My/one interpretation of the IRC is that by performing your own management/work on the property you are either 1. making excess contributions or 2. receiving personal benefit from the IRA.When I say manage the investment in an IRA, I am referring to collecting the rent and sending it into the IRA, taking repair calls from the tenant and making the calls to the proper repair people and paying them from the IRA account. I am not referring to doiing the physical labor, however, if I were to do that, I do not see how the IRS would construe that as a benefit to you persoanlly so long as you did not pay yourself for teh time and effort. In fact, it is a benefit soley to the IRA as the IRA had less expenses due to the fruits of your physical labor. I have never heard of anyone getting in trouble with the IRS my self-managing their IRA property so long as they do not take ANY financial personal gain.
As far as your "things to think about" you have some very valid points and these should be considered by anyone looking to hold RE in their IRA. Again, it is up to each individual to see if this fits in their plan or not. It is not for everyone. I actually believe the best method to SDI investing is to make loans with 10% minimum returns. It requires no management time/headaches, is secured by the property, and offers a very nice return with minimal effort and very little to no downside like stocks.
1. I wouldn't say "no loans" but as you mentioned they must be non-recourse. While they may cost a bit more, they are easy to get if you buy right and that is really the key. It is not always the cost of the money but the availability of it. You do have UBIT implications but they can be avoided by simply paying off the note 365 days prior to selling.
2. No question. Your personal funds are seperate from your IRA funds and therefore you need to have some capital reserves in the IRA to pay for ongoing expenses that arise.
3. Right on! You do lose the benefit of depreciation but outside an IRA, you get depreciation, but you can alos recapture that upon sale. Must weigh both sides.
4. That is also true and could be in stocks as you mentioned. This is another reason why I prefer to make loans with IRA funds rather than holding RE.
5. Exit strategy is not harder in my opinion if you have the right plan. Planning solves many potential problems and by the time you are 70 you should be pulling out the money anyways.
Thanx for the input Bob and Will. The more I look into this the less desireable having real estate in an IRA is to me.
If I was going to keep the money in the IRA, I like Will's idea of using the 120k as a note on a 1st trust deed. No complications, just a steady income stream. Altho, with mortgage rates so low you wouldn't be able to command a very high interest rate, and would need to be careful of usury. The worst thing that could happen would be having to foreclose on a default. Which might be a bit tricky in an IRA, especially if the debtor declared bankruptcy.
I still want to get this money out of the IRA with the least loss possible. Talking to as many tax specialists as I can on this subject should help me come up with the best strategy.
As a hypothetical example (from an uneducated viewpoint)... if I could buy a viable little business for 120k that made me 50k per year I think I would be way ahead of the game no matter how much tax I had to pay due to pulling out of IRA. 5 years of that business would mean 250k gross. If I could make 30-50% return on that 120k via a business I think pulling out of the IRA would be the smart thing to do. Don't you?
Altho, with mortgage rates so low you wouldn't be able to command a very high interest rate, and would need to be careful of usury.Not quite true Alfred. Although interest rates for owner occupants are at all time lows, in order to get them these days, you need excellent credit, provable income, and sign over your first born child to get them. Also, you would be better served making loans to investors rather than owner occupants to get higher rates. For us investors, it is not the cost of the money that is most important, but the availability of it.
I regularly pay 10%-12% for funds on short term basis 90 days - 2 years (depending on situation) and my investors love it as they always get the best returns with little effort and no worries. Teh key is to invest with someone who knows what they are doing, has a great track record, and your lending position is always first position and not to exceed 80% of low end value.
That way, you are assured your return even if you did have to foreclose.
I am not an attorney so I am not sure if I am 100% correct on the BK issue, but your recourse is first in the property (which if done right has enough equity to get your principle back and in this case, I believe it would not be considered a buy and flip so no UBIT - check with an attorney on that) and second (in my contracts) I persoanlly sign my own credit on the line and thus, if you were to foreclose on me for non-payment (which has never happended by the way) you could then go after my personal asseets in addition to the subject property in the case that your full principle and interest was not covered from taking back the subject property.
As an investor, I would want every recourse possible to get my money back (securing my investment) and as such, I offer that security to my private investors.
