Regular IRAs and Roth IRAs are generally not configured to allow investors to purchase hedge funds. IRA custodians often limit the options available to traditional investments, such as stocks, bonds and publicly traded funds, while allowing the purchase of certain annuities or savings account products. The answer generally depends on the facts and circumstances involved in the transaction. However, in general, there are ways in which a retirement fund investment can be properly structured in a hedge fund in which the holder of an IRA has some personal interest.
The main question to be asked and answered positively is if the IRS analyzed the transaction, could you argue that the owner of the IRA has personally benefited in any way directly or indirectly from investing in the IRA? Most funds will analyze the IRA holder's personal income or net worth to determine if the IRA can make the investment. Hedge funds don't offer IRAs on their own, and the owner of an IRA cannot make investments directly in hedge funds. In other words, an IRA can generally make an investment in a hedge fund in which neither the holder of the IRA nor any disqualified person has any personal property or relationship to it. The good news is that there are many self-directed IRA depositories that will allow you to use retirement funds to make these and other alternative investments.
Whereas, if a person bought a stake in a transfer entity, such as an LLC, with funds from an IRA and the LLC participated in an active operation or business, used a margin or acquired a debt, the income allocated to the IRA could be subject to the UBTI tax. If the depositary does not participate in hedge funds, the owner of the IRA must transfer the account to another custodian who does. Consequently, when it comes to using retirement funds to invest in a hedge fund with which the owner of an IRA has a personal relationship, issues such as management fee and accrued interest are elements that must be considered when structuring self-directed investment in IRA hedge funds. To begin with, the use of retirement funds cannot be invested in the GP entity, since it is the entity in which services are generally provided on behalf of the hedge fund and in which the management fee and accrued interest are usually used to invest IRA funds in a company in which the holder of the IRA is personally owned or provides services as an employee would likely violate the IRS's prohibited transaction rules.
The rules on prohibited transactions tend to become more of a problem when the person using IRA funds or any disqualified person related to the owner of the IRA has a personal interest or relationship with investing in the hedge fund. After examining the IRS's rules on prohibited transactions to determine if an IRA investment can be made in a hedge fund, another set of IRS rules should be reviewed to see if a tax would be imposed on income allocated to the IRA for investment in hedge funds. The key is to ensure that the IRA's investment in the hedge fund does not directly or indirectly benefit IRA owners, as that type of investment would likely result in a prohibited transaction. These include the IRA administrator himself, as well as the IRA owner's family members or business partners.
For example, if the only way Joe can attract investors to the fund is to demonstrate that he has also invested in the fund and that the only funds he had available to invest were IRA funds, the IRS could argue that using the funds from his IRA would benefit him personally, since without using the funds from his IRA he would not be able to attract investors to his fund and obtain personal financial return by owning the fund. If the owner of an IRA cannot demonstrate that he did not receive any direct or indirect personal benefit from the IRA's investment in the hedge fund, the IRS is likely to argue that the investment caused a prohibited transaction. .