What is a Qualified Purchaser? (And Why is the Term Important?)
As your wealth grows over time, your annual tax obligation grows with it. Many investors who experience success start to search for more tax-efficient investment opportunities that also offer the possibility of strong returns. This search may lead them to find that some attractive investments are limited to a certain classification of investor: qualified purchasers.
This discovery leads to natural questions:
What is a qualified purchaser?
What benefits do qualified purchasers enjoy?
Am I a qualified purchaser?
Qualified purchasers do gain access to a diverse range of investment opportunities, and they enjoy a series of benefits that everyday investors do not. If you do meet the qualified purchaser requirements, and if you are searching for tax-efficient opportunities that offer strong returns, you will be interested in real estate syndication.
Below, you’ll find a comprehensive qualified purchaser definition plus details on the origin of qualified purchasers, qualified purchaser benefits, qualified purchasers vs. other designations — plus the reasons why so many qualified purchasers choose real estate syndicates.
The Origin of Qualified Purchasers: The Investment Company Act of 1940
To fully understand qualified purchasers, you have to travel back in time to the Franklin D. Roosevelt Administration. Roosevelt entered office in 1933 during the heart of the Great Depression — an event caused in large part by a lack of financial regulation. In 1935, legislators asked the Securities Exchange Commission (SEC) to look into the state of the financial industry and report back to them.
Between 1938 and 1940, the SEC shared with Congress the Investment Trust Study — the contents of which led to the passage of the Investment Company Act of 1940. The Act included the term “qualified purchaser” and outlined criteria for qualification.
What does this mean for investors in the 21st century? In basic terms, the Investment Company Act of 1940 includes a series of SEC regulations that most investors and funds must adhere to. Individuals and entities that meet qualified purchaser requirements are exempt from these regulations.
Congress has altered the Investment Company Act of 1940 several times through the decades. But the core takeaways remain in place. The Act was designed and remains in place to protect individual investors after the catastrophe of the Great Depression. But certain investors — known as “qualified purchasers” — are exempt from many of the regulations included in the Act.
These exceptions open up attractive investment opportunities for individuals who meet the qualified purchaser requirements.
How to Become a Qualified Purchaser
Becoming a qualified purchaser does not include a formal process. There’s no application to complete or test to pass. Rather, becoming a qualified purchaser is done by simply meeting a series of criteria. Here’s a look at the criteria in place for individuals, entities owned by qualified purchasers and trusts.
An individual is a qualified purchaser if he or she owns more than $5 million in investments, excluding the individual’s primary residence or properties used for business purposes. The term “investments” is loosely defined in this case, but investments are typically considered to be cash and cash equivalents, stocks and bonds, futures and commodity futures contracts, financial contracts, plus real estate (again, non-primary residence and non-business use).
The same criteria that app
ly to individuals also apply to family-owned businesses — as long as the family-owned business is not organized solely
for investment in a fund.
Entities Owned by Qualified Purchasers
In some cases, the owners of an entity may want to invest money while enjoying the benefits of a qualified purchaser. In these cases, the entity must have at least $25 million to invest. The money must also be invested on behalf of the entity, or on behalf of a group made up entirely of other qualified purchasers.
A trust or a similar entity can enjoy the benefits of a qualified purchaser if it is wholly owned by other qualified purchasers. The same rule noted in the section on individuals applies here: The trust (or similar entity) cannot be formed solely for investment in a fund.
The Benefits of Becoming a Qualified Purchaser
How does becoming a qualified purchaser benefit an individual investor? The regulations outlined in the Investment Company Act of 1940 are challenging to comply with. Many funds struggle to maintain compliance, much less individual investors. The regulations include regular public disclosures that outline the rationale behind investments and information on various investment positions.
Designation as a qualified purchaser allows you more freedom to invest without making the same disclosures or providing details on rationale and positions. When you become a qualified purchaser, you are better able to use leverage to your advantage and maximize your flexibility to make investment decisions and structure your portfolio the way you see fit.
