How Many Capsules Would You Like?

     Many of you reading this are real estate investors. Some are entrepreneurs. Some are both. Some wish to become one. We are, by nature, risk takers, especially when compared to the general public. We look for opportunities and are willing to act when we find them. We look for ways to maximize the profit in our deals, the return on our investments. Some of us use aggressive tax minimization strategies. Some of us transact business that may be in gray areas—probably not illegal, but maybe employing a loose interpretation of the regulations. I understand that.

     I would caution you that there are areas where it may pay to be aggressive and there are areas where the risks are just not worth it. For instance, it may be well worthwhile claiming a tax deduction for a business expense that might be controversial if you do so armed with a good rationale. It is unlikely that you will be audited. If you are audited and your intention was not to commit fraud, what is the worst that could happen? You will have to pay the tax that you legitimately owe and you will probably pay a small amount of interest and, maybe, a penalty. Life will go on.

     What about self-directed IRAs? Here, the penalties for a misstep can be severe, almost draconian. A small mistake that results in the IRS claiming that you were self-dealing could cause your SD IRA to be distributed and the distribution added to your taxable income. If your SD IRA has not been established long enough or you are under age 59 ½ you may be required to pay penalties in addition to the income taxes that will be due. Your SD IRA will no longer exist and you may lose ~50% of its value. A very high price to pay.

     What about operating recklessly in areas where the Dodd-Frank Act or the SAFE ACT may apply? This could be lending funds secured by real estate to owner occupants. It could be providing seller financing on real estate sales to owner occupants without understanding or complying with the lending rules. Did you know that the CFPB is an independent agency of the US government? It has an unlimited budget. If they look at you, you lose. Sure, you would have the opportunity to have a day in court, if you chose, but you would be fighting a behemoth with unlimited resources. Losing could be a life changing experience—not in a good way. Is this a prudent risk to take?

      There are almost unlimited avenues to invest in and pursue business that don’t lead anywhere near the gray areas. There are times when we are presented with opportunities where we may not understand all the legalities or where we do understand and choose to take actions that might take us near, even into the gray areas. When we do so we are making business decisions. There are times when it could be extremely profitable (for a period of time) to disregard the regulations and operate with impunity. Our risk tolerance is individual. I have no trouble finding profitable avenues to invest in that have a small risk of severe consequences and that is where I prefer to do business. You are free to choose your own avenue—at least for a while.

     Let me give you an analogy. When you come into my pharmacy (I don’t practice much anymore but my pharmacist license is still active) with a miserable cold I show you two apothecary jars full of medicine. The blue jar contains capsules that give relief to most people, most of the time and are usually well tolerated. They reduce symptoms and often decrease the duration of the cold by a few days. They are reasonably priced. The red jar contains capsules of a phenomenal new medicine. I have the only available supply of this medicine. They will completely cure your cold in a few hours. Guaranteed. There is a small problem but because of this I can give you the medicine for free, if you want it and you sign the appropriate releases. The problem? At the factory the manufacturer filled one of the capsules with cyanide. If you take that one you will die in a few minutes. However, the jar contains 500 capsules and only one is cyanide. The odds of picking the cyanide capsule are quite small and if you take any of the others your cold will be cured.

     You have several choices. You could choose not to take any medicine and just let your cold run its course—your life will be the same as it has always been. You could pay a small amount, take the medicine from the blue jar, and have a good chance of improving your quality of life. You could take the medicine from the red jar and definitely improve your life, assuming you don’t die. Do you want any medicine? If so, from which jar? If you are choosing from the red jar, how many capsules would you like?