I still want to get this money out of the IRA with the least loss possible. Talking to as many tax specialists as I can on this subject should help me come up with the best strategy.I think, for your personal situation as you have explained it, you are on the right track here and getting pro advice is crutial. Get several opinions as one CPA or tax attorney may have a different view than another. The ultimate key is to keep your losses to a minimum by taking the IRA funds to cash to benefit your income today. :lol:
Alfred, an inherited IRA (minus the fact that someone died for you to get it) is an amazing thing. You do have to make yearly withdrawals but it can provide a lifetime of tax deferred earnings along with the possibility of withdrawing the money should you need it. In your business example, it sounds good but is it an actual opportunity to buy a business for $120k that grosses $50k, or 40%? Will you really net 30%-50% of that? If so, can you finance that business outside of cashing out the entire IRA? If you could swing the financing, I would suggest that and keep the IRA, invested however you want (may want to lean conservative to act as a reserve fund for the business). Even a partial withdrawal of the IRA if you needed a down payment, would be good as you won't be jumping up as many tax brackets. If you do find a business to purchase, it may be worthwhile to take out half on Dec 31 and half on Jan 1. You would owe the Dec 31 tax by April but you received all of the money 'at once' but spread the taxable income over 2 years and most likely lowered total taxes owed. That could even be preferable to the seller of the business as they may be able to spread the sale of the business over 2 years too.
Actually, my advice right now, if you just got this account is to slow down and think about what you want to do-not only about this money but, more importantly, with your life. Owning a business may be a big life change for you and do you want to jump into that right now? Maybe put the money in a money market account or something very safe (maybe 6 month CD's if you're willing to lock the money up for a period of time to give you a cooling off/contemplation period) while you look for businesses to purchase and figure out if that is what you want to do. You spoke very general about the business, are you just wanting to own a business because 'that's how you do it' or are you interested in a certain business area? What if the numbers you quoted are only available from a dog grooming business but you hate dogs? I would guess a business you can buy in CA for $120k is a service business. Are you going to do the services yourself? What happens if employee(s) leave-can you fill in at a moments notice (another job in the way?).
Slow down, don't let the money burn a hole in your pocket (use CD's if you have to) and really figure out what you want to do, how this money fits into that goal and then seek advice about taxes.
Bob Hines: thank you very much for your concern and time in writing back. You make very good and logical points. To give you some more info... I've had this IRA for over a year and it is invested in a real estate development project paying me 10%. It will soon be over and the 120k + cap gain will be going back into my SDI. One thing I've decided (since the economy has been unraveling) is that I don't want my investment capital out of my control any more... or I can lose it. I won't do another development project like I did with this IRA $. And I also have about 300k that I 1031 exchanged into a TIC (an interest in a luxury apartment). I want out of that as well. I'd rather own my own multi-unit building or some SFRs and be back in full control and able to preserve my capital. (The development project had some trouble with their lender and the TIC is in Phoenix and they are being hit by the crashing market there. Makes me nervous and there is nothing I can do about it.) So I learned a lesson: never let your investment capital out of your control.
There is no business that I want to buy at this time. My 120k/50k example was purely hypothetical (basically I was making the point that if there was a business that a would give such a good return... it would be worth taking a hit on the withdrawal of the IRA monies).
I've just realized that RE or any other investment will never give me the returns that a successful business that I own would. But I don't want a job. It would be a business system, run by a manager that I allow to profit share and I would just be involved in solid oversight, marketing & expansion programs, etc. My plan is to begin a deep study of how to start, buy and analyze businesses before I do anything. I'm planning for the future. When the $ comes back into my SDI I could do something like create a 10% short term note/1st TD with it for decent income. Then, down the road when there really is a business opportunity that would make busting the IRA worthwhile... I could then do so. But you may be right... it might be best to just keep the IRA and invest it well and use financing or other sources for the $ to buy or start a business when I'm ready.
One idea: I could put the IRA $ into a Checkbook LLC IRA and then be in full control to use that money to buy, rehab and flip foreclosures (really building up the profits tax deferred). Plus I could take out whatever I needed from that as a downpayment on a new business (like you suggested). Having the Ckbook IRA doing that, and then 1031 exchanging out of that TIC into let's say a multi-unit income property that I own completely would probably put me on a very strong foundation and give me great passive income. The cash flow from both the multi-unit and from doing foreclosure flips with the IRA would probably give me all the capital I'd need to start or buy small business systems in the future.