Don’t Get Confused: Qualified Purchaser vs. Similar Terms
There is a lot of confusion around what a qualified purchaser is and what the benefits are, in part because other investor-related terms are strikingly similar. Here’s a look at some of the terms that are often confused with qualified purchaser, including a distinction between the terms.
Qualified Purchaser vs. Qualified Institutional Buyer
Qualified purchasers are sometimes confused for qualified institutional buyers, but the two are completely different.
Qualified institutional buyers, sometimes known as QIBs, maintain at least $100 million in securities and operate, as the name suggests, as institutional investors. In many cases, QIBs can qualify as qualified purchasers when they meet the criteria listed above. But, in general, the concepts of qualified buyers vs. qualified institutional buyers relate to different exemptions. So, the names are similar at first glance, but the concepts should not be confused.
Qualified Purchaser vs. Qualified Client
Because the terms qualified purchaser and qualified client are so similar to one another, they are often used interchangeably — but that’s not correct.
The threshold to be a qualified client is lower than to be a qualified purchaser. Also, funds enjoy the benefits of working with qualified clients, whereas qualified purchasers enjoy the benefits of their designation. (More on this in a moment.)
To be a qualified client, an individual or couple must have a net worth of at least $2.1 million, or at least $1 million that an investor is actively managing. And here’s how funds benefit from signing qualified clients: When funds work with qualified clients, they are able to draw compensation in the form of carried interest. Their fees can derive from a percentage of the appreciation of their clients’ accounts, which is much more profitable for the fund. The Investment Advisers Act of 1940 (signed into law at the same time as the Investment Company Act of 1940) prohibits funds from drawing compensation in the form of carried interest from non-qualified clients.
Qualified Purchaser vs. Accredited Investor
These are the two most similar concepts in this section, but there are still several key differences between an accredited investor vs. qualified purchaser.
First, the thresholds to become an accredited investor are much lower than to become a qualified purchaser. Individuals must have earned $200,000 or more in each of the past two years and reasonably expect the same amount or more in the current year. The figure rises to $300,000 jointly with a spouse. Or, individuals or couples must have a net worth of $1 million or more, excluding the value of a primary residence.
Entities may become accredited investors by having $5 million or more in total assets, or if they are wholly owned by other accredited investors. For entities to become accredited investors, they cannot be formed solely to invest in a fund.
In 2020, accredited investor eligibility was expanded to include individuals with certain professional designations or certifications. Expanded eligibility also applies to employees of funds who want to become accredited investors for the purpose of participating in venture capital, hedge funds, as well as private equity funds.
Accredited investor status allows individuals, couples and entities to take advantage of investment types that are not available to non-accredited investors. This typically means private market securities. For example, common stock in a business qualifies as a security in the United States. Unless the business wants to issue an IPO and go public, it can only sell its common stock to accredited investors as the law is currently structured.
Bottom line: What is the difference between an accredited investor and qualified purchaser? Qualified purchaser status allows an investor to avoid regulations outlined in the Investment Company Act of 1940. Conversely, accredited investor status gives investors access to investment types that are not available to non-accredited investors.
Why Real Estate Syndications are Ideal for Qualified Purchasers
Many qualified purchasers are in a life stage when tax-efficient investments and wealth preservation strategies are top of mind. Real estate syndications offer the tax efficiency that many qualified purchasers are searching for, and the high-yield nature of a real estate syndication further promotes wealth preservation.
If you’ve been looking for a way to diversify your investments, real estate syndication is a perfect option.
If you’ve ever been hit with a surprisingly large tax bill at the end of the year, real estate syndication is a way to hold onto more of your money.
If you’ve ever wanted a non-traditional way to invest your money that also delivers a strong ROI, real estate syndication is the ideal investment vehicle.
At Madison Investing, we work each day with qualified purchasers who want to diversify, preserve wealth and achieve a strong return on investment. Our team targets markets and asset classes we have vetted and believe in — so that our clients enjoy hassle-free investment opportunities, passive income, plus a strong return.
Are you ready to unlock the benefits of real estate syndication? Signup for a Madison Investing account, and we’ll schedule a call to learn more about your investment objectives.