Category Archives: Self-Directed Roth IRA
Can an Inherited IRA be converted to a Self-Directed IRA?
Question: I have an inherited IRA that I received this year and would like to convert into a self directed Roth IRA. I have not taken any distributions at this point. Is this doable? Thanks in advance.
Answer: Thank you for your inquiry. You can indeed change an inherited IRA into a self-directed IRA with which you can invest in real estate, notes, options, oil and gas, private company stock, and a whole lot more. What you cannot do is convert an inherited traditional IRA into an inherited Roth IRA. The only way you could convert the IRA is if you inherited it from a spouse and you elect to treat it as your own, then convert it to a Roth IRA. Also, please remember that you cannot add to an inherited IRA, so you will need to take that into account when deciding on your investment strategy.
You must also take Required Minimum Distributions (RMDs) from the account regardless of your age, but fortunately there is no penalty for taking the distributions, only taxes if it is a pre-tax account such as a traditional IRA. If you fail to take an RMD you will be penalized 50% of what you should have taken from the account. I only mention this because you mentioned that you have not taken any distributions from the account yet. You generally must begin taking distributions in the year following the date of death of the original account owner. In some cases you may elect to take no distributions until the 5th year after the date of death, at which point all of the money in the IRA must be removed.
Please let me know if we can assist you with a self-directed IRA. Our company website is www.QuestIRA.com, and our toll free number is 800-320-5950. Have a wonderful holiday season, and a happy, healthy, and prosperous 2013!
Can I use my IRA to pay the mortgage on a investment property I own?
Question: I have an investment property, but I owe 100% on it. Can I use that self directed IRA to pay the mortgage? and then keep the property and the income in the IRA?
Answer: Unfortunately, the answer to your question is no, your IRA cannot be used to assist you in paying your mortgage on this property. Other than a rollover from one IRA to another, only cash may be contributed to your IRA. Additionally, it is a prohibited transaction to have a sale, lease or exchange of property between an IRA and a disqualified person (and you are a disqualified person as to your IRA) (See Internal Revenue Code, or IRC, Section 4975(c)(1)(A)). So you cannot convey the property to your IRA. Another prohibited transaction is that there can be no extension of credit between an IRA and a disqualified person (IRC Section 4975(c)(1)(B)), nor can there be a transfer to, or use by or for the benefit of, a disqualified person of the income or assets of an IRA. (IRC Section 4975(c)(1)(D).
The bottom line is that you may not use your IRA, either directly or indirectly, to benefit yourself right now, unless you simply take a distribution from the IRA and possibly pay taxes and penalties, depending on the type of account and your age.
I am sorry I wasn’t able to give you better news, but if you do need the services of a self-directed IRA Administrator or Custodian please do not hesitate to contact us.
The Balancing Act
I traveled to Pompano Beach, FL last week to record a financial segment for “The Balancing Act”, a Lifetime Television show. A lot of hard work went into this and it went off without a hitch! It was such an honor for me to be on their show, the topic was my personal favorite (and area of expertise), Self-Directed IRAs. I finally got to wear my awesome suit that I have been tweeting about but I wasn’t ready for my lesson on wearing make up and eating spicy food- ha ha!!
See below for the pics And click HERE for the Press Release!
The recording will air on February 19th- Make sure you record your DVRs to watch me appear on National Television!!
How Can My Minor Child Have a Roth IRA?
Article Written by H. Quincy Long in 2012
“How can my minor child have a Roth IRA?” If I only had a million dollars for every time I have been asked this question, I would be a very rich person! When entrepreneurial people learn of the myriad of possibilities for non-traditional investments within a self-directed IRA, they usually immediately see the benefit of starting on their child’s retirement now in addition to utilizing their own IRAs. In this article I will discuss the benefits of starting an IRA early, how a minor can qualify for a Roth IRA, the tax filing requirements for a minor with earned income, and what can be done with the IRA once the money is deposited in the account.
