Tag Archives: Prohibited Transaction

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

Can my Aunt lend me money out of her IRA?

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Question:

My aunt recently retired and transferred her retirement to a Merrill lynch account. She is going to loan me money for a real estate purchase. Could this be done in a self directed account?

Answer:

Loans may certainly be made from self-directed IRAs, including those secured by real estate.  This is an everyday occurrence at Quest IRA, Inc.  The only word of caution I want to give you is to be aware of the prohibited transaction rules.  There are a list of persons with whom an IRA is not permitted to do business, called “disqualified persons.”  Fortunately, you would NOT be a disqualified person as to your aunt’s IRA.  However, your aunt should be aware that a benefit to a person in whom she has an interest which would affect her best judgment as a fiduciary for her IRA may be deemed to be an indirect benefit to her, in which case the IRS might argue that it was a prohibited transaction if they ever audited her account.  At a minimum you should be sure that the loan is on commercially reasonable terms.

Unfortunately, a full discussion of the prohibited transaction rules is not possible in a short email.  The good news is that we have tons of articles and other materials on various topics related to self-directed IRAs on our website at www.QuestIRA.com.  Also, you may contact either Nathan Long in our Houston office at extension 3574 or Ryan Kimura in our Dallas office at extension 3584 if you want to have a fuller discussion.  Either of them can provide you with the necessary materials for your aunt to open an account.  Good luck with your investing, and I wish you a happy, healthy and prosperous 2011!

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

How can I take possesion of a real estate property without selling it from my IRA?

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Question:

Can I make a total distribution without selling the property in my IRA?  I would like to make a 60 day rollover and replace the IRA property with cash.  This would allow me to purchase another property.  Ultimately, I want my business to own the property outright.  Can I have an investor willing to buy the property and sell back to my business at a market rate?

Answer:

Yes, you can take a distribution of property from your IRA without selling it.  Simply get an appraisal of the property and request a distribution.

Unfortunately, you would not be able to replace the property with cash, since you can only roll over the same property as you distributed.  Also, if the IRS was able to detect that you sold the property to an investor who turned around and sold it to your business this would be an indirect prohibited transaction which would cause your IRA to be distributed as of January 1 of the year in which you did the prohibited transaction, so that should not be a path you pursue.

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

Either a Lender or Borrower Be

By:  H. Quincy Long         

            Personally, I think Shakespeare had it wrong when he penned this advice in Hamlet:  “Neither a borrower nor a lender be; For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry.”  Perhaps he may be forgiven for his error, however, since Shakespeare suffered from a lack of the tremendous benefits of a truly self-directed IRA. 

            Money in self-directed IRAs can be loaned out to any person who is not a “disqualified person.”  While this means that you cannot loan yourself or other related disqualified persons money from your self-directed IRA, you can loan the money to anyone else.  Loans can be secured by real estate, mobile homes, equipment or anything you like.  If you are really a trusting soul, you can even make a loan from your IRA unsecured (although in that case I personally would tend to support Shakespeare’s advice).

            First, let’s look at it from the borrower’s perspective.  At our office we offer a seminar entitled “Make Money Now With Self-Directed IRAs.”  One of the ways you can make money for yourself right now with your knowledge of self-directed IRAs is by creating your own “private bank.”  To do this, simply share the news that an IRA can be a private lender, refer people with IRA money to Quest IRA, Inc. to open a self-directed IRA, and then borrow their IRA money for your own financing needs.

            With private financing the loan terms can be whatever the borrower and the lender agree to within the legal limits.  If you know a person who is getting 5% in a “safe” IRA at a bank, and you can offer them 9% secured by a first lien on real estate with only a 70% loan to value, would they be happy with that?  Even with a higher interest rate, private financing can work for you. IRA loans can be done quickly and without a lot of fees or fuss, which may mean you can get a deal which might be lost if you had to wait on the bank.  This is especially true in distressed sale situations, such as a pre-foreclosure purchase.

            From a lending perspective, your IRA can grow at a nice rate while someone else does all the work.  In a typical hard money loan, the borrower even pays all of Quest IRA, Inc. modest fees as well as any legal fees for preparation of the loan documents.  True, you won’t hit a home run with lending, unless you are fortunate enough to foreclose on the collateral.  But the returns can be quite solid.  For example, by making very conservative hard money loans my Mom’s IRA has grown by about 10.5% in one year.  This is much better than the amount she was earning in her money market fund before she moved her IRA to an Quest IRA, Inc. self-directed IRA. 

            Even small IRAs can combine with other self-directed accounts to make a hard money loan.  My brother recently combined his Roth IRA, his traditional IRA, his wife’s Roth IRA, his son’s Roth IRA, his Health Savings Account (HSA), and 5 other IRAs to make a hard money loan.  The smallest IRA participating in this loan was for $1,827.00!  Each IRA made 2% up front and 12% interest on an 18 month loan, secured by a first lien on real estate with no more than 70% loan to value.

