The Retirement Secret

The Retirement Secret

Will BarnardPro Member
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Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes

OK, its no secret, just a catchy title for attention! Nationwide Property Investments has educated many on ths topic in live workshops and seminars around the country. I hope this thread clarifies and makes for an easier understanding on this subject, your votes are welcomed and encouraged, lets see if we can get 20!

This thread topic is an off-shoot from Rich Weese's thread about wealth creation. Several people have asked me about self directed IRAs, how they work, how to set them up, and the do's and dont's so I thought a post on the subject was in order as to not hijack Rich's thread.

There are currently over 45 million IRA holders in the US and steadily climbing, but less than 4% of them are self-directed. Eight billion dollars are withheld each WEEK by employees IRA/401k's!

Basically, a self directed IRA enables you to choose the investment type and the only investments you may not invest in with your IRA are insurance policies and collectibles (although some government issued gold bullion, etc are now approved).

In 1974 ERISA (Employee Retirement Income Security Act) stated that you may invest your retirement funds in any vehicle you choose with the exclusion of teh two forementioned. You may refer to IRS publication 590, pages 40 & 41 as well as Section 408 of the IRS code.

You must keep in ind that an IRA, self directed or not, is a "seperate entity" from you. Looking at it in this way will keep you safe and within the regulations of the IRS (especially as a SDI is concerned.

Second, there are three major categories of rules in regards to an SDI. 1. Disqualified parties 2. Prohibited transactions and 3. Unrelated business taxable income/unrelated debt financing income

Let start with disqualified parties.
Your SDI may not involve or benefit any disqualified person. These people include (but not limited to) you as the owner, your spouse, ancestors (grandparents/parents), lineal descendents (daughters/sons & grandchildren), investment advisors, fiuciaries (those providing services to the plan), or any business entity in which any of the disqualified persons mentioned above have a 50% or greater interest.

Prohibited transactions:
Selling, exchanging, or leasing any property between a plan (SDI) and a disqualified party. In other words, you can not purchase property with your IRA you currently own or any other disqualified party owns.
Lending money or other extension of credit between a plan and a disqualified person. Example - you may not personally guarantee a loan for real estate purchased by your IRA and you can not loan money from your IRA to your children or any other disqualified party.
Furnishing goods, services, or facilities between a plan and a disqualified party. - You can not use persoanl furniture to furnish your IRA's rental property.
Transferring or using, by or for the benefit of, a disqualified person the income or assets of a plan.
Example - your IRA cannot purchase a vacation property you or your family intends to use.
Dealing with income or assets of a plan by a disqualified person who is a fiduciary acting on his/her own interest or for his/her own account. Example- you can not loan money to your accountant or third party administrator.
Receiving any consideration for a personal account by a disqualified party who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan. In other words, you can not pay yourself income from profits generated from your IRA's rental property and you can not pay yourself a property management fee from the IRA.

UBTI/UDFI: This third category is most confusing and you should consult with a very (and I mean very) experienced accountant or tax attorney familiar with SDI's and the taxations involved.
In a nut shell, this tax was formed to level the playing field between IRA owners and the general business public. For example, if I as an SDI owner, opened up a coffee shop next to Starbucks, I could provide the same qulaity of product and service at a lower cost because I would be tax exempt. That would not be fair and thus, whenever your IRA participates in an active business activity such as the example, your IRA is subject to taxation. In addition, if you utilize debt leverage (financing) to purchase a property, you could be subject to taxation from teh profits inside the IRA. There is a way around this by simply paying off the debt with the IRA funds 365 days before you liquidate and thus, no taxes are due.
Another example - flipping properties is a business that competes with others and thus may be subject to UBTI. This may or may not be a bad thing and again, a discussion with your tax attorney on the tax implications are in order!

Here is a short list of IRS approved investments:
Rental property, flipping real estate, pre-foreclosures, forecloisures, REO's, mortagages, loans, businesses, limited partnerships, franchises, notes, raw land (must be all cash, no debt financing is allowed on raw land), residential real estate, commercial real estate, lease options, LLC's, international real estate, multifamily units, tax liens and deeds, vacation properties (as long as you dont use them), private and public stock, mutual funds, hedge funds, and the list goes on . . . .