First, let me briefly discuss the benefits of starting early on retirement savings. Assume your 15 year old daughter starts off her Roth IRA with $1,000 from her earnings and adds $1,000 per year until she retires at age 67. If she can earn an average return of just 10% per year, her tax free Roth IRA will be worth $1,552,472 at retirement – not bad for only investing a total of $52,000 over 52 years. Contrast this with an individual who starts saving at age 35 and puts $5,000 in for 32 years with the same annual return of 10%. His Roth IRA will be worth approximately $1,111,253 when he retires at age 67, and is contributions will total $160,000. No matter what your age and annual return assumptions are, one thing is very clear – the earlier you start saving the better!
Before you get too excited and start writing your IRA custodian or administrator checks to open Roth IRAs for your minor children, you must make sure that they qualify to make a contribution. In order to contribute to a Roth IRA, a single individual must have earned income (compensation) at least in the amount of the contribution and Adjusted Gross Income of no more than $122,000 (for 2011). For example, if your daughter earns $1,000 babysitting in 2011, she can contribute a maximum of only $1,000 to her Roth IRA, even though the contribution limit for individuals under age 50 is $5,000.
How can a minor earn money so they qualify to contribute to a Roth IRA? The younger your child is, the more difficult it will be to justify compensation if the IRS questions the contribution. I have heard of parents hiring their minor children as a model for advertising purposes in the parents’ trade or business, but if you intend to do this make sure that you actually use of the photos in your advertising. Keep track of how and when you used the photos, and have adequate documentation in your file as to what reasonable compensation would be for a model doing an advertising shoot with unlimited use of the photos. By the age of 8 or 9 children can be of some use to their parents’ businesses by doing things like cleaning up trash in the yard of rent houses, collating materials if the parent teaches classes, stuffing and stamping envelopes, or other menial tasks. At age 7 my daughter helped me with artwork to put on t-shirts by carefully writing in crayon “Do you have a self-directed IRA? I do!” I then had her wonderful artwork turned into a silk screen for the back of t-shirts with my company logo on the front. I gave away hundreds of the shirts to my clients. With the unusual writing on the back of the shirts, people asked a lot of questions and it turned out to be one of my most effective advertising campaigns! Other ways for minors to earn money include cutting grass, babysitting, or working at restaurants and offices when they are a little older. If you are hiring them in your own business, be sure that you always document the time spent working and pay them a reasonable wage.
The next questions I get asked when discussing Roth IRAs for minors are “What is the tax effect of my child earning compensation?” and “Does my child have to file a tax return?” I will briefly summarize the rules here, but always check with your CPA or tax professional. More information may also be found in IRS Publication 929, Tax Rules for Children and Dependents. A minor child who is a dependent on someone else’s tax return cannot claim a dependency exemption, but can still claim the standard deduction on their tax return if they are required to file. The standard deduction for a single dependent minor varies between $950 and $5,700 for 2010, depending on the type and amount of income. In general, for 2010 a dependent minor must file a tax return if 1) unearned income, such as interest and dividends, was over $950, 2) earned income was over $5,700, or 3) if the minor has both earned income and unearned income, the adjusted gross income was more than the larger of $950 or the earned income (up to $5,400) plus $300. If the dependent minor worked at an employer who withheld income taxes from their paycheck, in most cases they will want to file a return to collect a refund of this amount, even if there was no filing requirement.
There are situations where a dependent minor has to file a tax return regardless of the above filing requirements. One of the more common circumstances is when the dependent minor has self-employment income (such as from babysitting or cutting grass) of more than $400. In this case they will owe Social Security and Medicare tax on that income and will have to file a tax return to pay the tax. For example, a recent tax client of mine who was 18 years old and still a dependent on her mother’s tax return earned $3,183 doing clerical work, for which she received a 1099-MISC. She was not treated as an employee by the person who hired her, so she was required to file a dependent tax return to report this income. Because her Adjusted Gross Income was below $5,700 she owed no federal income tax. Unfortunately, she still owed $487 in Social Security and Medicare taxes. If she had been treated as an employee, the employer would have paid its portion and withheld her portion of the Social Security and Medicare tax from her paycheck. In that case she would not have had to file a federal tax return, unless she wanted to claim a refund for any federal income taxes withheld.