            One thing to avoid in hard money lending is usury.  Usury is defined as contracting for or receiving interest above the legal limit.  The usury limit varies from state to state, with a few lucky states having no usury limit at all on commercial loans.  Some people have the theory of “What’s a little usury among friends?”  However, if the investment goes bad and your IRA has made a usurious loan, the consequences of the borrower making a claim of usury could include the loss of all the principal of the loan plus damages equal to 3 times the interest.  Some states even have criminal usury statutes.  It is best to consult with a competent attorney prior to making a hard money loan to make sure your IRA does not violate any usury laws.

            To see how well hard money lending can work, let me give you an actual example.  One of our clients made a hard money loan from his IRA to an investor who purchased a property needing rehab.  The terms of the loan were 15% interest with no points or other fees except for the attorney who drew up the loan documents.  The loan included not only the purchase price but also the estimated rehab costs.  The minimum interest due on the loan was 3 months, or 3.75%.  The investor began the rehab by having the slab repaired, and before he could take the next step in the rehab process, a person offered him a fair price for the property as is.  The investor accepted the offer, and they closed about 6 weeks after the loan was initiated.

            From the investor’s perspective, was this a good deal?  Yes, it certainly was!  True, he was paying a relatively high interest rate for the time he borrowed the money.  However, he was able to purchase a property with substantial equity which a bank most likely would not have loaned him money to buy due to the condition of the property.  Also, while the interest rate was high, the cost of financing was actually comparatively low.  With a normal bank or mortgage company there are fees and expenses incurred in obtaining the loan.  Common fees include origination fees, discount points, processing fees, underwriting fees, appraisal fees and various other expenses relating to the loan.  On the surface an interest rate may be 8%, but the cost of the financing is actually higher than 8% since a borrower has to pay the lender’s fees in addition to the interest on the loan.  Spread out over a lengthy loan term these additional fees do not add much to the cost of the financing.  However, if an investor has to pay all of these fees up front and then pays the loan off in only 6 weeks, the cost of the financing goes way up. 

            In this case the investor’s total loan costs were limited to 3 months minimum interest at 3.75% plus $300 in attorney’s fees for preparing the loan documents.  Best of all, the investor walked away from closing with $20,000 profit and no money out of his pocket!  Far from “dulling the edge of husbandry” this loan actually made the “husbandry” (ie. the purchase and resale of the property) possible.  Incidentally, the purchaser of the property was absolutely thrilled to get the property at less than full market value so that they could fix it up the way that they wanted it.

            What about the lender in this case?  The lender was also quite happy with this loan.  His IRA received 3 months of interest at 15% while only having his money loaned out for 6 weeks.  For the 6 week period of the investment, his IRA grew at a rate of approximately 30% per annum!  Although his yield was above the legal limit for interest in Texas on loans secured by real estate, prepayment penalties are generally not included in the calculation of usury here, so there was no problem.  The investor was happy, the new homeowner was happy, and the lender was happy.  Anytime you can create an investment opportunity with a win-win-win scenario, you should.

            When I lecture about hard money lending, I ask the audience what they think is the worst thing that happens if you are a hard money lender.  Invariably, most people in the audience answer that you have to foreclose on the property.  Nonsense!  If you are doing hard money lending correctly, the worst thing that can happen is that the borrower pays you back!  Unfortunately, this is a common risk of hard money lending.  Most hard money loans are made at 70% or less of the fair market value of the property.  If you are fortunate enough to foreclose on a hard money loan, your IRA will have acquired a property with substantial equity while the investor did all the work of finding and rehabbing the property! 

            While it is true that foreclosing on a property owned by a friend may cause an end to that friendship, a properly secured hard money loan will at least not “lose itself” as Shakespeare asserts.  In fact, it may lead to substantial profit for your IRA!  To avoid losing a friend, simply don’t loan money from your IRA to someone you would feel bad foreclosing on.  In order to be a successful hard money lender, you do have to be prepared to foreclose on the property if necessary.

            In modern times I believe the proper advice, at least in the right circumstances, is “Either a lender or a borrower be!”  You can make more money for yourself right now by borrowing OPI (Other People’s IRAs).  Borrowing from someone else’s IRA can even lower the total cost of your financing compared to a conventional loan from a bank or mortgage company, especially on short term financing.  From a lending perspective, your IRA can make great returns by being a hard money lender, either through higher than average interest rates or, better yet, through foreclosing on property with equity.  You may find that hard money lending from your self-directed IRA is a great way to boost your retirement savings without a lot of time and energy invested on your part.

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 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.