Non-Wealthy IRA Savers Who Invested IRAs Into Small Business, Startups and Real Estate LLCs Targeted in 'Build Back Better' Plan The $3.5 trillion reconciliation package pending in Congress contains two sections that will affect anyone already invested in these assets.

The proposed $3.5 trillion budget-reconciliation package still working its way through Congress contains two provisions that will restrict IRA investments into startups, small business, and real estate LLCs. These provisions came as a surprise to the over one million IRA investors who already invest a portion of their IRA into these non-publicly traded assets. The problematic sections, 138312 and 138314, change more than 40 years of IRA laws and practice, which have allowed IRAs to invest into publicly traded companies as well as privately held small businesses, LLCs, real estate and startups.

The two problematic sections are not to be confused with IRA provisions in the bill that are targeting large accounts and high-income earners. These targeted provisions include a $10 million cap on total retirement account balances as well as sections that close out the so-called "back door Roth IRA" for high-income earners. Those sections seem intentionally targeted and will land on what Speaker of the House Nancy Pelosi has called the "wealthy few".

Related: How a Company's Relationship With Its Accounting Firm Changes as It Grows

The bill targets investment choice instead of account size or income level

Sections 138312 and 138314 do not target the "wealthy few," and instead will affect hundreds of thousands of working Americans and retirees who choose to invest a portion of their IRA accounts off Wall Street.

Scott Mackes of Mt. Pleasant, SC, is a military veteran who is now self-employed. Scott has invested his IRA into startups and real estate projects that are led by other military veterans. But under the proposed provisions, IRA accounts like Scott's will no longer be able to invest in these opportunities. What's worse, Scott will also be forced to distribute the existing investments he made from his IRA within two years and will be subject to taxes and early withdrawal penalties. Scott says these IRA provisions are "devastating" to him and his IRA and to those raising capital from IRAs for small businesses, startups and real estate projects.

Section 138312 of the bill states that an IRA cannot invest into any asset where the income or net worth of the IRA owner are a qualification to invest. Under federal and state securities laws, most non-publicly traded assets require the small business, private fund or startup raising capital to consider the income or net worth of the investor before allowing them to invest. If these provisions are passed, the small business or startup that complies with the securities laws in raising capital, which are designed to protect investors, won't be able to accept IRAs as investors. That seems like an odd policy proposition, as an IRA is closed out from investing in a private asset when that company has complied with securities-law requirements. Shouldn't the policy by the other way around, i.e. if a company raising capital doesn't comply with securities laws, then IRAs cannot invest?

IRA savers feel like they're being penalized for being responsible

Retired NYPD detective Jannette La Sota grew her retirement savings over a 25-year law enforcement career. She previously used financial advisors, but became tired of poor performance and high advisory fees. She now manages her own accounts investments and chooses to invest a portion of those funds in real estate and crowdfunding offerings. In a letter to her Congressman and Senators, she said that the IRA provisions in the bill will "penalize me, and people like me, by taking away the very tools needed to secure our retirement. My life has improved greatly with these investments in my portfolio, and now [Congress] wants to punish me for putting in the time and education to go from inexperienced to sophisticated investor. The money I saved in this plan, and the ability to decide how to invest and use it, is crucial to my ability to care for myself as I age."

Jannette's frustration is one that is common amongst IRA investors that will be affected by this bill, as they have typically spent decades building their account and have been intimately involved in selecting and managing their IRAs investments into non-publicly traded assets.

Investments into small biz and real estate benefit local investors and communities

Many IRA investors choose real estate, small business and startup investments as they want their investments to not only do well but to also benefit their community. Jennifer Grace is a loan-signing agent and notary in Sacramento, CA. Jennifer is concerned about the IRA provisions in the bill. "When I have used my retirement funds to invest in stock or companies that I don't have a connection with, I have lost money," she explains. "When I began investing in single-family homes and local companies that improve neighborhoods, I am supporting my community."

John Kilpatrick of Issaquah, WA, is a retired finance professor and university administrator who still works as a self-employed financial economist and as a visiting professor at Washington State University. John says he invests his IRA into "workforce housing, to provide clean, safe affordable housing for hardworking Americans." These are "fixer-upper" properties, and John says that he likes investing his IRA this way as he feels that he and his IRA are "doing well by doing good."

Section 138314 will restrict the popular IRA-owned LLC structure

The real estate industry and the hundreds of thousands of IRA investors who invest their IRA in real estate have been watching this bill closely. Section 138314 will significantly restrict IRA investors like John and Jennifer. Many IRA owners have their IRA form and own an LLC outright. The IRA owner is the manager of the LLC, without compensation or personal benefit, and the LLC is funded by the IRA's cash. The LLC then ends up purchasing and holding the real estate investment. The LLC returns all of its income or profits to the IRA. There are many reasons why an LLC is used for IRA real estate investors. First, the LLC provides liability protection to the IRA and to the IRA company. Second, some IRA custodians who allow IRA accounts to own real estate, trust companies or community banks require the IRA to establish an LLC before purchasing real estate, as the LLC protects the IRA custodian.