There is an interesting exception to the requirement that a dependent minor pay Social Security and Medicare tax on their earned income. If a child under age 18 works in their parents’ trade or business and their parents’ business is either a sole proprietorship or a partnership in which the parents are the only partners, the income is exempt from Social Security and Medicare taxes. This exception does not apply if the business is incorporated or if the partnership includes persons other than parents. The exemption is extended to those under age 21 for work other than in a trade or business, such as domestic work in the parent’s private home. So if a minor earns compensation of less than $5,700 working in their parents’ trade or business or for domestic work in their private home and they have no other income, no federal income tax or Social Security and Medicare taxes would be due. This means that no tax return would have to be filed, but they would still qualify to contribute to a Roth IRA up to the amount of their earned income, subject to the $5,000 maximum contribution! However, just to be safe it may be advisable to go ahead and file a zero tax due return for documentation purposes. Always check with your CPA or tax advisor to find out if your child will owe state or local income taxes on this income. More information on the family employee exception to Social Security and Medicare taxes may be found in IRS Publication 15, Circular E, Employer’s Tax Guide, Chapter 3.
What you can do with the money once in a Roth IRA? The beauty of a self-directed IRA is that even small amounts can be invested in non-traditional investments. There are at least four ways a small Roth IRA can be invested. The Roth IRA may be combined with IRAs of other people to make a single investment. The most IRAs I have seen participate in a single note investment was 10 different accounts, with the smallest IRA investor being only $2,000. That note had a yield of 12% per year! Another investment which is common in small IRA accounts is an option to buy real estate. Once you have an option, you may let it lapse, exercise the option and close on the property, sell the option to a third party for a fee if the option agreement allows this, or even release the option for a cancellation fee from the property owner. Another variation on this idea is for the Roth IRA to enter into a sales contract, then assign that contract to a third party for a fee. Finally, the IRA could buy a property with a loan, either from taking over the property subject to the seller’s existing financing, negotiating non-recourse seller financing, or obtaining a non-recourse loan from a private party or another non-disqualified IRA. However, if the IRA either owns debt-financed property or operates a business of any type (including a real estate dealer business), it may be required to file IRS Form 990T and pay Unrelated Business Income Tax (UBIT).
If your child qualifies, there is no doubt that one of the best things you can do for them is to open a Roth IRA. Perhaps the best part of this strategy is the time you will spend with your child teaching them the benefits of saving early and the methods of investing their money wisely. This is truly a win-win situation for both you and your child. Happy investing!
As a fee based advisor can I manage my parents, spouse and grandparents self-directed IRA through my company and not charge them a fee?
Question: I have recently started a registered Investment Advisory firm, a fee-based advisor, no commissions. I’m trying to determine if I can manage the IRA’s of my parents, spouse, grandparents, etc, in my business, but not charge them a fee. So I would receive no compensation for managing their IRA’s. From what I’ve read, this should be okay, as long as I receive no form of compensation. Is that correct?
Second question, I also have set up a LP in which I will raise money from investors for. The LP would make business acquisition loans to one of my companies, in order to finance the purchase of a business. And the LP would receive a good interest rate on the investment. I’m trying to figure out for sure if it would be a prohibited transaction for my parents IRA that I am managing, to invest in the LP. I think that would be a prohibited transaction, is that correct?
Answer: You ask a couple of good questions. With respect to your first question, it is certain that you would not be permitted to take any compensation if you performed those services for your family’s IRAs. However, I would be somewhat cautious in using your firm to manage their IRAs, because you are, as you know, a disqualified person as to each IRA that you listed. The potential problem you run into is Internal Revenue Code (IRC) Section 4975(c)(1)(C), which defines a prohibited transaction to include the direct or indirect “furnishing of goods, services, or facilities between a plan and a disqualified person.” Another potential argument is that such a transaction might fall within IRC 4975(c)(1)(D), in which a prohibited transaction is defined to include the “transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan.” Admittedly, I take a fairly conservative approach to such issues. I am not aware of any case which actually was decided solely on the basis of the provision of “services” by a disqualified person to an IRA, but I think it’s fair to say that the conservative approach would be to not manage your family’s IRA assets at your firm, unless you are aware of a class prohibited transaction exemption or a specific ruling allowing you to do so. If you are aware of such a ruling, I would love to hear about it. I am smart enough to know how dumb I am, and I am always looking for more knowledge.
