nope.  Those kinds of prohibited transactions are defined in the Internal Revenue Code section 4975… that’s stuff like buying from or selling to your own IRA, or doing deals with family members or with your IRA company or anything that could look, smell or sound like a potential conflict of interest.  Those are the sorts of things that set off a nuclear blast in  your IRA, from which there is no recovery.

But buying an S-corp in your IRA?  Serious… but not that serious.  The real price of that action is likely to be that the s-corporation you buy in your IRA will lose its tax-favored S-status.  Bottom line:  The corporation will revert back to double-taxation from single-taxation.

That’s a big deal for two reasons.  First, the distributions made by the corporation to your IRA will inherently be smaller, because they’ll be subject to taxes beforehand.  But maybe even more importantly:  You will have screwed up everybody else who owns shares of that S-corporation, because the S-status is corporation-wide and not an individual issue.  So by buying those shares in your IRA, you’re going to cause EVERYBODY ELSE who owns an s-corporation to take a big hit.

And that is the danger of buying an s-corporation in your IRA.  The good news?  It’s NOT a prohibited transaction in the sense of IRC 4975.  It’s not going to result in the kind of penalties, interest and taxes that will eliminate 50-100% of your IRA’s value.

But still… just don’t do it, ok?  That’s a very good operating principle.

Hey, check out my free ebook on the critical topic of prohibited transactions over on today’s show page at SelfDirected.org/scorporations… there you’ll also find a link to download a free copy of my ebook The Definitive Guide to Self-Directed IRA’s.  Check them out, and enjoy!

My friends, invest wisely today, and live well forever!


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Bryan Ellis

I am host of Self Directed Investor Talk, which I'm told is America's #1 podcast and for affluent self-directed investors. I'm also something of an expert in self-directed IRA's, solo 401k's and 1031 exchanges. You can find more of my writing in some cool places like TheStreet.com, Entrepreneur.com, ThinkRealty and even Forbes (that was always one of my goals!). I live in metro Atlanta, Georgia with my wife and business partner Carole Ellis(she's a real business partner... not just because she's my wife... I'd want to work with her if I wasn't married to her... and I'd want to marry her, too). I also have 4 children ranging in age from 2 to 20 (yes, you read that correctly). It's my goal to be the name everybody thinks of when they think of Self-Directed IRA's and Solo 401(k)'s.