You may self-direct traditional IRA's, ROTH, SEP, 401k's, 403b's, HSA's, and more.

All these rules and guidelines (which can be complicated, but hopefully simplified for you here) were created by the IRS to ensure that the investment activity EXCLUSIVELY benefit the IRA and not any disqualified party. IF you participate in any prohibited transaction or involve any disqualified party, the IRS can and will immediately make you take full distribution of the IRA, pay the income taxes on the entire IRA value and additionally tack on a 10% early withdrawal fee. In essence, you lose half of your IRA or more. Example, if you had an IRA worth 1 million dollars and made a loan to yoru son for $20 from the IRA, the IRS would not just distribute the $20, but the entire $1 million and you would be subject to the penalties.

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Investor · Spokane, WA · Member since 2009 · 76 posts · 16 votes
17y

Hi Will,

thanks for such a thorough overview. I have been discussing using an IRA with my son. He had looked into it for traditional real estate buy and hold investing--he has mid six figures in an IRA he inherited--This should be enough for him to go discuss the concept further with a good RE tax Attorney/CPA friend.

can you run through a scenario with either rehabbing or buy and hold using a self directed IRA?

I assume that there are a lot of folks who may have a self directed IRA with signfiicant funds that might be good lenders for our projects where they good earn a great secured rate of return etc.

I assume the pooling of several IRA funds would lead to some type of security registration requirement, so hopefully there would be folks with large IRA's as they convert out of their 401k's etc----ie. $1-5 Millon etc. that might see the benefit of putting 10-20% of their money to work in property mortgages on good lower LTV, cash flowing properties.

any real life examples discussing costs of borrowing, terms etc. would be great.

thanks

Jeffrey

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  • Residential Real Estate Broker · Payson, AZ · Member since 2009 · 3k+ posts · 1k+ votes
    17y

    Great post Will!!!

  • Investor · Los Angeles, CA · Member since 2008 · 24 posts · 11 votes
    17y

    That's why I have Will as my partner....he's much smarter about this IRA stuff then I am. Good job Will.

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y

    Thank you guys, appreciate that!

  • Investor · Spokane, WA · Member since 2009 · 76 posts · 16 votes
    17y

    Hi Will,

    thanks for such a thorough overview. I have been discussing using an IRA with my son. He had looked into it for traditional real estate buy and hold investing--he has mid six figures in an IRA he inherited--This should be enough for him to go discuss the concept further with a good RE tax Attorney/CPA friend.

    can you run through a scenario with either rehabbing or buy and hold using a self directed IRA?

    I assume that there are a lot of folks who may have a self directed IRA with signfiicant funds that might be good lenders for our projects where they good earn a great secured rate of return etc.

    I assume the pooling of several IRA funds would lead to some type of security registration requirement, so hopefully there would be folks with large IRA's as they convert out of their 401k's etc----ie. $1-5 Millon etc. that might see the benefit of putting 10-20% of their money to work in property mortgages on good lower LTV, cash flowing properties.

    any real life examples discussing costs of borrowing, terms etc. would be great.

    thanks

    Jeffrey

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y

    Jeffrey,

    Your assumption of pooling sveral IRA funds together would indeed require SEC approvals and many legal steps. Also, we are with the understanding that pooling funds can be done, but if IRA funds are involved, the IRA amounts can not exceed 25% of the total. (still looking into this)

    Scenario: Your son has $400k in an IRA. He rolls it over into a SDI with Equity Trust Company. He then finds a home in a nice area that needs a major rehab. The ask price is $150k and he gets an offer accepted at $120k. The IRA goes into escrow with the seller and closes with the IRA funds of $120k plus escrow fees.
    He has identified that the rehab will require $50,000 and the ARV is $275,000. The IRA funds and pays for all the rehab expenses thorugh the "direction of investment" form available on the equity trust website. Your Son may not work on or get paid for any of the rehab or managerial responsibilities which means EVERYTHING must be contracted out. A project manager would also be recommended. This keeps your son at arms length from the transaction and prevents any prohibited transactions.