You are correct in your assumption that the second scenario would definitely be a prohibited transaction, for several reasons. Depending on your ownership percentage, the LP may or may not be a disqualified person to your parents’ IRAs. Even if the LP was not a disqualified person, you personally are a disqualified person and would likely benefit either directly or indirectly from your parents’ IRA investments (see Rollins v. Commissioner, in which case loans were made from Mr. Rollins 401(k) plan to non-disqualified entities of which Mr. Rollins was the largest (although a minority) shareholder and of which he was an officer – in that case the court held that Mr. Rollins had the burden of proving that he didn’t receive a direct or indirect benefit, which he failed to do). Depending on the circumstances even if the LP is not a disqualified person the plan asset regulations of 29 C.F.R. § 2510.3-101 may come into play, in which case the LP would be ignored for purposes of the prohibited transaction rules of IRC 4975, and it would be like the IRAs made the loan directly to your company, which would be prohibited. Even if you could somehow get around the plan asset regulations, if your parents made the IRA investment with the understanding that the LP would turn around and enter into a transaction with your company this would be considered a prohibited arrangement (see Advisory Opinion Letter 2006-01A, for example, and the regulations contained in 29 C.F.R. § 2509.75-2). The bottom line on this question is no, you cannot do it in the manner you describe it.
The problem with answering something complicated in a quick email is that it may raise more questions than it gives answers. This can be a complex area of the law, and before undertaking any of the acts you had questions about I would definitely suggest that you sit down with a lawyer who is very familiar with the prohibited transaction rules to discuss the situation in detail and get some actual advice. I cannot give you tax, legal or investment advice in this case, but I hope I at least gave you some information to review with your legal counsel. Good luck, and have a great day!
If I convert my regular IRA to a self-directed IRA do I have to pay the taxes?
Question: I have found your website to be particularly helpful, and am considering making the jump to Quest and self-directed. Here’s my concern:
If I convert the IRA to self-directed, I must pay the taxes. Do the taxes need to be paid out of the account or can I pay them independently? Also, when do I need to pay them? Do I pay them when I file my regular taxes?
Answer: On the contrary, you will not have to pay taxes if you move your IRA into a self-directed IRA here unless you convert the funds from a traditional, pre-tax IRA into a Roth IRA. We are able to hold traditional IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs, Individual 401(k)s, Coverdell Education Savings Accounts (ESAs), and Health Savings Accounts (HSAs). Every one of these accounts can be self-directed and can buy real estate, notes, private company shares, and a whole lot more!
If you do a Roth conversion, then the obligation to pay the taxes is yours personally. Some people pull money out of their IRAs to pay taxes, of course, but depending on your age this may cause you to owe taxes and penalties on the amount withdrawn. My suggestion is that you call one of our offices to discuss your individual situation.
I have heard that you can set up an self-directed IRA LLC than can invest in your own business. Is this true?
Question: Hello, I am in Austin and hoping to set up my own online business through my IRA. I will be the sole owner. Is this possible? Do I need to form an LLC? And lastly, if the business becomes profitable, would I be able to pay back the IRA and then run it as a regular business from which I can make personal use of the profits?
Answer: Thank you for your inquiry. First let me start by reiterating what it says below, which is that we do not provide tax, legal, accounting, investment or other professional advice. Anything I say is merely educational in nature and you should absolutely consult your own advisors.
I have been asked similar questions many times. First, let me answer your last question. No, if your IRA owns the business, you would not be able to pay back the IRA and then run it as a regular business from which you can make personal use of the profits, unless of course you took the LLC as a distribution from your IRA and paid taxes and, if you’re under age 59 1/2, penalties on it. To the extent your IRA has money in it you can always take a distribution of cash, provided you are willing to pay taxes and/or penalties.
Do you need an LLC to own a business in your IRA? It depends on the business, but under most circumstances an LLC would be a good idea, simply because of all the issues that an active business has to deal with, especially if you have any employees.
Is it possible to set up an online business through your IRA where your IRA (not you) would be the sole owner? Well, that’s the $64,000 question, as they say, isn’t it? There are several issues with doing this. First of all, unless the business is set up to be owned by a taxable entity such as a C corporation or an LLC which elects to be treated as a C corporation, the profits from the business would be considered Unrelated Business Income (UBI) to the IRA and as a result the IRA would owe Unrelated Business Income Tax (UBIT) on its profits. This may take away some of the advantages you hoped to achieve by starting the business in your IRA. You may want to review IRS Publication 598, which describes UBI in more detail. Note that if the business pays its own income taxes (because it is a C corporation or other taxable entity), then the UBI would not pass through to the IRA. The fact that a particular investment may cause your IRA to owe UBIT does not necessarily mean that you should not make that investment, but it certainly is a factor you will want to be very familiar with prior to entering into such an investment.
