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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  • Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    16y

    Great information on self directed retirement investing. Several great links.

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    16y

    This may be the very best thread to get you stated leaning about self directed IRA's and now that it is in the proper place (its own section) we should get even more people to view it.

    Ask away, I will monitor this thread and be sure to help answer your questions.

    Will

    You may have questions about prohibited transactions, disqualified parties, other options to the SDIRA, or what is the best use for you, so ask away.

  • Residential Real Estate Agent · Orange County, CA · Member since 2009 · 289 posts · 95 votes
    16y

    Hey Will! Good to see you back on the board.

    I actually do have a SDIRA question. One of the podcasts that I listen to very quickly mentioned using an LLC inside of your IRA as a way to get around paying the individual fees and waiting for the SDIRA company to approve any transaction. I don't think you can get around the disqualified parties using this. The whole idea is that the SDIRA owns the LLC and then the LLC makes the investments. Because the LLC decides on the investments, there are no fees or approval process from the SDIRA company.

    Any thought on this?

  • Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    16y

    I think there is some confusion on the use of a self directed 401K vs a self directed IRA account. There are some definite advantages to a self directed 401K. Perhaps Will can further explain some of these and what the differences are between these two vehicles.

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    16y

    Chris,
    You are correct, you do have check writing abilities and avoid the timeline process of a TPA (third party administrator), however, you MUST still remain in compliance of all IRS rules and guidelines which include prohobited transactions and disqualified parties.
    Just because you have a LLC IRA does not mean you can violate any of the IRS rules.

    The advantage of the LLC in your IRA is that you can invest in things such as tax lien certificates or buying at the courthouse steps as you would not be able to do that with a traditional SDIRA due to the timelines to get the money out. The other advantage is that you avoid all the TPA fees. The disadvantage is that you alone, must make sure you stay in compliance with the IRS rules as well as the larger cost to set it up (usually $2500-$3000).

    Charles,
    Not sure what confusion you are referring to as far as SD 401k or SDIRA. I did not see that mentioned in Chri's post.

    The main difference between the two is that in a 401k plan, you have borrowing provisions up to 50% of your vested interest up to a max of $50k whereas in a IRA, you do not. This borrowing provision alone can allow you to benefit/grow your retirement account and at the same time, benefit yourself outside the plan (completely legally) if you know how.

  • Involved In Real Estate · St. Paul, MN · Member since 2010 · 65 posts · 15 votes
    16y

    Does anyone have a link or title so I can look up Rich's original thread that this one is a spinoff of? Also Rich mentioned he was going to follow up on this one. Is there a link to that one? Great stuff!

  • Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    16y
    Originally posted by Dustin Gott:
    Does anyone have a link or title so I can look up Rich's original thread that this one is a spinoff of? Also Rich mentioned he was going to follow up on this one. Is there a link to that one? Great stuff!



    Here is Rich's follow-on posting (in his blog):

    http://www.biggerpockets.com/blogs/575/blog_posts/2786-retirement-secret-part-2-my-1st-part-

    http://www.biggerpockets.com/blogs/575/blog_posts/2792-retirement-secret-part-2-my-part-deux-

  • Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    16y
  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    16y

    Mr. Babiak is by far the king of BP links here.
    Great job Steve.

    Will

  • Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    16y
    Originally posted by nationwidepi:
    Mr. Babiak is by far the king of BP links here.
    Great job Steve.

    Will



    I second that. Thanks Steve for providing these threads.
  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    16y

    Bump . . .

    Keep the questions coming BP Nation. This topic is of high importance in many aspects.

  • Investor · Willow Spring, NC · Member since 2009 · 5k+ posts · 3k+ votes
    16y

    Excellent topic.

    I am in the process of setting up a SDIRA. I have a couple questions. Not that I plan on using it, but checkbook control doesn't seem to help me in many cases. Courthouse purchases (about half my buys) require bank cashier checks to the trustee, not personal or SIDRA checks. Ditto with RE closings, at least around here, unless you find the closing escrow a week or more in advance. The last non-trustee (non foreclosure) closing I did was 4 days from offer (Monday) to close (Friday.) Not enough time for regular checks to clear the attorney's escrow account. Also, these are (I assume) paper checks rather than electronic payments (e.g. Wachovia bill pay.)

    Another question: on sale, doesn't the selling attorney require disclosure of a TIN/EIN? What would it be? It isn't my SSN, the person, but the SDIRA. Is tax identification for the SDIRA required?

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    16y

    Chris,
    If you invest at trustee sales (or sherriff sales) as well as other time sensitive investments, chgeckbook control is essential/necessary. That being the case, the words checkbook control do not mean you MUST write a regular business check from the account.
    For trustree sales, you would get cashier's checks in the increments necessary and go to trustee sale.
    For other transactions, you could wire the funds. The key is to make sure you stay within the legal requirments of the IRS as far as SDIRA's are concerned.

    If you had a third party administrator (TPA) rather thna check writing control, you could also have expidited processing and even have them send a wire, rather than a check, so you can complete deals inside of 2 days with a TPA.

    Escrow, or a closing attorney would receive the information that the purchaser was an IRA (you are correct - not your SSN, and no EIN). If you did have checkbook control, to accomplish this, you must set up an entity with the entity in control of the IRA, thus, you have your EIN.

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

    will just got back here and wanted to thank you for your response to my question last month, sorry it took so long.

    jeffrey

  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    16y
    Originally posted by Jeffrey Gordon:
    will just got back here and wanted to thank you for your response to my question last month, sorry it took so long.

    jeffrey
    You are quite welcome, my pleasure.

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