Should You Be Afraid of Designated Investment Agreements?

Thu, Feb 4, 2021 3-minute read 475 words

In this post, I briefly explain the purpose of Designated Investment Agreements, and why you should pay attention to them.

This year, I am broadening the scope of this blog, and expanding the topics to include several other passions of mine: trading, investing, and e-commerce. Please do keep in mind that I am not a professional financial adviser, and all information on this blog should not be construed as professional financial advice.

My trading experience is limited to stocks and crypto currencies, and I have been doing it successfully now for over five years. To minimize the taxes, I trade stocks exclusively in my retirement and tax-advantaged accounts - HSA and Roth IRA.

What is Designated Investment Agreement

During stock trades, you may occasionally come across Designated Investment Agreements (DIA). You are placing an order to purchase some stock, and suddenly a warning pops-up, announcing that to purchase this particular stock, you need to sign a Designated Investment Agreement. The agreement would usually ask you to confirm that you are a “sophisticated investor”, have a high risk tolerance and the decision to purchase this particular security was solely yours.

Do not freak out! Take a deep breath, and take a closer look at the stock that you are trying to purchase, before committing or signing anything. There are two main reasons why your broker may require you to sign the DIA: high volatility and tax liabilities. You need to figure out which reason applies to this particular stock.

Designated Investment Agreement for High Volatility Securities

In majority cases DIA is meant to serve as “cover-your-ass” for your broker simply due to the high volatility of the security you are trying to purchase. The stock has shown to be go up or down too quickly in the past. Should you lose money in this trade, your broker does not want to be held responsible. If you are willing to take such risk, then you should be okay with signing the DIA.

Designated Investment Agreement for Securities with Tax Liabilities

Trading certain securities may lead to complex tax liabilities, if you trade them in tax-advantaged accounts. A good example of such securities are Limited Partnerships (including Master Limited Partnerships) that have an a specific tax structure. Any income that you earn from LP/MLP stock (including realized gains and dividends) is considered Unrelated Business Taxable Income (UBTI) by IRS. If any year, your total UBTI income in your retirement/tax-advantaged account reaches 1,000, you will have to pay taxes on that income. This may also involve filing special forms with IRS and your broker. So if you trade in retirement account, you should definitely think carefully before proceeding.

In summary, you should treat Designated Investment Agreements seriously if you are a high-risk risk averse trader or you are trading in tax advantaged accounts and wish to avoid unnecessary taxes.