Another issue with your plan is that the IRS may consider your services to the IRA owned business to be an excess contribution to your IRA under Internal Revenue Code Section 4973, or worse, a prohibited transaction under Internal Revenue Code Section 4975. Your question reminds me of the facts of Chief Counsel Advice No. 200917030, which may be summarized as follows:
Chief Counsel Advice (CCA) 200917030 involved a couple who formed a Roth IRA owned corporation into which they directed payments for consulting, accounting and bookkeeping services they provided to other individuals and businesses. This was found to be a listed transaction similar to the one described in Notice 2008-4, which should have been reported by the taxpayers on Form 8886, Reportable Transaction Disclosure Statement. The CCA said in this case, like the transaction in Notice 2004-8, the structure of the transaction purportedly allows a taxpayer or multiple related taxpayers to create a Roth IRA investment that avoids the contribution limits by transferring value to the Roth IRA Corporation comparable to a contribution to the Roth IRA, thereby yielding tax benefits that are not contemplated by a reasonable interpretation of the language and purpose of Code Sec. 408A (the Code section authorizing Roth IRAs). In this case, the value of the services provided was shifted from Taxpayers or their business to the Roth IRA Corporation when the Taxpayers provided services through the Roth IRA Corporation as employees of the Roth IRA Corporation. Furthermore, the total value of services provided by Taxpayers to clients of the Roth IRA Corporation was not received by Taxpayers in the form of salary or other compensation from the Roth IRA Corporation. As in the Notice 2004-8 transaction, Taxpayers shifted the value of income or property from Taxpayers or a business of Taxpayers to the Roth IRA Corporation, thereby purportedly avoiding the contribution limitations applicable to Roth IRAs. Taxpayers or their business engaged in transactions with the Roth IRA Corporation by providing services to clients through the Roth IRA Corporation. Value was transferred from Taxpayers or their business to the Roth IRA Corporation comparable to a contribution to the Roth IRA whenever the Roth IRA Corporation received payment from clients as a result of the services provided by Taxpayers.
The bottom line is that the IRS naturally wants to collect taxes on services you provide. And an IRA is intended to be used for arms-length investments, not to derive a current benefit. To the extent you change either of those basic premises you may get into trouble with the IRS if they review the transaction.
Having said this, does it mean that you cannot own a business in your IRA? No, it does not mean that at all. It means that you cannot provide personal services to that IRA-owned business. In other words, the business must be an investment only. You may of course invest in a business which you know someone else is starting, assuming the person starting the business is not otherwise a disqualified person. Also, as mentioned above, you will want to investigate the tax structure of the business to see if it will subject your IRA to UBIT, and if it does, whether the after-tax profits you expect your IRA to receive are higher than other investments your IRA might make.
If your need is for current income, some people consider doing what the IRS refers to as a ROBS arrangement (Rollover for Business Startups). The IRS has concerns about this set up, and you may find tons of information on the internet about these types of arrangements. This typically involves 1) setting up a brand new C corporation, 2) appointing yourself as director and President of that corporation, 3) adopting a 401(k) plan for the corporation with you as trustee of the plan, 4) rolling your IRA into the 401(k) plan, and 5) as trustee of the 401(k) plan investing in all the shares of the corporate as employer securities. The set up is fairly expensive, but there are many firms who offer to set up a ROBS arrangement on your behalf who swear by its legitimacy. If you decide to go that route then by all means make sure whoever you go to for the plan is aware of the IRS’ concern and satisfy yourself that they have met those concerns.
I am aware that this information probably conflicts with a lot of the information out there on the world wide web, where anything is possible and you can avoid all these pesky prohibited transaction rules by simply starting an IRA-owned LLC, or what is sometimes referred to as a “checkbook control IRA.” Unfortunately, the prohibited transaction rules still apply in almost all cases, and so if you cannot do it directly in your IRA then you cannot do it simply by imposing an LLC in between the IRA and the transaction.
