Host of the show: Selina Stoller

Your IRA Can Do Real Estate

Did you know that you can own investment property in your IRA? Quincy Long will be discussing how you can increase your retirement fund with your real estate investments.

• What is a self directed IRA and what is the difference from a regular IRA?
• What are some of the benefits of self directed IRAs?
• What investments are Quest client purchasing with their self directed IRA?
• If you want to buy a property do you have to by it cash or can you finance it?
• Do you need an LLC to buy real estate in  your IRA?

Listen to this call on June 29th and NOON EST.

Who Should Listen and Why

• All Real Estate Investors

(Click Here to Listen to Call)

Foudation for Debate from the Advisor asking Quincy: Gentleman, The debate continues:)  I actually have an account with Entrust out of Equity Trust in Ft. Myers, FL.  I use this company website as a resource: http://www.trustetc.com/new/self-directed-ira/self-directed-investment-options/rehabs-and-flips.html  But, it does not seem to give much information regarding the the tax treatment of Flipping notes in an IRA:  I am networking with a lot of younger investors and there seems to be a lot of questions and little information.  When we ask our tax professionals they “look at us like-you can’t do that.”  Most tax and legal professionals do not seem to understand much, if anything about Self Directed Investing.  So here is a follow up to the conversation if you can help us clear this up.  Just to put this into context, the original question was, “what would you do with $50k in a Self Directed IRA.”  I would say the average reader is in their late 30’s.  

IRA Investor 1: I find it very hard to believe that flipping notes could be considered appreciably different than transacting stocks quickly.

IRA Investor 2: I don’t think we are saying that they are “appreciably” different, just that the two investment options (stocks on public market vs. private market notes) are different in other means. I have no idea which is the correct and legal answer, but in my opinion, I see how one can argue that notes sold/transfered from flipping which deal with a buyer and a seller who negotiate between themselves and have contact between them in a private manner is functionally different than flipping stocks in a public market where the buyer and seller never negotiate and never have contact. To add to the confusion, what if you bought and immediately sold an actual business inside your 401k/IRA. Would UBIT apply?

IRA Investor 1: Flipping stocks doesn’t just magically occur either. A buyer and a seller still have to agree on a price for a transaction to occur. There may be fewer things to negotiate in these transactions, but I don’t see how they are really different from a “business standpoint.” What about trading something on the pink sheets? Is that somehow different still?

IRA Investor 2: I almost always agree with you, but will have to agree to disagree on this. Regardless of who is right, as no final evidence has been discovered clearly (and may never be clear), we just have two different thoughts on this. I see a difference in stocks vs. flipping notes as explained, you do not as explained. No problem.  Not only that, when they discuss the fact that the IRA can use debt leverage on a rehab, it makes no mention of UDFI which also triggers UBIT (unless debt is paid off 365 days before sale). As I have mentioned in the past, unfortunately, find details are often missing from TPA’s such as ETC. 
 
Advisor: It seems like there is a lot of mis information and confusion out there regarding the subject.  I certainly appreciate your thoughts, time and any information you can cite to help us clear this up.  Please note that am not asking for advice-just information on where we can find facts in regards to this subject. 

Quincy: I think you’re trying to over analyze this and impose rationality and reason on the US government, which is of course quite impossible.  Step back and ask yourself one question while forgetting entirely about the IRA aspect of it – would note flipping be considered a trade or business if you did it personally?  If the answer is yes, then it is, by definition, a trade or business within the IRA as well, and it will generate UBIT, assuming it is “regularly carried on.”  If the answer is no, then it should not generate UBIT.  Whether something else like day trading stocks is or isn’t a trade or business is irrelevant.  You are focusing on the IRA aspect of it when you should be focusing on whether or not it is a trade or business.  In general terms, anything that you buy as “inventory” for resale to the public is going to be considered a trade or business, whether it is real estate, notes, widgets or anything else.  Unfortunately, the standard of when you cross the line from being an investor to being in a trade or business is fuzzy at best and depends on many factors.  Oh well, that’s the world we live in.

I have attached my short paper on UBIT.  You may also find more information on UBIT in IRS Publication 598.  The Internal Revenue Code sections dealing with UBIT are 26 USC 511-514.  I hope that helps some.  Good luck!

Advisor: Thank you for taking the time to help me out with this.  It seems to me that it is best to err on the side of caution with this since the penalties can be so steep.  I see a lot of guys buying and flipping homes in IRA’s.  These guys are considered “Dealers” because they also buy and flip properties outside of IRA’s.  I would say since these are bought with the intention of immediately offering them for sale to the public that they would then be subject to UBIT.  The same would hold tru for a note that is immediately flipped. 

When you say “regulatory carried on,” do you mean this is something you do inside the IRA X amount of times per year, X amount of times during the life if the IRA?  

Quincy: Review Page 3 of IRS Publication 598, which states:  “Business activities of an exempt organization ordinarily are considered regularly carried on if they show a frequency and continuity, and are pursued in a manner similar to comparable commercial activities of nonexempt organizations.”  An example is given in the publication.  I agree that intent is very important.  I’m not sure that an occasional flip in an IRA among many other investments will cause UBIT, but certainly if that’s all that the IRA invests in and the IRA owner also flips properties outside of his or her IRA that would weigh heavily in the consideration of whether the IRA had dealer income.  While IRAs are very rarely audited, it is always important to give the IRS what they are due, because they have what it takes to take what you have. 

