Tag Archives: Debt Leverage

Self-Directed IRA & Qualified Plan Information, Self-Directed Roth IRA, Self-Directed Traditional IRAs

Does Flipping Notes, Loans or Homes Create UBIT?

Conversation Between 2 Persons: Gentleman, The debate continues:)  I actually have an account with ….  I use this company website as a resource: 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.

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

Person 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?

Person 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?

Person 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 Equity Trust.

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’s Answer: 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!

Full H. Quincy Long UBIT White Paper

Person 2: Thank you for taking the time to help me out with this.  It seems to me that it is best t 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’s Answer: 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.

Self-Directed 401(k), Self-Directed Traditional IRAs

Using Self-Directed IRAs and 401(k)s to More Money Now and to Build Your Retirement Wealth for the Future

By H. Quincy Long

            Self-directed IRAs and 401(k) plans have been around for more than 25 years, but many people are just now becoming aware of how powerful this idea can be.  There are currently trillions of dollars in retirement plans.  Do you know how to unlock your own retirement funds as well as the retirement funds of those within your circle of influence for real estate related and other non-traditional investments?  Your knowledge of self-directed retirement plans can help make you money now as well as ensuring that you retire in style.

            Plans available for self-direction.  A lot of retirement wealth is in traditional IRAs and employer sponsored plans.  If you leave an employer, the funds in the employer plan can be moved into a self-directed traditional IRA.  This includes money rolled over from 401(k) plans, 403(b) plans, 457 deferred compensation plans, and the federal thrift savings plan.  Self-employed people may have their own Individual 401(k) plan, which may even include the new Roth 401(k), no matter what their income level.  Other employer sponsored plans which can be self-directed are SEP IRAs and SIMPLE IRAs.

            The king of all IRAs when it comes to building tax free wealth is the Roth IRA.  Even if you do not qualify for a Roth IRA due to income limitations currently, in 2010 the income limitation for conversions from a traditional IRA to a Roth IRA will be eliminated.  At that point even the very wealthy will be entitled to have a Roth IRA.  This is a great planning opportunity.

            How does paying for your child’s education or your health care expenses with tax free income sound?  You can even self-direct a Coverdell Education Savings Account (ESA) or a Health Savings Account (HSA), and as long as distributions are for qualified education or health care expenses they are TAX FREE FOREVER.  With an HSA you even get a tax deduction for putting the money in!

            Perhaps the best news of all is that you may combine your IRAs and other self-directed plans to make non-traditional investments.  Even better, you can invest your IRAs with other people’s IRAs or even non-IRA money of people you know.  The key element is that you must have your plans administered at a self-directed IRA company like Quest IRA, Inc.

            Make money now.  We have all heard that knowledge is power.  Your knowledge of self-directed retirement plans can translate into money in your pocket today.  How?  It’s easy!  While it is true that you may not derive a current benefit from your own IRA’s investments, this does not mean that you cannot benefit right now from Other People’s IRAs (OPI).  Simply become knowledgeable about self-directed plans by reading books and attending seminars or workshops, then spread the good news!

            Quest IRA, Inc has many seminars and workshops to help you and those whose IRAs you want to use to make money for yourself.  There are also numerous books on the market explaining the power of self-directed retirement plans, such as Hubert Bromma’s “Investing in Real Estate With Your IRA and 401(k)” which are selling quickly.  For more information on seminars and workshops in your area, visit the Quest IRA website at www.QuestIRA.com  Even if you don’t have a dime of retirement funds yourself, you can use your knowledge to:

            *          Borrow other people’s IRA money to do your deals today

            *          Sell real estate, notes or other non-traditional assets to people’s IRAs

*          Make others aware of an opportunity to invest in your business (always be aware of securities laws when raising money)

            Anytime you go to a gathering of people, there are most likely millions of dollars available for non-traditional investments in their retirement plans.  It is up to you to let people know about this powerful tool, and how they can take some or all of that anemic money and put it to work in a way that benefits both you and them.  You will look highly intelligent and will inspire confidence with your advanced knowledge.  You owe it to yourself to learn more today.  Quest IRA, Inc. can help.

            Invest your own IRA in what you know best.  With all your knowledge of self-directed IRAs, you will most likely want to invest your own retirement funds in non-traditional investments as well.  What investments do you know the most about?  Almost without exception, you can invest in what you know best with your own IRA.  The law contains very few investment restrictions for retirement plans, but most custodians refuse to allow IRAs to invest in non-traditional investments such as real estate simply because they are not set up to handle them.  Not true with Quest IRA, Inc.!

            Quest IRA, Inc. self-directed retirement plans are under the same laws as plans at any other custodian or administrator.  We are simply more flexible when it comes to administering non-traditional investments in your IRA or other self-directed plan.  Quest IRA, Inc. clients have used their retirement plans to purchase all of the following and much more:  real estate, both foreign and domestic, including debt leveraged real estate, real estate options, loans secured by real estate, unsecured loans, limited partnership interests, limited liability company shares, stock in non-publicly traded corporations, land trusts, factored invoices (including factored real estate commissions), tax lien certificates, foreclosure property, joint ventures, oil and gas interests and even race horse colts!  You are limited only by your imagination.

Ignorance may be bliss, but it will not make you wealthy.  Use your knowledge of self-directed IRAs to make money now, to help others build their retirement wealth as well as your own, and to retire in the style and comfort in which you would like to become accustomed.  Contact Quest IRA, Inc. today!

Self-Directed Roth IRA, Self-Directed Traditional IRAs

The Truth About Self-Directed IRAs and Other Accounts

By H. Quincy Long

There is a lot of confusion over self-directed IRAs and what is and is not possible.In this article we will disprove some of the more common self-directed IRA myths.

Myth #1 – Purchasing anything other than CDs, stocks, mutual funds or annuities is illegal in an IRA.

Truth:The only prohibitions contained in the Internal Revenue Code for IRAs are investments in life insurance contracts and in “collectibles”, which are defined to include any work of art, any rug or antique, any metal or gem (with certain exceptions for gold, silver, platinum or palladium bullion), any stamp or coin (with certain exceptions for gold, silver, or platinum coins issued by the United States or under the laws of any State), any alcoholic beverage, or any other tangible personal property specified by the Secretary of the Treasury (no other property has been specified as of this date).

Since there are so few restrictions contained in the law, almost anything else which can be documented can be purchased in your IRA.A “self-directed” IRA allows any investment not expressly prohibited by law.Common investment choices include real estate, both domestic and foreign, options, secured and unsecured notes, including first and second liens against real estate, C corporation stock, limited liability companies, limited partnerships, trusts and a whole lot more.