    Upon completion of the rehab, you lists with a realtor at $$265k for a quick 30 day sale and teh IRA gets the price from a buyer.
    All closing costs, holding costs (utilities, insurance, taxes, etc) must be paid from teh IRA funds via the direction of investment form. This is accomplished by filling out the form, faxing it in, and then ETC handles the paperwork and sends the check (or wires the money- whichever options you choose).

    Upon closing on the back end, the IRA profits $63,000 after resell costs and holding costs. That income could very well be subject to taxation via UBTI. Consult your CPA for exact calculations of the tax due.

    For a buy and hold, similar situation. Son finds home from motivated home seller and buys a $100,000 property worth $150k. It will rent for $1400 monthly and all the income goes back into the IRA. All the expenses are paid from the IRA. Your Son should also employ a property manager for the property to keep that arms length distance.
    Lets say he finds a home and wants to use leverage: He must have the IRA place at least 30% down, use a non-recourse loan (no persoanl guarantee) and then continue with teh buy and hold process. Now he wants to sell. If he still has a loan on the property upon sale or within 365 days, his IRA is subject to UBTI due to UDFI. It can be avoided by simply paying off the loan and holding the property for 365 days, then selling - no UBIT.

    I persoanlly believe that using a SDI to make loans is much easier and way less headaches, plus you don't have to watch out for all the items that could potentially cause your IRA to be in violation.
    I have both. Property in an IRA and loan money with the IRA. I prefer the loans as the ownership of property (long-term) is much more of a headache and managerial responsibility than the loans are. (Just my opinion)

    TIP: One of the greatest advantages of making frineds with other SDI owners is your ability to loan to each other form your IRA's as you are not disqualified parties. Then you can use those funds to make investments, pay the interest back to each IRA and reap the rewards of the profits fro the loans outside your IRA, thus improving your networth and income today.

  • Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    17y

    Will,

    Some great posts. My vote button seems to not be working once again, otherwise I would have voted already (I have told Josh of this trouble more than once, but it comes and goes; later on I will probably have no trouble voting on this thread, but for now... )

    How about getting "Subject To" property into SDI, any special considerations about that? This idea was tossed around at a REIA meeting I attended earlier this year, so input from the forum experts is welcome.

    Also, I was under the impression there are some age related restrictions on certain holding periods - is there any real truth to that?

    Thanks.

  • Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    17y

    Will- your info was a natural follow up to my info. There are probably some other posters that could piggy back on it also. Rich in FL.

  • Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    17y

    Will- I just thought of something I could break off from yours to follow up on retirement from the stand point of one who is. Do you mind? Rich

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y

    Steve, download the free firefox browser and you should have no more problems. Since doing so, I have no problems on BP, but did with IE and SBC browser.

    Correct me if I am wrong but a sub2 purchase does require a "promise to pay" correct? If so, that promise would constitute a prohibited transaction.

    If you can take a property sub2 without persoanlly signing any promises to pay and the ONLY recourse is to take the property itself back, you are fine and in the clear as far as I can see (I am not an attorney and this is just by opinion adn observation, do not construe this with legal advice and consult with your attorney on it before moving forward)

    Age related restrictions? Never heard of it! Not sure what it is in reference to. your infant son can have an IRA, there is no age limit for owning an IRA. So long as you don't persoanlly benefit from your child's IRA, you could certainly have it self -directed and would think you could make the investment choices for an under aged child (non-legal adult) Again, consult with an attorney.

  • Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    17y

    Will,

    I use a mix of browsers as well, but I do occasionally have the voting problem even using Firefox. In fact, on this thread, I was just a moment ago able to vote on your first post, but then nothing after that.

    As somebody in your state stated in the movies "I'll be back ..."

