Tuesday, February 28, 2012

Disqualified Entrepreneurship

My company is headquartered downtown in a largely depressed, somewhat industrial, Midwestern small city. According to Sperling's Best Places, Racine has a population of about 81,000, a median home price of $122,100, unemployment of 14.1%, and a cost of living about 11% below the US average. When my wife and I decided to relocate our family out of the Los Angeles area (neither of us were California natives), we had three main criteria in mind:
  1. Affordability (we were tired of renting again, after having owned a house in Denver, then a condo in Santa Barbara, but not about to buy into the overpriced Southern California housing market).
  2. Family (my family is scattered to the winds, but my inlaws are concentrated within a couple hours of here).
  3. Water (we learned to sail when we lived in Santa Barbara; my office is adorned with pictures of beautiful sailboats as inspiration for the boat we plan to own someday).
Racine fit the bill. Housing is still depressed here. The value of our home (purchased in 2008) has dropped about 6% since we bought it, putting us about where we started in terms of equity. But then, it's a place to live not an investment, and it satisfies that requirement.

About three years ago, we bought a small building downtown (four blocks from Lake Michigan) as the company was expanding beyond me and a part-time assistant. The downtown area is perhaps half vacant. So much real estate on the market. I see these buildings and all the potential they represent. I think of all the businesses that could fill them.

I've started getting interested in alternative investments. I'd far rather invest in a business that I am committed to building, than buy some miniscule share of a public company, where the value of my investment is driven more by perception than by anything else. But the odd thing about tax regulations, and the focus of virtually all government incentives for building and growing companies is that they preference investment in someone else's business but not your own.

While the IRS allows an endless variety of investments to be held in one's retirement accounts, there is this unbending rule regarding disqualification, which prohibits a party from transacting with themselves. As Pensco's Top 50 Questions & Answers explains:
Generally speaking, it takes three elements to create a prohibited transaction for an IRA:
  1. the IRA;
  2. a disqualified person in relation to an IRA (e.g., the owner or owner’s spouse, ascendants, descendants, etc.)
  3. a transaction between 1 and 2 above.
As I read it, that means, it's okay to invest in someone else's business, but not your own. Now, granted, it does appear there are convoluted ways to invest in a startup, or an existing company that you are a minority owner of, but as far as I can tell, the rules that prohibit self-transacting prevent such a business from being one's source of income.

In other words, if your IRA owns the company, you can't get paid by it. What's more, it would be forbidden for my IRA to buy a building that a business I own would rent, or for me to personally own a building that a business my IRA owns would rent. What an odd way to hinder entrepreneurship. Sure, your investment can grow in your retirement savings. But some of us still need to pay our bills today.

I look longingly at these vacant buildings, and glancingly at my retirement savings, invested in small stakes of large companies that I have little connection to, and I wonder just how much more I could accomplish, if I could take my own funds to invest in expanding my firm, or starting a new one.

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