Myth #2 – Only Roth IRAs can be self-directed.

Truth: Because of the power of tax free wealth accumulation in a self-directed Roth IRA, many articles are written on how to use a Roth IRA to invest in non-traditional investments.As a result, it is a surprisingly common misconception that a Roth IRA is the only account which can be self-directed.In fact, there are seven different types of accounts which can be self-directed.They are the 1) Roth IRA, 2) the Traditional IRA, 3) the SEP IRA, 4) the SIMPLE IRA, 5) the Individual 401(k), including the Roth 401(k), 6) the Coverdell Education Savings Account (ESA, formerly known as the Education IRA), and 7) the Health Savings Account (HSA).Not only can all of these accounts invest in non-traditional investments as indicated in Myth #1, but they can be combined together to purchase a single investment.

Myth #3 – I don’t qualify for a self-directed Roth or Traditional IRA because I am covered by a retirement plan at work or because I make too much money.

Truth:Almost anyone can have a self-directed account of some type.Although there are income limits for contributing to a Roth IRA (in 2008 the income limits are $169,000 for a married couple filing jointly and $116,000 for a single person or head of household), having a plan at work does not affect your ability to contribute to a Roth IRA, and there is no age limit either.With a Traditional IRA, you or your spouse having a retirement plan at work does affect the deductibility of your contribution, but anyone with earned income who is under age 70 1/2 can contribute to a Traditional IRA.There are no upper income limits for contributing to a Traditional IRA.Also, a Traditional IRA can receive funds from a prior employer’s 401(k) or other qualified plan.Additionally, you may be able to contribute to a Coverdell ESA for your children or grandchildren, nieces, nephews or even my children, if you are so inclined.If you have the right type of health insurance, called a High Deductible Health Plan, you can contribute to an HSA regardless of your income level.With an HSA, you may deduct your contributions to the account and qualified distributions are tax free forever!It’s the best of both worlds.All of this is in addition to any retirement plan you have at your job or for your self-employed business.

Myth #4 – I can’t have a self-directed 401(k) plan for my business because I am self-employed and file a Schedule C for my income.

Truth:You can have a self-directed SEP IRA, a SIMPLE IRA or a 401(k) plan even if you are self-employed and file your income on Schedule C of your personal tax return.With a SEP IRA, you can contribute up to 20% of your net earnings from self-employment (calculated by deducting one-half of your self-employment tax from your net profits as shown on Schedule C) or 25% of your wages from an employer, up to a maximum of $46,000 for 2008.With the SIMPLE IRA, you can defer up to the first $10,500 of your net earnings from self-employment (calculated by multiplying your net Schedule C income by 0.9235% for SIMPLE IRA purposes), plus an additional $2,500 of your net earnings if you are age 50 by the end of the year, plus you can contribute an additional 3% of your net earnings as an employer contribution.Beginning in 2002 even self-employed persons are entitled to have their own 401(k) plan.Better yet, in 2006 the Roth 401(k) was added, allowing even high income earners to contribute after tax dollars into an account where qualified distributions are tax free forever!With an Individual 401(k) you can defer up to $15,500 (for 2007 and 2008) of your net earnings from self-employment (calculated by deducting one-half of your self-employment tax from your net profits as shown on Schedule C), plus an additional $5,000 of your net earnings if you reach age 50 by the end of the year, plus you can contribute as much as an additional $30,500 based on up to 20% of your net earnings for2008 (or 25% of your wages from an employer).This means that a 50 plus year old self-employed person can contribute up to $51,000 for 2008!

Myth #5 – Because I have a small IRA and can only contribute $5,000, it’s not worth having a self-directed IRA.

Truth:Even small balance accounts can participate in non-traditional investing.Small balance accounts can be co-invested with larger accounts owned by you or even other people.For example, one recent hard money loan we funded had 10 different accounts participating.The smallest account to participate was for only $1,827.00!There are at least 4 ways you can participate in real estate investment even with a small IRA.First, you can wholesale property.You simply put the contract in the name of your IRA instead of your name.The earnest money comes from the IRA.When you assign the contract, the assignment fee goes back into your IRA.If using a Roth IRA, this profit is tax-free forever!Second, you can purchase an option on real estate, which then can be either exercised, assigned to a third party, or canceled for a fee.Third, you can purchase property in your IRA subject to existing financing or with a non-recourse loan from a bank, a hard money lender, a financial friend or a motivated seller.Profits from debt-financed property in your IRA may incur unrelated business income tax (UBIT), however.Finally, as mentioned above, your IRA can be a partner with other IRA or non-IRA investors.

Myth # 6 – If I want to purchase non-traditional investments in an IRA, I must first establish an LLC which will be owned by my IRA.

Truth:A very popular idea in the marketplace right now is that you can invest your IRA in an LLC where you (the IRA owner) are the manager of the LLC.Effectively you have “checkbook control” of your IRA funds.Providers generally charge thousands of dollars to set up these LLCs and sometimes mislead people into thinking that this is necessary to invest in real estate or other non-traditional investments.This is simply not true.Not only can an IRA hold title to real estate and other non-traditional investments directly with companies such as Quest IRA, Inc., but having “checkbook control” of your IRA funds through an LLC can lead to many traps for the unwary.Far from protecting your IRA from the prohibited transaction rules, these setups may in fact lead to an inadvertent prohibited transaction, which may cause your IRA to be distributed to you, sometimes with substantial penalties.This is not to say that there are not times when having your IRA make an investment through an LLC is a good idea, especially for asset protection purposes.Nonetheless, you must educate yourself completely as to the rules before deciding on this route.Having a “checkbook control” IRA owned LLC is kind of like skydiving without a parachute – it may be fun on the way down, but eventually you are likely to go SPLAT!

Myth #7 – I can borrow money from my IRA to purchase a vacation home for myself.

Truth:Although the Internal Revenue Code lists 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 made to discourage disqualified persons from dealing with the assets of the plan in a self-dealing manner, either directly or indirectly. The assets of a plan are to be invested in a manner which benefits the plan itself and not the IRA owner (other than as a beneficiary of the IRA) or any other disqualified person.Investment transactions are supposed to be on an arms length basis.

As a result of these legal restrictions, a loan from your IRA or staying at a vacation home owned by your IRA, even if fair market rates are paid for interest or rent, would be prohibited.

Myth #8 – With a self-directed IRA, I can borrow my IRA funds to purchase real estate and then put all the profits back into the IRA.