Sorry, didn't read through all the discussion. But with a quick scan I saw:
One idea: I could put the IRA $ into a Checkbook LLC IRA and then be in full control to use that money to buy, rehab and flip foreclosures (really building up the profits tax deferred).
Rehabbing would be an active business and would be subject to UBIT. Even if you're doing it with no financing. Not to say this isn't a good idea, but be aware that in a traditional IRA any active business is subject to UBIT. Convert it to a Roth, paying the taxes once, to avoid this.
Another option... could do one rehab and a portion of the profit would pay the taxes on busting out of the IRA. I've paid Uncle Sam... my 120k remains in tact (plus, I also have whatever other after tax profits are left from the rehab project). Example: officially pull the 120k out of IRA... make 75k on the rehab... pay 35k(?) in taxes on the IRA... pay 20k(?) on the 75k profit from rehab... 20k left + 120k = 140k is the net I realize from this action and down the road I go. How's that?
IRA's & Trusts are subject to UBIT if you use a loan or financing to leverage a transaction. I work with many investors using IRA funds, some with checkbook control.
We have 3 proprietary solutions to leverage your IRA investment, use normal recourse lenders, and NOT incur UBIT. :D
We are now doing our 2nd transaction since developing the 1st solutions and will now broaden the availability.
We can't advertise or patent the process, since the IRS will work very fast to stop us from using what works under current tax rules. :cry:
Why don't you elabortae via a PM to me as I am interested in that.
or send me an email which is below in my signature.
I will send you an e-mail this weekend.
I want to make these solutions available to as many real estate investors as possible .. I need to keep it under the radar screen to avoid UBIT tax laws being re-written.
Additionally it is proprietary so I need to avoid advertising the details publicly.
In response to my Bias to the Solo K plan. Yes, I do make $ setting up these types of plans for my clients. However, my recommendations about the Solo K. Plan are justified whether I get paid or not..
Why a Solo K over IRA/LLC.
1. Contribution Limits are nearly 10x Higher than IRA
2. EXEMPTION from UDFI/UBTI tax.
(IRC 514(c)(9)(C)()ii). the code excludes: Acquisition indebtedness, Real property acquired by a qualified organization-mean; any trust which constitutes a qualified trust under section 401K
3. Participant Loan Feature-Borrow up to $50K or 50% of account value for any purpose.
4. No Income Restrictions for Roth Participation.
5. The BIG one-NO CUSTODIAN REQUIRED. Self Directed, Self Managed-no need to set up LLC and pay custodial fees.
There are no threshholds for how much profit must be generated, how much money must be contributed to the plan, or how soon profits and contributions must happen. Your self employment activity can be part time, and it can be ancillary to full time employment elsewhere. A person can even participate in an employer's 401K in tandem with their own Solo 401K. The only reporting requirement for the "K" plan is filling form 5500-EZ. Only required to be filed once the plan assets exceed $250K in value. I can share many more benefits with you as to why I say: The Solo K is far superior to and Individual IRA/LLC plan. The Solo 401K plan, allows you to serve as employee, employer, participant, administrator and trustee. The result is that it is the most flexible, capable, simple, inexpensive and powerful Investment vehicle allowed by law in the United States. NO CHARGE!!
Here is a technical question for you:
My IRA is an inheritance or stretch IRA. Don't think I can switch it into a Solo K plan or anything. The only choices I have are to just take my minimal distributions... or just pull it out and pay the income tax on it (no 10% penalty on stretch IRAs). Am I correct?
If I can't stay within a tax deferred retirement entity and have total flexibility (like this Solo K would offer) then I'm just going to take this action as I think it will serve me in the long run (despite everyone else's admonition not to do so)...