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y
    I wonder who you mean???? :)

    Could it be the Governator! (although not for much longer)

  • Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    17y

    Will- I voted for this post and I don't even UNDERSTAND it. It must be good. I could tell by the voters. You didn't answer my question 3 posts up in this thread???? Rich

  • Clovis, CA · Member since 2009 · 134 posts · 16 votes
    17y

    awesome post.... now lets look at practical applications



    Lets start with an IRA, Self Directed ROTH type IRA.(SDRIRA) Lets assume we're following all the right "arms length rules" and all that. (good work on the posts above Will...very detailed)

    Say I've got 50K in an SDRIRA and I want to wholesale a home to another investor.

    Direct your SDR IRA to purchase a home at 30K and then assign contract to investor for 2-8K. All profit returns back to your SDRIRA tax free (at 59 1/2).

    Or

    Direct your SDRIRA to purchase an option on a property you want to buy.

    Home: FMV is 180K
    Negotiated purchase price: $120K
    Option fee to execute contract: $2000

    Direct SDRIRA to purchase an option on the home.
    Find a home buyer who wants the home at full market value.
    Sell option to home owners for $10K
    Tax-free profit potential (500% ROI)

    Or another one.

    Purchase defaulted 2nd position notes for 5-10% of FMV.

    have an investor friend with an SDRIRA to purchase the first position note for 80% of FMV.
    Hold the home for a number of years and resell it at a profit.
    He gets his money back (plus appreciation/paydown)
    You get your money back, plus as the owner of the note, you can charge penalties, and principle/interest from the original 2nd NPN.

    Or...(last one I promise) you could use multiple partners for Tenants in Common.

    Partner A: Has 50K in SDRIRA
    Partner B: Has 85K in SDRIRA

    House costs 135K valued at $187,000
    Hold for a few years then both partners sell for a profit to their IRA.

    Like will started saying earlier, it may be easier to use your SDRIRA to loan money out to other investors for mortgages, loans, hard money etc.

    So many ways to slice this thing...great discussion guys!

    Keep it up.

    Jay Gray
    Holding & Gray Investments, LLC

  • Clovis, CA · Member since 2009 · 134 posts · 16 votes
    17y

    Sorry for the mistypes and spelling errors...wanted to get this out before my conf call...JG

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y
    Originally posted by Rich Weese:
    Will- I just thought of something I could break off from yours to follow up on retirement from the stand point of one who is. Do you mind? Rich
    By all means buddy, go right ahead, as I stated in the email to you, love to hear your valuable input!
    Please make sure to email me or PM me the link to your thread, don;t want to miss it. I am off now for real.
    Have a great wekend all!

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y

    Jason, excellent post and practical applications of the SDIRA. I do suggest that all investors speak with their tax attorney as wholesaling in the scenarios above may be UBTI applicable.

  • J ScottPro Member
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    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    17y

    Another scenario that I've been considering...

    I have a good bit of money in my own personal SDI and a good investor friend of mine has a good bit of money in his SDI.

    We can provide either secured or unsecured (depending on our level of risk tolerance) to each other from the other person's SDI.

    In turn, we each have a substantial amount of new cash that we can use to invest (individually, as the SDI rules wouldn't allow us to mingle our own IRA funds), and any profits that we make can be retained outside of our IRA, as we're using the other person's IRA money (as a loan) and not our own.

    At some agreed-upon point in the future, we each repay the other's IRA with the initial principal...

  • Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
    17y

    J Scott, have you run this by a tax attorney yet? I'd really like to know if the IRS would flag anything about this arrangement.

    I asked about this a few weeks ago and Will weighed in:
    http://www.biggerpockets.com/forums/51/topics/36866-self-directed-ira-will-this-work-

    Will, this is what I called you to ask about, but you've generally answered it above--thanks for the best post I've ever read on SDIRAs.

  • J ScottPro Member
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    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    17y
    Originally posted by Jon Klaus:
    J Scott, have you run this by a tax attorney yet? I'd really like to know if the IRS would flag anything about this arrangement.