Truth:When real estate or any other asset is purchased within a self-directed IRA, the money never leaves the IRA at all.Instead, the IRA exchanges cash for the asset, in the same way that an IRA at a brokerage house exchanges cash for shares of stock or a mutual fund.Therefore, the asset must be held in the name of the IRA.For example, if Max N. Vestor were to purchase an investment house in his self-directed IRA, the title would be held as “Quest IRA, Inc. FBO Max N. Vestor IRA #12345-11.”Since the IRA owns the asset, all expenses associated with the asset must be paid by the IRA and all profit resulting from that investment belongs to the IRA, including rents received and gains from the sale of the asset.

Myth #9 – If my IRA buys real estate, it must pay all cash for the property.An IRA cannot buy real estate with debt.

Truth:An IRA can own debt-financed property, either directly or indirectly through a non-taxed entity such as an LLC or partnership.Any debt must be non-recourse to the IRA and to any disqualified person.An IRA may have to pay Unrelated Debt Financed Income Tax (UDFIT) on its profits from debt-financed property.In general, taxes must be paid on profits from an IRA-owned property that is debt-financed, including profits from the sale or disposition of the property, in the same proportion that it had debt.For a simplified example, if the IRA puts 50% down, then 50% of its profits above $1,000 will be taxable.Although at first this sounds terrible, in fact leverage can be an extremely powerful tool in building your retirement wealth.The same leverage principle applies inside or outside of your IRA – you can do more with debt-financing than you can without it.One client was able to build her Roth IRA from $3,000 to over $33,000 in less than 4 months even after paying the taxes due by taking over a property subject to a debt and selling the property to another investor!

Myth #10 – An IRA cannot own a business.

Truth:A self-directed IRA is an amazingly flexible wealth building tool and can own almost anything, including a business.However, due to the conflict of interest rules you cannot work for a business owned by your IRA and get paid.Some companies have a plan to start a C corporation, adopt a 401(k) plan, roll an IRA into the 401(k) plan and purchase employer securities to effectively start a new business, but this is not a direct investment by the IRA in the business and is fairly expensive to set up.Also, if your IRA owns an interest in a business, either directly or indirectly through a non-taxed entity such as an LLC or partnership, the IRA may owe Unrelated Business Income Tax (UBIT) on its profits from the business.A solution to this problem may be to have the business owned by a C corporation or another taxable entity.

Self-Directed Roth IRA

Preparing for 2010: Converting your Traditional IRA Assets to a Roth

Preparing for 2010:
Converting your Traditional IRA Assets to a Roth
by Hubert Bromma, CEO of Entrust
As we face an ailing U.S. economy bombarded by the subprime crisis, the rising cost of oil and the products that depend on it, and an expensive, ill-advised war, there is the opportunity for investors to profit from long-term gains at the expense of current economic problems. However, in the context of these current economic conditions, IRA holders can look toward the future and can take advantage of a change to the tax law that takes affect in 2010.

In 2010, regardless of your income, you can convert your traditional IRA assets to Roth IRA assets. Under the current law, you cannot convert a traditional IRA to a Roth if your adjusted gross income (AGI) exceeds $100,000. If any of your assets are currently undervalued, 2010 could be a great opportunity to convert your funds. The  assets will be taxed based on their fair market value as of December 31, 2010, and you also have the option of paying your tax bill over two years. You can pay the tax with cash outside of the IRA, which preserves your IRA assets. After the tax is paid, your earnings will never be taxed again.

Roth IRAs offer the added benefit that there are no required distributions. Unlike a traditional IRA, which requires that you begin taking minimum distributions starting at age 70½, with a Roth, you can let your assets sit and continue to grow. In a time when people work longer, you can amass wealth in a non-taxed environment for as long as you want.

Because you can convert as much or as little of your IRA as you want, you can choose to convert only the assets that have a current low value but that you anticipate having more value in the future. For example, if your self-directed IRA has real property that has been decreasing in value in today’s market but you expect a turnaround, that asset may be ideal to convert at the current fair market value.
Fair Market Value
Neither the Internal Revenue Code nor IRS regulations provide a general definition of fair market value for income tax purposes. The IRS regulations, however, use the following definition in connection with specific income tax issues as well as for estate and gift taxes:“The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.”

This is the definition adopted for purposes of valuing charitable contributions of property,pension plan assets,and real property interests disposed of by nonresident aliens and foreign corporations.The courts have also followed this definition when addressing tax issues.

You must determine the fair market value before converting your traditional, pre-taxed assets to Roth, post-taxed assets. This value is used to compute the federal tax, and possibly state tax, that you owe. The best way to establish the fair market value is through a qualified appraiser. The appraiser must have an arms-length relationship with the taxpayer and the asset. The IRS might also accept a recent bona fide offer from a third party who is not considered disqualified under IRS regulations involving IRAs and qualified retirement plans.

Debt-financed assets, such as real estate, must be valued at net asset value. This means that the fair market value subtracts the amount of debt remaining after the date of the appraisal or valuation. Private placements should be assessed by persons or firms qualified to make such appraisals. Cash, stocks and bonds, and publicly traded assets use the established values on the date required for valuation.
Plan Ahead to Minimize Tax and Maximize Gain

The object is to pay as little tax as is legally required and to pay the tax with non-IRA funds, thus preserving the funds that are never be taxed again. If you can, convert as much as possible, concentrating on assets that have the highest potential of future appreciation or income within your time horizon.Tax planning with a professional is always a good idea, but especially so in 2010 if you want to take full advantage of the new law. The amount you convert is added to your income for 2010, and your tax is calculated on your total adjusted gross income. So in 2010, it behooves you to have as little income as possible and plenty of losses. You can also spread the tax burden and pay part in 2011 and 2012.

After you have converted the asset, you can withdraw all or part of it at any time without paying federal taxes if you are at least 59½ years old. However, you may owe state tax. States differ on how assets in IRAs are taxed, and you should make sure that your have adhered to your state’s tax requirements.

The biggest question you have to think about is how well is your crystal ball working; how well can you and your tax advisors foretell your economic and tax-paying future?
Clearly, the more flexibility that you have and the more time that you have will give you more opportunity for appreciation and improve the possibility of the conversion paying for itself. But if past history and inflationary pressures are any indication, if , for example, your real estate investment is valued at 35% less than when your IRA purchased it, the increase in value over time should not only make up the 35% but even more. So converting now at its lowest fair market value may be a wise investment.
Doing The Numbers

It can be daunting to figure out the tax implications when taking inflation and cost of living indicators into account. If your property is in a traditional IRA, when you take distributions, which remember are required, you pay tax on that property at your ordinary income tax rate. Some pundits suggest that your tax rate will be lower when you are older and retire. This may be, but tax rates have hardly decreased over time.Just to take a simple case, let’s say your property has a fair market value of $100,000 today. If the property appreciates as a result of inflation by 2.5% annually over 20 years, the fair market value will be $163,000. You will be paying tax on an asset valued at least 63% higher just due to inflation. Paying tax in 20 years at 35% leaves you with a property worth about $106,000, without taking into consideration any gain as a result of appreciation.