I hope that somewhat answers your question, although I realize that such a response often creates more questions than it does give answers. Good luck with your investments, and if you need assistance with a self-directed IRA (emphasis on the self-directed part) please feel free to let us know.
Follow Up Question: Thanks so much for your informative and thorough reply. After researching some more, and since I don’t need that much capital, I think the best option for me is to take an annuity distribution from my IRA which apparently is not subject to the 10% penalty.
Follow Up Answer: Correct. As long as you maintain the payments for the LONGER of 5 years or until you are 59 1/2 there is no 10% premature distribution penalty. Note
that there are 3 different methods of calculating the amount of the distributions, but it’s fairly easy to find calculators online. The key thing to know is that you cannot vary the annuity plan during the 5 years or you will have to go back and pick up the 10% penalty amount. If you can live with these restrictions, an annuity payment, or series of Substantially Equal Periodic Payments as it’s more formally known, is a great alternative. Best of luck with your business venture.
Testimonial: Thanks again. Your generosity in sharing your expertise amounts to altruism!
Can I invest my IRA into International Real Estate? More specifically a 300 acre orchard in Belize?
Question: Thank you for your article on IRA myths: http://www.eldr.com/blogs/its-your-ira/top-10-self-directed-ira-myths-debunked
I have a 300k self directed IRA at Schwab, but I am intrigued by a non-stock market investment alternative.
I’m aware of a 300 acre orchard for sale in Belize for 400k. Your article mentioned that debt can be used in the IRA and then tax must be paid on the portion of the investment funded by debt. I presume it would be prudent to borrow around 200k to fund the business with working capital. Do you have a suggestion on the legal entity best suited for this scenario, the order in which transactions should occur, etc. Is there a book that spells out doing this?
Answer: Thank you for your question. I do not know of a book spelling out how to do a debt-financed transaction in a foreign country, though there are certainly books on international investing. Typically what we see at Quest IRA is a local corporation or other entity formed to hold the investment, and the IRA owns the shares of the entity. Of course this implies that you have someone down in Belize to manage the entity for you.
I am not sure what the banking situation is down there and whether or not you could borrow money with a 50% down payment, so that is one thing you would need to investigate. The tax situation is another factor. You will want to understand the local tax implications of any investment. As far as the IRA being taxable, that does apply when either the IRA owns a business which is non-taxed at the business owner level (i.e. either it is directly owned by the IRA or the IRA invests in a non-taxed entity such as a partnership or an LLC), or when the IRA rents personal property (rents from real property are exempt), or when the IRA owns debt-financed property either directly or through a non-taxed entity. Depending on how you structured the transaction, it may be possible to avoid the Unrelated Business Income Tax (UBIT) if the IRA invests in a taxable entity. More information on this topic may be found in IRS Publication 598, which is freely available at www.irs.gov, or by reviewing Internal Revenue Code Sections 511-514. I have also attached some information for you to this email. Of particular interest to you may be the following paragraph in the AICPA Planning article attached: (Found on www.QuestIRA.com)
Exempt organizations can also avoid the debt-financed property rules by investing in such property through a foreign corporation. In PLR 9952086, an exempt organization held 100% of the stock in a foreign corporation that invested in a foreign corporation that invested in a U.S. partnership holding debt- finance securities. The Service held that the dividends paid by the foreign corporation to the exempt organization were excluded from UBTI as dividends under Section 512(b)(2) and were not debt-financed income because the exempt organization had not incurred debt to acquire its interest in the foreign corporation.
In a series of three recent private letter rulings, the Service has again concluded that dividends received from a foreign corporation is tax-free dividend income even if the foreign corporation borrows to invest in securities. See, e.g., PLR 200251016 (Sept. 23, 2002); PLR 200251017 (Sept. 23, 2002); PLR 200251018 (Sept. 23, 2002); PLR 199952086 (Sept. 30, 1999).
Good luck with your investments, and have a great day!
Checkbook Control IRA LLC Pros and Cons with SDIRA Authority H. Quincy Long Hosted by Cash Flow Depot
Here is the replay of the Teleconference on this debated topic: http://instantteleseminar.com/?eventid=32541861
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