Section 138314 causes problems for IRA owners, as it states that an IRA owner cannot serve as "officer" of a company where their IRA invests into. The manager of an LLC is an officer, so anyone who has used an IRA-owned LLC will be affected. This restriction is something wealthy IRA owners can easily side-step, as they have teams of investment professionals and asset managers who already serve as managers of their LLCs, but everyday IRA investors buying single-family rentals with their IRA-owned LLC will be forced to wind down these LLCs. Many won't find it practical to own real estate in their IRA, as the maintenance burden and fees from their IRA custodian can significantly cut into the profits and returns that they are hoping to earn.

The IRA provisions will dry up capital needed for small susiness and startups

The IRA restrictions in the bill will also impact the small businesses and investment projects where these IRA dollars flow. Jamison Manwaring is co-founder and CEO of Neighborhood Ventures, a local real estate company that exclusively invests in Arizona and who has IRAs as investors. Neighborhood Ventures recently bought a hotel and is converting it to an apartment building to address the housing shortage in the Phoenix metro area. Projects like these require capital, and Neighborhood Ventures raises that capital from individuals and IRAs.

"The proposed restriction on IRAs will dry up funds that are needed for local ventures and small businesses and will just force those funds back to Wall Street where they make little difference," Jamison says. "Our investors like to know that they are investing in their community. The proposed restriction hurts them and restricts their ability to grow their account, but it also hurts companies like ours who invest in local projects and who work hard to solve housing and affordability issues in our communities."

The effect of these new rules is that more dollars will flow back to Wall Street. That is something most IRA savers who invested into these affected assets were trying to avoid.

Section 138312 eliminates investment opportunity in the highest returning assets

Fred Wilson, a well-known venture capitalist, and blogger wrote about the bill on his site AVC.com. He wrote that the bill would eliminate the ability of IRA holders to invest their IRAs into the highest-returning assets available: VC funds, private equity, and private companies. As Wilson detailed, "I am sure they are proposing this to prevent wealthy people like me from using the tax shield of the IRA to invest in private businesses, but there are better ways to do that than a blanket prohibition. A blanket prohibition will hurt Main Street, not Wall Street. We already limit what folks who aren't wealthy can invest in by nature of a multitude of regulations. It upsets me to no end that this paternalistic approach keeps the wealthy making lots of money and everyone else on the sidelines."

Why is Congress trying to restrict what assets an IRA can own?

The provisions appear to be written to prevent billion-dollar IRA accounts and to disallow investments in founders' shares. Kazusa Flanagan of Honolulu, HI, was concerned about how Sections 138312 and 138314 would affect her ability to invest her IRA and wrote her U.S. Senators. She got a response from Senator Schatz (D-HI), who wrote back that he is a strong supporter of progressive tax policy and said that these specific IRA provisions are "intended to prevent taxpayers from abusing Roth IRAs to shield assets from taxation; for example, by contributing undervalued founders' shares to a Roth IRA in order to skirt contribution limits. I recognize that modifications to IRA contribution rules affect many taxpayers, and I will keep your concerns in mind as the Senate considers potential changes to IRA treatment in its own reconciliation legislation."

It's quite clear that Congress is concerned with reports of Peter Theil's billion-dollar IRA that was built by investing in founders' shares. Unfortunately, the IRA provisions, and specifically 138312 and 138314, are written so broadly that they scoop up hundreds of thousands of IRA accounts of non-wealthy IRA savers who simply choose to invest in small business, startups and real estate LLCs. These IRA savers aren't buying undervalued founder's shares, but are being dragged into the restrictions nonetheless.

Related: Have You Made These Year-End Tax Moves? Here's How to Keep More of Your Money

If the wealthy are the problem, then Congress should specifically target large accounts

So, what's the solution? How can there be progressive tax policy for IRAs that hits the "wealthy few" but doesn't scoop up hundreds of thousands of working Americans hoping to have an IRA account with a balance they can actually retire on? In his aforementioned blog post, VC Fred Wilson offered a possible solution, writing, "What we should do instead is limit the tax advantages of an IRA to a set amount of money, something like single-digit millions. That will limit their attractiveness as a tax shield for millionaires but maintain them as a wealth generator for everyone else."

Section 138301 of the bill does what Wilson suggested, limiting total IRA and other retirement account balances at $10 million. This restriction alone, if passed, would directly target the "wealthy few" and limit the tax benefits in their accounts. It's not progressive tax policy to limit investor choice that will affect everyone, especially when that is mostly going to burden and restrict the non-wealthy who are just trying to catch up to the wealthy. If the $10 million cap is enacted, then Sections 138312 and 138314, which restrict investor choice for everyone, won't be needed.

The bill is awaiting a vote in the U.S. House of Representatives and is part of the $3.5 trillion reconciliation package that is being negotiated in Congress. It's uncertain which provisions of the bill are being negotiated but it's clear that IRA savers who have invested their accounts into small business, startups and real estate LLCs are contacting their Congressional offices to help educate their representatives on how the bill will impact them.

Senate Majority Leader Schumer said on October 4 that the House and Senate plan to vote on the final negotiated bill by the end of this month. The hundreds of thousands of IRA savers who invest in these non-publicaly traded assets will be anxiously awaiting the final text to see if their retirement savings will be harmed.