Your cost of living may also increase at a nominal annual rate of 3.5%, based on current rates. That means you have to make up the difference between the fair market value of the property and what your real cost of living is on the amount that you need to live on, or $199,000. In this scenario, you need the property to appreciate to at least $306,000. Tax on $306,000 is $107,000, leaving you with the $199,000 that you need to just break even with the original fair market value. So in this case, you hope for either better appreciation or lower taxes.

The income on the property also plays a big role over time. Let’s say that your property has a 7% net operating income annually. Over 20 years, that equals about $314,000. You also invest the income in money markets that make 4%, adding another $15,000. So when you add your $329,000 in income over 20 years to the fair market value of $306,000, you end up with an IRA worth $635,000! Tax on a distribution of $635,000 at the rate of 35% is about $222,000, leaving you with $413,000, a little more than twice as much than the IRA had in real dollar terms.

If you had paid the tax with money outside the IRA in 2010, you would pay $35,000 (35%) on the $100,000 fair market value. Taking into account how much you could have made on the tax you paid in 2010 over 20 years-we’re using 14.8% compounded annually, which totals about $553,000-and adding that to the $413,000 in the above scenario, your IRA is valued at nearly $628,000 ($996,000 taxed at 35%) rather than $635,000. But that money does not get taxed on distribution. You end up with $628,000 and not $413,000.
Is It Worth It?

In summary, if you pay tax in 2010 on a low cost basis, the outcome in the long term can be substantially better if your assets earn a good return and they appreciate in value. If you expect very high appreciation and income, converting to a Roth IRA in 2010 could be profitable. Most importantly, do the numbers with the advice and input of competent accounting and tax professionals. And you also need to think about paying taxes 20 years from now. In our example, the tax bite is $338,000 in 20 years, not $35,000 in 2010. Keep in mind that you can spread the tax over two years. If you plan now, you can possibly minimize your tax burden by managing your income and losses. But who knows, the value of dollar may be relatively the same and render the question moot.
Self-Directed Roth IRA, Self-Directed Traditional IRAs

Option Strategies for Your IRA

Many people would like to buy real estate in their IRAs but have a mistaken belief that they do not have enough money to do so.  Nothing could be further from the truth!  You may invest in real estate with your IRA without a lot of money in several ways, including partnering with other IRAs or non-IRA money, buying property with debt, or by using one of the most powerful and under utilized tools in real estate investing today – the option.

In this article we will focus on some option basics.  First, what is an option?  Once consideration for the option is paid, it is the owner’s irrevocable offer to sell the property to a buyer under the terms of the option for a certain period of time.  The buyer has the right but not the obligation to buy.

You might wonder why an owner would agree to tie up his property with an option.  Advantages to a property owner include:  1) the owner may be able to time his income for tax purposes, since option fees are generally taxable when the option is either exercised or expires (always check with your tax advisor); 2) if the owner needs money, an option may be a way to get money that he doesn’t have to repay, unlike a loan; 3) options are very flexible, and the owner may be able to negotiate an option which allows him to keep the property until a more opportune time – this is especially true of an owner in a pre-foreclosure situation.

Do the paperwork right!  Options are extremely powerful and very easy to mess up.  Be very specific, clear and complete about all the details.  Remember, with options, you have to negotiate for both the option and for the purchase of the property. With a well written option, the following must be, as my old law professor was fond of saying, “patently obvious to the most casual observer”:

a)         Who is granting the option?  Does it include heirs, successors and assigns?
b)         Who is receiving the option?  Does it include assignees of the buyer, or is it an exclusive option to purchase by the buyer only?
c)         What property is being optioned?  Property can be anything, including real estate, a beneficial interest in a land trust, a real estate note or nearly anything else.
d)         What is the consideration for the option?  Remember, there must be some consideration for the option in the form of money, services or other obligations.
e)         How is the option exercised by the buyer?  This is one of the easiest things to mess up in an option.  If the procedure is not clear for exercising the option, it is an invitation to litigation!
f)          What will be the purchase price of the property if the option is exercised?
g)         How will the purchase price be paid when the option is exercised?  Will it be for cash?  Seller financing?  Subject to the owner’s existing mortgage?
h)         Will the option consideration be credited to the option price or not?
i)          When can the option be exercised?  For example, does the option holder have the right to exercise the option at any time during the option period, or can the option only be exercised after a specified amount of time?
j)          When will the option expire, and under what circumstances?  The option should have a definite termination date, but might also include other circumstances under which the option terminates, such as a default under a lease.
k)         When it comes time to close, what are each party’s obligations?  For example, who pays for title insurance, closing costs, etc?  Are taxes prorated?

So what forms do you use?  The answer is my favorite as a lawyer – it depends! There is not and cannot be a “standard” option for all purposes.  They are simply too flexible.  You must decide on a specific use for the option and then, as Shakespeare said, “Get thee to a lawyer!” (Okay, it was “Get thee to a nunnery” but I like it better as revised!).

When you have negotiated an option agreement for your IRA, you have several choices.  First, you can let the option expire on its own terms.  Sometimes this is the best course of action if the deal is not what you expected, especially if you only paid a small amount for the option.

Another choice is that your IRA could exercise the option and buy the property.  Since there are ways to finance property being purchased by your IRA, including seller financing, bank financing, private party financing or even taking over property subject to a loan, this may be a good strategy for your IRA, even if the IRA does not have the cash to complete the purchase.  Be aware that if your IRA owns debt financed property, either directly or indirectly through an LLC or partnership, its profits from that investment will be subject to Unrelated Business Income Tax (UBIT).  This is not necessarily a bad way to build your retirement wealth, but it does require some understanding of the tax implications.

A third choice which is often employed in the context of self directed retirement accounts is to assign your option to a third party for a fee.  Your option agreement should specifically allow for an assignment to make sure that there are no problems with the property owner.  This is a great technique for building a small IRA into a large IRA quickly.  I had one client who put a contract on a burned house for $100 earnest money in his daughter’s Coverdell Education Savings Account, then sold his contract to a third party who specialized in repairing burned houses for $8,500.  In under 1 month the account made a profit of 8,400%, and all parties were happy with the deal!  The account holder then immediately took a TAX FREE distribution to pay for his daughter’s private school tuition.

