Crowdfunding in Equity Investment - Tax Implications?

Question

I am told that when investing in crowdfunding equity investments, you are issued a K1 document at the end of the year for taxes.

What are the tax implications when investing with taxable money vs money from a SDIRA?

Are the returns considered income or dividend?

When the project is cashed out at the projected 5 -7 years (typical of most offerings), is that considered income, dividend or capital gains?

I would prefer to use my SDIRA but wanted to see if there would be argument to use taxable money.

Thanks

Brian Eastman · Answer

@Ronald Thompson

The issue is that a self directed IRA may be subject to UBIT taxation in an equity crowdfunding environment.

When a tax-exempt entity such as a retirement plan has an equity stake in a trade or business activity, and the business is a pass-through for tax purposes, then the tax-exempt entity is exposed to UBIT.  This trust tax paid by the IRA is meant to level the playing field so that tax-exempt entities do no drive taxpaying businesses out of business.

The implications of UBIT will vary depending on the situation and may or may not spoil the benefits of equity crowdfunding.

Generally speaking, if the operating income of the venture is the prize, then UBIT will diminish the returns to the point where making the investment with non-qualified funds will be the better option.

If the gain in value of the venture is the prize, i.e. in venture capital plays, then UBIT may not be much of a barrier.  There might be minimal operating income subject to UBIT, but the eventual payout when you sell your IRA's interest at a higher value than the initial purchase is not taxable.

Bottom line is that you need to speak with a CPA knowledgeable on these topics relative to the specifics of the investment you are considering.

As an aside, debt crowdfunding would generate passive income not subject to UBIT.

See IRS publication 598 for information on UBIT.

Jim Groves · Answer

Ron, for what it's worth I make debt investments with my SDIRA, which appears to be a popular option on the most popular debt crowdfunding platforms.  I wouldn't use it for equity crowdfunding because you may be missing out on some of the favorable tax treatment available for those types of investments (e.g. capital gains, depreciation).  Granted, everyone has a different situation and may not be able to enjoy those benefits, but in my situation I prefer to use taxable money for equity.