I'm doing RE projects right now (rehabbing REOs and flipping them). I've only got 200k in liquid capital for this. I'm going to pull the 120k out of the stretch IRA and add it to my working capital (giving me 320k) allowing me to make more profits in RE. I'll use a protion of my profits to pay the income tax I will incur from pulling the 120k out. If I'm making 50%+ return on my money each year doing these small RE projects it seems to me that paying the tax is a small price to pay for total freedom/flexibility and the ability to maximize my profits.
I think after all the ideas and discussions, your persoanl plan and abilities to make that plan a reality seem to be yoru BEST option. While it sucks to pay Uncle Sam anyting, it is a necessary eveil at times and I think you have made a fine justification for it. Take out the entire IRA, use those funds to make serious profits from flipping, use the after-tax profits to pay the taxes on the disbursed IRA and you are still ahead of the game then when you started and NOW, you are liquid outside of a somewhat hindernaced account. At that point, you will want to start some future tax planning and legal tax avoidance strategies. Perhaps a solok plan or self administered pension plan would be best suited.
Will in CA - about to go snowboarding in Big Bear with epic snow levels!
Thanks for the support Will. As for tax planning... once we launch our startup this year we will make NV our domicile state... dissolve our CA corps and set up NV corps... goodbye state income tax! Goodbye to the CA Welfare State! We'll use a friend's home/address as ours in NV because we are buying a motorhome and taking off to: put a sales team for our startup in every major city in the USA... grow our account base (with Fortune 500 companies) and continue to do RE projects in the hot areas of the country. We're out to amass as much cash as possible in this short window of time before the deflationary phase turns inflationary and money turns to trash (right before the big upswing into inflation we'll turn all our cash into tangible assets).
Enjoy the snow. We live in Idyllwild in a little mountain cabin on a creek. Enjoying the snow as well.
You may want to check out South Dakota for your domicile state. Check with Rich Weese as well. He uses that state as his homebase.
Will is right about Rich Weese, and Rich has posted that a few times here in the forums and I think it is even on Rich's blog page too. A search should turn up the stuff Rich wrote.
Will look into it. Have a friend in Calif with a SD corp he uses for RE.
I already have 25k towards ownership of a trailer site in an RV development going up in NV (Pahrump). That is main reason why would make NV domicile state. Stick a little used trailer on it, hook up utilities and it's "home"... I'm a legal, NV resident. Maybe SD corps would be more optimum living in NV too. I'll check it out. Have a year to do so. Thanx.
Your correct about NOT being able to rollover your inherited IRA into a solo K plan. However, a few year back several rule changes were made with regards to Inherited Retirement Accts. Seeking the advice of a Estate Planning/Tax attorney who;s well versed in these matters would serve you well. You may be able to take a distribution-pay uncle sam. then rollover the net into your own Roth IRA or Solo K plan. You also may be able to extend the life expectancy of the existing plan by averaging your age with the decedents. .
Thanks Matt. But you know... any retirement acct will have restrictions and be problematic... it's the federal government right?
The idea of deferring taxes and having your capital "uninhibitedly" grow sounds great, but the govmt will get the taxes later, AND the tax rates will be higher then they are now, you can be certain of that.
I'd rather be able to act in an unfettered and free style with my capital ("it is my money, I'll use it when and how I want") and work out the best strategies I can to mitigate the taxable events through each year.
Having those monies totally free for my use will allow me to get a much bigger return from them (being an active investor) than I ever could keeping them in a govmt tax deferred account.
If you look into the future... due to the inhibitions of a retirement acct slowing your investment actions and options down, plus the higher tax rates when you start taking the money out later in timeâ€”one would actually wind up a lot poorer in the end with less net worth, than one who took the money (paid the tax penalty) and actively invested it through the years with good returns.
If one did 2 decent RE rehab projects a year and obtained a 25% return each, he'd have a 50% return on that money annually. Shelter and use every tactic possible to avoid paying 1 penny more than you have to (avoidance not evasion)... keep taking your profits and reinvesting it back in and the deals get bigger (or mulitple) and that 25% gets bigger too.
Government is all about lowering our prosperity not increasing it. The less I have to do with them the better. Thus... goodbye IRA... here is your tax Uncle Sam... I'm now much more free to prosper... my first deal with that money will repay my tax loss.
Good that I'm writing this because I'm convincing myself even moreso that this is the way for me to go personally.
Thanks for your input.
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