A fourth choice that sometimes is overlooked is the ability to release the option back to the property owner for a cancellation fee.  In other words, this is a way for your IRA to get paid not to buy! Let me give you an example of how this might work.  Suppose you want to offer the seller what he would consider to be a ridiculously low offer.  When the seller balks, you say “I’ll tell you what.  You sign this option agreement for my IRA to purchase this property at my price, and we’ll put in the option agreement that I cannot exercise my option for 30 days.  If you find a buyer willing to offer you more money within that 30 day period, just reimburse my IRA the option fee plus a cancellation fee of $2,500.”  Either way, your IRA wins!

The creative use of options can make your IRA grow astronomically if done correctly.  In future articles I will be discussing different types of option strategies.

Self-Directed Roth IRA, Self-Directed Traditional IRAs

Wealth Building Options for Your IRA

Many people would like to buy real estate in their IRAs but have a mistaken belief that they do not have enough money to do so.  Nothing could be further from the truth!  You may invest in real estate with your IRA without a lot of money in several ways, including partnering with other IRAs or non-IRA money, buying property with debt, or by using one of the most powerful and under utilized tools in real estate investing today – the option.

In this article we will focus on some option basics.  First, what is an option?  Once consideration for the option is paid, it is the owner’s irrevocable offer to sell the property to a buyer under the terms of the option for a certain period of time.  The buyer has the right but not the obligation to buy.

You might wonder why an owner would agree to tie up his property with an option.  Advantages to a property owner include:  1) the owner may be able to time his income for tax purposes, since option fees are generally taxable when the option is either exercised or expires (always check with your tax advisor); 2) if the owner needs money, an option may be a way to get money that he doesn’t have to repay, unlike a loan; 3) options are very flexible, and the owner may be able to negotiate an option which allows him to keep the property until a more opportune time – this is especially true of an owner in a pre-foreclosure situation.

Do the paperwork right!  Options are extremely powerful and very easy to mess up.  Be very specific, clear and complete about all the details.  Remember, with options, you have to negotiate for both the option and for the purchase of the property. With a well written option, the following must be, as my old law professor was fond of saying, “patently obvious to the most casual observer”:

a)         Who is granting the option?  Does it include heirs, successors and assigns?
b)         Who is receiving the option?  Does it include assignees of the buyer, or is it an exclusive option to purchase by the buyer only?
c)         What property is being optioned?  Property can be anything, including real estate, a beneficial interest in a land trust, a real estate note or nearly anything else.
d)         What is the consideration for the option?  Remember, there must be some consideration for the option in the form of money, services or other obligations.
e)         How is the option exercised by the buyer?  This is one of the easiest things to mess up in an option.  If the procedure is not clear for exercising the option, it is an invitation to litigation!
f)          What will be the purchase price of the property if the option is exercised?
g)         How will the purchase price be paid when the option is exercised?  Will it be for cash?  Seller financing?  Subject to the owner’s existing mortgage?
h)         Will the option consideration be credited to the option price or not?
i)          When can the option be exercised?  For example, does the option holder have the right to exercise the option at any time during the option period, or can the option only be exercised after a specified amount of time?
j)          When will the option expire, and under what circumstances?  The option should have a definite termination date, but might also include other circumstances under which the option terminates, such as a default under a lease.
k)         When it comes time to close, what are each party’s obligations?  For example, who pays for title insurance, closing costs, etc?  Are taxes prorated?

So what forms do you use?  The answer is my favorite as a lawyer – it depends! There is not and cannot be a “standard” option for all purposes.  They are simply too flexible.  You must decide on a specific use for the option and then, as Shakespeare said, “Get thee to a lawyer!” (Okay, it was “Get thee to a nunnery” but I like it better as revised!).

When you have negotiated an option agreement for your IRA, you have several choices.  First, you can let the option expire on its own terms.  Sometimes this is the best course of action if the deal is not what you expected, especially if you only paid a small amount for the option.

Another choice is that your IRA could exercise the option and buy the property.  Since there are ways to finance property being purchased by your IRA, including seller financing, bank financing, private party financing or even taking over property subject to a loan, this may be a good strategy for your IRA, even if the IRA does not have the cash to complete the purchase.  Be aware that if your IRA owns debt financed property, either directly or indirectly through an LLC or partnership, its profits from that investment will be subject to Unrelated Business Income Tax (UBIT).  This is not necessarily a bad way to build your retirement wealth, but it does require some understanding of the tax implications.

A third choice which is often employed in the context of self directed retirement accounts is to assign your option to a third party for a fee.  Your option agreement should specifically allow for an assignment to make sure that there are no problems with the property owner.  This is a great technique for building a small IRA into a large IRA quickly.  I had one client who put a contract on a burned house for $100 earnest money in his daughter’s Coverdell Education Savings Account, then sold his contract to a third party who specialized in repairing burned houses for $8,500.  In under 1 month the account made a profit of 8,400%, and all parties were happy with the deal!  The account holder then immediately took a TAX FREE distribution to pay for his daughter’s private school tuition.

A fourth choice that sometimes is overlooked is the ability to release the option back to the property owner for a cancellation fee.  In other words, this is a way for your IRA to get paid not to buy! Let me give you an example of how this might work.  Suppose you want to offer the seller what he would consider to be a ridiculously low offer.  When the seller balks, you say “I’ll tell you what.  You sign this option agreement for my IRA to purchase this property at my price, and we’ll put in the option agreement that I cannot exercise my option for 30 days.  If you find a buyer willing to offer you more money within that 30 day period, just reimburse my IRA the option fee plus a cancellation fee of $2,500.”  Either way, your IRA wins!

The creative use of options can make your IRA grow astronomically if done correctly.  In future articles I will be discussing different types of option strategies.

Self-Directed Traditional IRAs

The Truth About Self-Directed IRAs and Other Accounts

There is a lot of confusion over self-directed IRAs and what is and is not possible.  In this article we will disprove some of the more common self-directed IRA myths.

Myth #1. Purchasing anything other than CDs, stocks, mutual funds or annuities is illegal in an IRA.

Truth:

The only prohibitions contained in the Internal Revenue Code for IRAs are investments in life insurance contracts and in “collectibles”, which are defined to include any work of art, any rug or antique, any metal or gem (with certain exceptions for gold, silver, platinum or palladium bullion), any stamp or coin (with certain exceptions for gold, silver, or platinum coins issued by the United States or under the laws of any State), any alcoholic beverage, or any other tangible personal property specified by the Secretary of the Treasury (no other property has been specified as of this date).

Since there are so few restrictions contained in the law, almost anything else which can be documented can be purchased in your IRA.  A “self-directed” IRA allows any investment not expressly prohibited by law.  Common investment choices include real estate, both domestic and foreign, options, secured and unsecured notes, including first and second liens against real estate, C corporation stock, limited liability companies, limited partnerships, trusts and a whole lot more.