One thing I would caution you about is not to confuse the payment of UBIT with the penalties associated with prohibited transactions.  It is perfectly legal to make investments which subject your IRA to taxation, but if you do a prohibited transaction it blows up your entire IRA and you and others may owe excise taxes and penalties as well.  The two subjects are completely separate, but many people, even educated ones, get them mixed together in their minds.

Question: I recently opened a traditional IRA with your office.

 Before I direct Quest to invest the money in “ABC Realty LLC”, I want to make sure I understand what I can and can not do as a realtor as it relates to providing services to the LLC (ABC Realty LLC) of which my IRA will be a member investor.

FYI – We have set up the LLC so that my brother, who is a non-IRA investor, is the ‘managing member’ of “ABC Realty LLC”. He is the only one who will have signature authority to sign contracts, issue checks, etc…

“ABC Realty LLC” is planning to flip single family homes. When the homes are purchased and certainly when they are ready to be sold, can I, as a licensed realtor, list the homes and represent “ABC Realty LLC” in negotiations as long as I do not receive any compensation or commission?

Thank you and kindest regards.

Answer: First, let me make it clear that, as indicated below, Quest cannot give you tax, legal or investment advice.  While we strive to provide the best education possible for our clients, we cannot play the role of advisor, since these are self-directed IRAs.

 You ask a very good question to which there is no clear answer.  The conservative approach would be to avoid acting as the agent for property to be purchased or sold by ABC Realty LLC.  The problem is that one of the prohibited transactions in Internal Revenue Code Section 4975(c) is that you cannot directly or indirectly provide “goods, services, or facilities” between a plan and a disqualified person.  Where the line is between your duties as a fiduciary to your IRA and the prohibition against providing services is I cannot tell you.  It is possible also that the IRS might consider your brokerage activity as an excess contribution under Internal Revenue Code Section 4973. That seems to be a favored technique of the IRS these days.  The problem may be exacerbated by your naming of the LLC, since it contains your last name.  I assume your brother’s last name is the same also?

 As you correctly state below, under no circumstances can you receive compensation for anything you do relating to your IRA’s investment activity.

 Remember, any and all expenses for your IRA’s investments must come from the IRA and any income must go to the IRA.  Neither you nor any other disqualified person may benefit from the IRA’s investments, other than of course when you take a distribution from the IRA.  All transactions must be on an arms-length basis.

 Finally, you mentioned that the LLC will flip single family homes.  Depending on your volume and the way you handle it, such activity may be considered Unrelated Business Income which may subject the IRA’s profits to taxation, even though the IRA is normally tax exempt.  You may find out more information on this topic in IRS Publication 598.  Also, I have attached some information on the subject for your review.

 I’m sorry that I am unable to give you clear, definitive answers or any tax, legal or investment advice.  I wish you the best of luck with your investments.  Have a great day!

Self-directed IRAs and 401(k) plans have been around for more than 25 years.  There are currently billions of dollars in self-directed retirement plans.  Do you know how to unlock your retirement funds and those of your clients for real estate related investments, including loans secured by real estate?  Your knowledge of self-directed retirement plans can help make you money now as well as ensuring that you retire in style.

             7 types of plans which can be self-directed.  There are seven different types of plans which can be self-directed, each of which may be invested in real estate secured loans and other non-traditional investments.  They are the Roth IRA, the Traditional IRA, the SEP IRA, the SIMPLE IRA, the Individual 401(k) Plan, the Coverdell Education Savings Account (ESA), and the Health Savings Account (HSA).

             Endless investment possibilities for self-directed IRAs.  Self-directed IRAs and other plans may invest in a wide variety of non-traditional investments, including real estate secured loans, loans secured by collateral other than real estate, unsecured loans, real estate of all types, options, and private company ownership, including limited liability companies, limited partnerships, and non-publicly traded stock in corporations.  If title can be held to an asset, it can likely be held in a self-directed IRA.  This is because the IRS only tells you what you cannot invest in within an IRA (life insurance and collectibles), not what you can invest in.  With few exceptions, the only limitation is your imagination!

             Restrictions on what you can do with your IRA.  Although as noted above there are very few investment restrictions, certain transactions (as opposed to investments) are considered to be prohibited.  If your IRA enters into a prohibited transaction, there are severe consequences, so it is important to understand what constitutes a prohibited transaction.  Essentially, the prohibited transaction rules were written to discourage certain persons, called disqualified persons, from dealing with the income and assets of the plan in a self-dealing manner.  Disqualified persons to your IRA include, among others, yourself, your spouse, your parents and other lineal ascendants, your kids and other lineal descendants and their spouses, and any corporation, partnership trust or estate which is owned or controlled by any combination of these persons.  Lending money from your IRA to any disqualified person is included within the definition of a prohibited transaction.