    I asked about this a few weeks ago and Will weighed in:
    http://www.biggerpockets.com/forums/51/topics/36866-self-directed-ira-will-this-work-

    Will, this is what I called you to ask about, but you've generally answered it above--thanks for the best post I've ever read on SDIRAs.


    Thanks Jon...I had missed that thread...

    I haven't spoken to a tax attorney about this yet (haven't decided if I want to seriously pursue the idea), but I did called Pensco Trust (an SDI custodian) and asked them this question.

    Basically, they said that my transaction was legal and that the other transaction would be legal as well, but they carefully avoided my specific question about the two transactions together.

    Based on the info in the other thread, I'm going to consult my attorney and my accountant before I consider this any further...I'll let you know what they have to say...

  • Real Estate Investor · Gardner, KS · Member since 2009 · 37 posts · 6 votes
    17y

    Great information Will!!! I've been talking with my relatives about this and it sounds like they can't loan to me... :cry: bummer... good thing i read this first.

  • Real Estate Investor · Gardner, KS · Member since 2009 · 37 posts · 6 votes
    17y

    wait i just re read your post and it says lineal descendants... "lineal descendant
    n. a person who is in direct line to an ancestor, such as child, grandchild, great-grandchild and on forever. A lineal descendant is distinguished from a "collateral" descendant, which would be from the line of a brother, sister, aunt or uncle.".... correct me if I'm wrong but an in law could loan to me or my business correct?

  • J ScottPro Member
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    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    17y
    Originally posted by Justin Bird:
    correct me if I'm wrong but an in law could loan to me or my business correct?


    Correct...
  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y

    Justin, that is correct. Your brothers and sisters are not disqualified parties, nor are your aunts, uncles, cousins, etc.

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y
    Originally posted by Jon Klaus:
    Will, this is what I called you to ask about, but you've generally answered it above--thanks for the best post I've ever read on SDIRAs.
    You are most welcome Jon. Thanks for the compliment and I am glad it was helpfull to you. :D
  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y

    IMPORTANT info/advice on staying within the IRS rules and guidelines:
    No transaction is illegal in dealing with IRA's (more specifically, SDIRA's) IF you get PERMISSION!

    You are not allowed to purchase your own home with your IRA and you are not allowed to loan yourself money from your IRA. Both those transactions are prohibited by the IRS. However, if you get permission, and they allow it, it is perfectly legal!
    Example: John Smith has a SDI with $200k in it. John has a home which he owes his lender (say Bank of America) $100,000. John wants to pay off his home with his IRA but wants to do it legally and ethically, so H=John goes out and gets quotes from three different lenders on the rate and terms of a new mortgage loan on his home. As it turns out, the three quotes average 6% interest on a 30 year term.
    John takes these quotes and a letter of intent to the IRS asking for permission to have his SDI pay off BofA and that he would in turn pay his SDI at an interest rate of 6%. Since John has shown that the 6% rate is the current fair market charge of mortgage interest and has shown in his letter of intent that the transaction exclusively benefits the IRA (in that it will receive a fair 6% rate of return) and that John himself is not personally benefitting from the IRA, the IRS approves his transaction and he has the green light to proceed.

    That all said, the idea of forming a small group of SDI owners who loan to each other and the funds are then used to benefit you personally outside the IRA (in addition to benefitting the IRA itself) could still be viewed by the IRS as a prohibited transaction as a whole. Individually, each transaction on its own merit is legal.
    As I stated in a previous post, investors SHOULD consult their RE attorney who is very familiar with SDI's and the IRS rules and guidelines, however, they may still not be able to clarify for a 100% fact one way or the other and the ONLY way to do that (in my opinion) is to ask the IRS. In doing so, if I were to personally want to ask this very question, I would do so having someone else ask for permission and not myslef, because if they said it would be ruled as a prohibited transaction and I was still willing to "risk it", I certainly would not want thme to have my name already flagged for the proposed transaction.

    If anyone has anything to add or any questions you need clarification on, please feel free to post them here and I will do my best to answer them.

    Will B
    (Back from weekend get-away)

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