Myth #2. Only Roth IRAs can be self-directed.

Truth:

Because of the power of tax free wealth accumulation in a self-directed Roth IRA, many articles are written on how to use a Roth IRA to invest in non-traditional investments.  As a result, it is a surprisingly common misconception that a Roth IRA is the only account which can be self-directed.  In fact, there are seven different types of accounts which can be self-directed.  They are the 1) Roth IRA, 2) the Traditional IRA, 3) the SEP IRA, 4) the SIMPLE IRA, 5) the Individual 401(k), including the Roth 401(k), 6) the Coverdell Education Savings Account (ESA, formerly known as the Education IRA), and 7) the Health Savings Account (HSA).  Not only can all of these accounts invest in non-traditional investments as indicated in Myth #1, but they can be combined together to purchase a single investment.
Myth #3. I don’t qualify for a self-directed Roth or Traditional IRA because I am covered by a retirement plan at work or because I make too much money.

Truth:

Almost anyone can have a self-directed account of some type.  Although there are income limits for contributing to a Roth IRA (in 2008 the income limits are $169,000 for a married couple filing jointly and $116,000 for a single person or head of household), having a plan at work does not affect your ability to contribute to a Roth IRA, and there is no age limit either.  With a Traditional IRA, you or your spouse having a retirement plan at work does affect the deductibility of your contribution, but anyone with earned income who is under age 70 1/2 can contribute to a Traditional IRA.  There are no upper income limits for contributing to a Traditional IRA.  Also, a Traditional IRA can receive funds from a prior employer’s 401(k) or other qualified plan.  Additionally, you may be able to contribute to a Coverdell ESA for your children or grandchildren, nieces, nephews or even my children, if you are so inclined.  If you have the right type of health insurance, called a High Deductible Health Plan, you can contribute to an HSA regardless of your income level.  With an HSA, you may deduct your contributions to the account and qualified distributions are tax free forever!  It’s the best of both worlds.  All of this is in addition to any retirement plan you have at your job or for your self-employed business.

Myth #4. I can’t have a self-directed 401(k) plan for my business because I am self-employed and file a Schedule C for my income.

Truth:

You can have a self-directed SEP IRA, a SIMPLE IRA or a 401(k) plan even if you are self-employed and file your income on Schedule C of your personal tax return.  With a SEP IRA, you can contribute up to 20% of your net earnings from self-employment (calculated by deducting one-half of your self-employment tax from your net profits as shown on Schedule C) or 25% of your wages from an employer, up to a maximum of $46,000 for 2008.  With the SIMPLE IRA, you can defer up to the first $10,500 of your net earnings from self-employment (calculated by multiplying your net Schedule C income by 0.9235% for SIMPLE IRA purposes), plus an additional $2,500 of your net earnings if you are age 50 by the end of the year, plus you can contribute an additional 3% of your net earnings as an employer contribution.  Beginning in 2002 even self-employed persons are entitled to have their own 401(k) plan.  Better yet, in 2006 the Roth 401(k) was added, allowing even high income earners to contribute after tax dollars into an account where qualified distributions are tax free forever!  With an Individual 401(k) you can defer up to $15,500 (for 2007 and 2008) of your net earnings from self-employment (calculated by deducting one-half of your self-employment tax from your net profits as shown on Schedule C), plus an additional $5,000 of your net earnings if you reach age 50 by the end of the year, plus you can contribute as much as an additional $30,500 based on up to 20% of your net earnings for 2008 (or 25% of your wages from an employer).  This means that a 50 plus year old self-employed person can contribute up to $51,000 for 2008!
Myth #5. Because I have a small IRA and can only contribute $5,000, it’s not worth having a self-directed IRA.

Truth:

Even small balance accounts can participate in non-traditional investing.  Small balance accounts can be co-invested with larger accounts owned by you or even other people.  For example, one recent hard money loan we funded had 10 different accounts participating.  The smallest account to participate was for only $1,827.00!  There are at least 4 ways you can participate in real estate investment even with a small IRA.  First, you can wholesale property.  You simply put the contract in the name of your IRA instead of your name.  The earnest money comes from the IRA.  When you assign the contract, the assignment fee goes back into your IRA.  If using a Roth IRA, this profit is tax-free forever! Second, you can purchase an option on real estate, which then can be either exercised, assigned to a third party, or canceled for a fee.  Third, you can purchase property in your IRA subject to existing financing or with a non-recourse loan from a bank, a hard money lender, a financial friend or a motivated seller.  Profits from debt-financed property in your IRA may incur unrelated business income tax (UBIT), however.  Finally, as mentioned above, your IRA can be a partner with other IRA or non-IRA investors.

Myth # 6. If I want to purchase non-traditional investments in an IRA, I must first establish an LLC which will be owned by my IRA.

Truth:

A very popular idea in the marketplace right now is that you can invest your IRA in an LLC where you (the IRA owner) are the manager of the LLC.  Effectively you have “checkbook control” of your IRA funds.  Providers generally charge thousands of dollars to set up these LLCs and sometimes mislead people into thinking that this is necessary to invest in real estate or other non-traditional investments.  This is simply not true.  Not only can an IRA hold title to real estate and other non-traditional investments directly with companies such as Quest IRA, Inc., but having “checkbook control” of your IRA funds through an LLC can lead to many traps for the unwary.  Far from protecting your IRA from the prohibited transaction rules, these setups may in fact lead to an inadvertent prohibited transaction, which may cause your IRA to be distributed to you, sometimes with substantial penalties.  This is not to say that there are not times when having your IRA make an investment through an LLC is a good idea, especially for asset protection purposes.  Nonetheless, you must educate yourself completely as to the rules before deciding on this route.  Having a “checkbook control” IRA owned LLC is kind of like skydiving without a parachute – it may be fun on the way down, but eventually you are likely to go SPLAT!
Myth #7. I can borrow money from my IRA to purchase a vacation home for myself.

Truth:

Although the Internal Revenue Code lists 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 made to discourage disqualified persons from dealing with the assets of the plan in a self-dealing manner, either directly or indirectly. The assets of a plan are to be invested in a manner which benefits the plan itself and not the IRA owner (other than as a beneficiary of the IRA) or any other disqualified person.  Investment transactions are supposed to be on an arms length basis.

As a result of these legal restrictions, a loan from your IRA or staying at a vacation home owned by your IRA, even if fair market rates are paid for interest or rent, would be prohibited.