             How you can use knowledge of self-directed IRAs to make more money today and to secure your future retirement.  Although you cannot use your own IRA to make more money for yourself now (unless you are over age 59 1/2 and can take distributions), there is nothing prohibiting you from making money using OPI – Other People’s IRAs.  As a professional in the lending industry there might be a number of ways you can do this.  First, if you are a real estate investor yourself, you may borrow OPI to fund your real estate deals.  This is an especially powerful tool for acquiring real estate which may need some fixing up.  After the property is fixed up, you can refinance into a permanent loan or sell the property.  Second, you can assist your loan customers in getting bridge loans from self-directed IRAs on properties for the purchase and repair, then set yourself up as a refinance lender.  This is a direct way to put money in your pocket now from arranging the refinance loan and possibly even the IRA loan, depending on the law where you live.  Many lending professionals use this technique to generate business for themselves.  Dealing with savvy real estate investors can lead to multiple loans for them as well as for their buyers when the properties are resold. 

             Ignorance may be bliss to some people, but it will not make you wealthy.  In this extremely competitive market, you owe it to yourself to learn about and utilize whatever techniques there are to generate a steady stream of quality clientele.  The more you know, the better you look as a lending professional, which in turn generates more and better business for you.  Between the advantages of using OPI to generate more business and income for yourself today and self-directing your own retirement accounts into something which you know and work with everyday for income in your retirement, there are very few tools out there today more powerful than the self-directed IRA.

Question: I have a self directed traditional IRA with a custodian that allows private placement investments.

I would like to invest some of the IRA in an early stage S-Corp, initially as a 1 year unsecured convertible note at 8% interest that then converts into common stock once the company turns into a C-Corp (this will likely be a Series A VC event).

In doing diligence on the company I have found that it is not only attractive as an investment, but I am also a perfect fit for it and they agree and want to hire me.

Can I invest $100K via my IRA and take about 2.5% ownership in the company (no other disqualified parties have any relationship with the company), then become an employee, or would this be considered benefitting me and therefore a prohibited transaction? If so, I have to choose being becoming an investor or an employee, but I want both.

I believe it is an excellent investment as well as job opportunity. I would not be “buying” my employment, it’s a great fit. It would be a fabulous job, love to do it and work with some great people on a very worthy vision and business. If important info, none of us are getting paid for the first few months as all money is going into product and biz dev.

Answer: Thank you for your question.  In my view you would certainly be taking a risk by having your IRA invest as you suggest in your question.  You appear to be well informed of the issues, but allow me to clarify them just in case.  First of all, as I’m sure you know the corporation would not be a disqualified person as to your IRA since no disqualified person would own 50% or more of the corporate stock.  That’s the good news.  On the other hand, you personally are a disqualified person (fiduciary) as to your own IRA, so any investment that you make with your IRA which either directly or indirectly benefits you (other than as a beneficiary of the IRA) could be considered a prohibited transaction.  Additionally, the corporation would likely be considered to be a person in whom you have an interest which would affect your best judgment as a fiduciary for your IRA.  If you do want to proceed with this investment after consulting with a lawyer familiar with the prohibited transaction rules, you will want to open a separate IRA in case the transaction is later determined to be a prohibited transaction.

I have attached a paper I presented at a boot camp on IRA owned entities last year (found at www.questira.com).  Although much of the material is not relevant to your question, there are a number of cases which may be useful to you and your attorney in helping to understand the issues with this transaction. You may want to review Section XII of the paper and the Advisory Opinion Letter 89-03A in Appendix 13. While not directly on point, it does show the sensitivity of the issue of investing in a company where you work. I wish you the best of luck.  Let me know if I can answer any more questions for you.  Have a great day!

Question: My question didn’t get to you timely at RICH on Saturday. Here it is:

We lost our manager who was collecting rents and note payments for each of our ROTH IRAs (husband and I). I it okay to pay a friend to do this for me? If so, is there a special kind of a bank account we should utilize, similar to the kind that attorneys use to hold other people’s money? Our concern is that should something happen to our friend, what will happen to our funds, etc.? We want to foresee any unfortunate circumstances. Thank you for making yourself available for our questions

Answer: Thank you for your question.  It is permissible for you to have the payments sent directly to your account here at Quest IRA if you like.  We process many incoming payments each day, and the online system is updated nightly so that you can verify what has been deposited, as well there is an email notification that will be sent to the email associated with your account as Quest IRA for every transaction.  You are right to be concerned about who handles your precious IRA monies.  If you choose to have a non-disqualified party collect the funds, pay any bills for your real estate, etc., that is fine from an IRA standpoint.  The manager can then simply remit the net proceeds to Quest IRA for deposit into your IRAs.  To manage real estate, the person may need to be licensed by the Texas Real Estate Commission, assuming your rental real estate is in Texas.  These professionals typically have a trust account into which they place the rental payments.  There are also companies which service notes.  In either of these cases, you will want to inquire whether they have errors and omissions and fidelity bond coverage, like we do.  Since I am not in the business of managing real estate and/or servicing notes, I do not know how common that type of insurance coverage is for the people and companies who perform these services. I hope that helps.  Have a wonderful day!