Myth #8. With a self-directed IRA, I can borrow my IRA funds to purchase real estate and then put all the profits back into the IRA.

Truth:

When real estate or any other asset is purchased within a self-directed IRA, the money never leaves the IRA at all.  Instead, the IRA exchanges cash for the asset, in the same way that an IRA at a brokerage house exchanges cash for shares of stock or a mutual fund.  Therefore, the asset must be held in the name of the IRA.  For example, if Max N. Vestor were to purchase an investment house in his self-directed IRA, the title would be held as “Quest IRA, Inc. FBO Max N. Vestor IRA #12345-11.”  Since the IRA owns the asset, all expenses associated with the asset must be paid by the IRA and all profit resulting from that investment belongs to the IRA, including rents received and gains from the sale of the asset.

Myth #9. If my IRA buys real estate, it must pay all cash for the property.  An IRA cannot buy real estate with debt.

Truth:

An IRA can own debt-financed property, either directly or indirectly through a non-taxed entity such as an LLC or partnership.  Any debt must be non-recourse to the IRA and to any disqualified person.  An IRA may have to pay Unrelated Debt Financed Income Tax (UDFIT) on its profits from debt-financed property.  In general, taxes must be paid on profits from an IRA-owned property that is debt-financed, including profits from the sale or disposition of the property, in the same proportion that it had debt.  For a simplified example, if the IRA puts 50% down, then 50% of its profits above $1,000 will be taxable.  Although at first this sounds terrible, in fact leverage can be an extremely powerful tool in building your retirement wealth.  The same leverage principle applies inside or outside of your IRA – you can do more with debt-financing than you can without it.  One client was able to build her Roth IRA from $3,000 to over $33,000 in less than 4 months even after paying the taxes due by taking over a property subject to a debt and selling the property to another investor!

Myth #10. An IRA cannot own a business.

Truth:

A self-directed IRA is an amazingly flexible wealth building tool and can own almost anything, including a business.  However, due to the conflict of interest rules you cannot work for a business owned by your IRA and get paid.  Some companies have a plan to start a C corporation, adopt a 401(k) plan, roll an IRA into the 401(k) plan and purchase employer securities to effectively start a new business, but this is not a direct investment by the IRA in the business and is fairly expensive to set up.  Also, if your IRA owns an interest in a business, either directly or indirectly through a non-taxed entity such as an LLC or partnership, the IRA may owe Unrelated Business Income Tax (UBIT) on its profits from the business.  A solution to this problem may be to have the business owned by a C corporation or another taxable entity.

Health Savings Accounts, Self-Directed 401(k), Self-Directed Roth IRA, Self-Directed Traditional IRAs

How Do I Invest Thee? Let Me Count the Ways!

Many people find it very easy to see the benefits of self-directing their Roth and Traditional IRAs, SEP IRAs, SIMPLE IRAs, Individual 401(k)s, Coverdell Education Savings Accounts (ESAs) and Health Savings Accounts (HSAs) into something other than the same old boring stocks, bonds, annuities and mutual funds.  The central idea of a self-directed IRA is that it gives you total control of your retirement assets.  With a self-directed account you can invest your IRA funds in whatever you know best.

When I spoke recently at John Schaub’s Real Estate All Stars conference in Las Vegas, Nevada, I outlined some of the top strategies our clients have actually used to build their retirement wealth.  A brief description of these strategies is included in this article.  This shows the tremendous flexibility of investing through a self-directed account.

Strategy #1 – Purchasing Rental Real Estate for Cash.  Even the IRS acknowledges on its website that real estate is an acceptable investment for an IRA.  In answering the question “Are there any restrictions on the things I can invest my IRA in?” the IRS includes in its response that “IRA law does not prohibit investing in real estate but trustees are not required to offer real estate as an option.”  One of our clients purchased a 10 unit apartment complex for $330,000 cash.  In April, 2008 his total rent collection was $5,235.  Even after payment of taxes and insurance, his cash on cash return is excellent, and the client believes that the value of the property will increase significantly over time.  A discussion of the relative benefits and disadvantages of owning real estate directly in an IRA is beyond the scope of this article, but for those who know how to successfully invest in real estate it is great to know that real estate is an option for your self-directed account.

Strategy #2 – Purchase, Rehab and Resale of Real Estate.  In this case study, our client decided not to hold onto the real estate purchased with his IRA.  The client received a phone call one evening from an elderly gentleman who said he needed to sell his home quickly because he wanted to move to Dallas with his son.  After a quick phone conversation, it was clear that the price the seller wanted was a bargain even considering the needed repairs.  Our client dropped what he was doing and immediately headed over to the seller’s house with a contract.  The buyer on the contract was our client’s IRA, and of course the earnest money came from the IRA after the client read and approved the contract and submitted it with a buy direction letter to Quest IRA, Inc.  They agreed on a sales price of $101,000.  Approximately $30,000 was spent rehabbing the property with all funds coming from the IRA.  The property was sold 6 months later for $239,000, with a net profit after sales and holding expenses of $94,000!

Strategy #3 – Purchase and Immediate Resale of Real Estate (Flipping).  The previous two examples show the tremendous power of buying real estate for cash with a self-directed IRA.  However, both of these strategies require a significant amount of cash in your account.  How else can you invest in real estate if you have little cash?  One of our clients was able to put a commercial piece of vacant land under contract in his Roth IRA.  The sales price was $503,553.60 after acreage adjustments.  Using his knowledge of what was attractive for a building site, our client was able to negotiate a sales price to a major home improvement store chain for $650,000.  On the day of closing Quest, IRA Inc. received two sets of documents, one for the purchase of the property for $503,553.60 and the other for the sale of the same property for $650,000.  After sales expenses, the IRA netted $146,281.40 from the sale with only the earnest money coming from the account!  A word of caution in this case is that if property is flipped inside of an IRA the IRS may consider this to be Unrelated Business Taxable Income (UBTI), causing the IRA (not the IRA owner) to owe some taxes on the gain.  Even if taxes had to be paid, it is hard to argue that this transaction was not beneficial to the IRA and ultimately the client!  It should also be noted that in this situation everyone involved in the transaction was aware of what everyone else was doing, so there was no “under the table” dealings.

Strategy #4 – Assignments and Options – Getting Paid NOT to Buy!  Another favorite strategy for building tremendous wealth without a significant amount of cash is the use of options and assignments.  One of our clients put a property under contract in his daughter’s Coverdell Education Savings Account for $100.  The sales price was a total of $5,500 because the house had burned down.  The seller was just getting rid of the property for its lot value since he had already received a settlement from the insurance company and had purchased another house.  Our client then used his contacts to find a person who specialized in rehabbing burned out houses.  The new buyer was willing to purchase the property for $14,000 cash.  At closing one month after the contract was signed, the seller received his $5,500 and the Coverdell ESA received an assignment fee of $8,500 right on the settlement statement.  That is an astounding 8,400% return on the $100 investment in only 30 days!  Even better, our client was then able to take a TAX FREE distribution from the account of $3,300 to pay for his 10 year old daughter’s private school tuition.  In a similar transaction, another client’s Roth IRA recently received an assignment fee of $21,000 plus reimbursement of earnest money for a contract.

Strategy #5 – Using the Power of Debt Leveraging.  One of my favorite true stories of building wealth in a Roth IRA involves purchasing property subject to a debt.  If an IRA owns debt-financed property either directly or indirectly through a non-taxed entity such as a partnership or LLC taxed as a partnership, profits from that investment are taxable to the same extent there is debt on the property.  One of our clients used her knowledge of real estate investing and what she learned from a free Quest IRA, Inc. educational seminar to tremendously boost her retirement savings.  After noticing a large house in downtown Houston which was in bad shape but in a great location, our client tracked down the owner in California who was being sued for approximately $97,000 in delinquent taxes on the property.  She negotiated a deal with the seller for her Roth IRA to purchase the property for $75 cash subject to the delinquent taxes.  With closing costs her Roth IRA’s total cash in the transaction was only around $3,000.  Within 4 months she was able to sell the property for a profit to her Roth IRA of $43,500!  Because the property had debt on it and because her Roth IRA sold the property for a short term capital gain, the taxes on the profit were approximately $13,500.  Still, using the power of debt leveraging her Roth IRA was able to achieve a 1,000% return in less than 4 months even after paying Uncle Sam his share of the profits!

Strategy #6 – Hard Money Lending.  Another excellent strategy for building your retirement wealth is through lending.  Loans from IRAs can be made secured by real estate, mobile homes or anything else.  Some people even choose to loan money from their IRAs on an unsecured basis.  As long as the borrower is not a disqualified person to the lending IRA, almost any terms agreed to by the parties are acceptable.  In many states there are limits to the amount of interest that can be charged, and loans must be properly documented, but IRA law does not impose any limits other than the prohibited transaction rules.  For those wanting to avoid the direct ownership of real estate within their IRA, a loan with an equity participation agreement is often used.  Several of my own self-directed accounts combined together recently to make a $25,000, 7 1/2 year, 12% first lien loan against real estate with 6% in points up front.  True, this is not exactly setting the world on fire as far as return on investment goes, but I was very pleased with a safe return on a relatively small amount of cash.  If I get to foreclose on the collateral my accounts should be able to make a substantial profit, since the land securing the loan was appraised at $45,000.  At my office we routinely see hard money loans secured by first liens against real estate with interest at 12%-18% for terms ranging from 3 months to 3 years.

Strategy #7 – Private Placements.  Many of the best opportunities for passive growth of IRAs include the purchase of private limited partnership shares, LLC membership units and private stock which does not trade on the stock market.  Let me give you two examples from my own retirement account investments.  In one case my 401(k) plan invested in a limited partnership which purchased a shopping center in northern Louisiana.  The initial investment was $50,000, and in a little over 2 years the partnership has returned $59,321.  The plan’s remaining equity is estimated as of 12/31/2007 at $31,598 and the return on investment will be around 82%.  Even though the property is debt-financed the taxes on the profit have been almost nothing since the plan has taken advantage of depreciation and all of the normal deductions.  Once your IRA or other plan owes taxes due to debt financing, it gets to deduct a pro rata share of all normal expenses.  Another of my 401(k) plan investments is bank stock of a community bank in Houston, Texas.  The initial shares were sold at $10 per share in February, 2007.  The book value after less than 1 year of operations was $11 per share, and shares have recently been selling to other private investors for as much as $14.25 per share!  That is a great return for a completely passive investment, and when the bank finally sells the shares are expected to sell for well above these amounts.

Strategy #8 – Owning a Business in Your IRA.  One of the most innovative strategies we have seen is the ownership of a business by an IRA.  Although neither you nor any other disqualified person may provide services to or get paid for working at a business owned by your IRA or other self-directed account, this does not mean that your IRA cannot own a business.  Some companies do market the ability for you to start a C corporation, adopt a 401(k) plan, roll your IRA into the plan, and purchase “qualifying employer securities,” but this is different than an IRA owning a business directly.  For example, my Health Savings Account invested $500 for 100% of the shares of a corporation which arranges for hard money loans to investors.  The company is fully licensed as a Texas mortgage broker.  The structure of the company is a C corporation.  Since being a mortgage broker is a business operation, profits from the venture would have been taxable to my HSA if the entity formed to own the business was not taxable itself, and the tax rates for trusts such as IRAs and HSAs are much higher than for corporations.  While normally dividends from C corporations are taxable a second time to the shareholder, dividends paid to an IRA or HSA are tax free as investment income.  The corporation is run by non-disqualified persons who handle the due diligence on the loans and the legal work, as well as by a licensed Texas mortgage broker who sponsors the corporation’s mortgage broker license.

Strategy #9 – Using OPI (Other People’s IRAs) to Make Money Now.  Even if you have not found the investment strategy of your dreams among the strategies discussed in this article, or if you have no IRA or if you are more focused on making money now to live on, your time spent reading this article can still be of great use to you.  For each of the above strategies I have focused on the possibility that your IRA could be the investor.  But what if you are the recipient of the IRA’s investment money?  Are you a real estate investor having a hard time finding funding for your transactions?  If you know people with self-directed IRAs or people who would move their money to a self-directed account, you can borrow their IRA money and virtually create your own private bank!  You can also partner with OPI where the IRA puts up the money and you share in the equity for finding the deal and managing the project.  Simply by explaining to people that they can own real estate in their IRAs you may be able to sell more property, either as a real estate broker or as the seller.  You can even provide financing for your sales by having OPI make loans to your buyers.  Finally, OPI can be a great way to raise capital for your business venture, although you must be aware of and comply with all securities laws.  One bank I know of told me that 42% of their initial capital came from retirement accounts!  Although you cannot use your own retirement account to benefit yourself at present unless you are over age 59 1/2, these are just some of the ways you can use OPI to make money for yourself right now.  A good network is the key to your success.

What I have discussed in this article have been some of the more common investment strategies actually used by our clients.  The only restrictions contained in the Internal Revenue Code are that IRAs cannot invest in life insurance contracts or collectibles.  Almost any other investment that can be documented can be held in a self-directed IRA.  As long as you follow the rules and do not invest in prohibited investments, your only real limitation is your imagination!