In life there are a lot of things we learn by accident, which may be very beneficial to us. Sometimes understanding these processes may take a while. Sometimes after proper comprehensible statement …BLAM, you get it. That is incisively what happened to me. When I original heard in regards to the topic, I will talk about in this E-book, it was perplexing, however, I knew that it could reap big rewards in the future. It took a while for me to grasp the process. I do not forget attempting to tell a buddy who owned an apartment building with regards to _________ and what it could do for him. I do not forget getting it all confused (like telling an individual a good joke, but while you are attempting to say the good joke, in mid sentence you realize that you don’t do not forget it all and it is not coming out right, so you just say forget it because you are screwing the joke up). Fortunately, by fault I came all over the company Pensco Trust who has educated me on this outstanding prospect of____________. I am considered one of their “Preferred Professionals.” My learning curve is your benefit. Enough with my teasing games, the intention of this E-book, is to educate you on Self Directed IRAs. So buckle up!
This publication is made to provide basic selective information in regard to Self Directed IRA’s. It is staged with the understanding that I am not engaged in rendering accounting or legal advice. If you need legal counsel services of a proficient professional must be contacted. I may not in any way guarantee that this material will be in the right manner applied for the purposes intended and I assume no obligation for it is rectify and proper use.
We all recognise that Social Security (SS) is engaged in a struggle and the cash there will ultimately disappear. Prior to 1935 there was no personal SS. All that existed were persons saving their cash in their bank/under the mattress. In 1935 SS was created. Remember that this was the same time amount of time of the Great Depression. Keep in mind the life expectancy back then was like 62 years old. Now it is 76. Baby Boomers make up a huge share of the population. Baby Boomers are retiring everyday. You want some hard facts? Well according to Research Corporation Study: The New Landscape of IRA Rollover © 2005 BISYS Retirement Services.
o The original of the baby boomers reached age 59.5 in July 2005
o 4 million more will reach age 59.5 each year
o 24 million people will reach age 65 by 2010
o 55% plan on to work after “retirement”
Now on the flip let’s say there was no problem with SS. Have you ever talked to an individual who gets SS checks? They don’t get a lot of money. It is sad sometimes. I am not attempting to offend anyone, but the majority of the older humans you see at Wal-Mart greeting you and marking your receipt didn’t have a “nest egg” to rely on when they “retired”. The topic I will talk about will prevent that from ever happening to you and I.
1974 congress devised IRA (Individual Retirement Account) to supplement Social Security. We recognise these are programs to aid shelter cash away for tax benefits. Typically humans go after the established investments. We always listen when it comes to stocks, bonds and CD’s. Yes all investments have risks, but the thing regarding these investments is that you may not affect the outcome of the business/your return. You are a spectator, looking at the game. Also, you can’t use leverage (an example of using leveraged will be discussed later). Also, with stocks if any little blip in market occurs, like oil, war, scandal, etc. your value could go down. Real estate does go up and down but in general you don’t lose all of your cash in worst case scenarios. Real estate appreciation has kept pace or exceeded inflation. It is a cycle. When it goes down, the value does not go down instantaneously (like Enron).
Self Directed IRA (SDI) an overview. Now I am not bashing stocks, I have them, if you talk to any financial planner, they will tell you to always be diversified in your investments. This is what SDI does for you. Ideally you must have SDI, stocks, bonds etc.
SDI has been a well held secret. Why? I think it is because of ignorance, and I also the folks on Wall Street don’t benefit. A broker at an investment company will not tell a person when it comes to it, because they can’t make cash off of the dealing (let alone having them grasp how it works). The last reason is because there are “professionals” who don’t have a clear understanding on it is use.
To get a SDI, you would either have to go through an Administrator, or a Custodian.
What is an Administrator? Banks, brokerage firms (like Charles Schwab) and insured credit unions.
What Is A Custodian?
There are very few self-directed IRA/401k custodians in the United States. In order to be a custodian for self-directed products, the custodian is known as a “passive custodian.” This merely means that they are obligated by law to provide only custodial and administrative services for the qualified plan. They may provide NO investment advice. This tremendously reduces the fees affiliated with conventional investments because you, the investor, make all of the investment decisions. They are also FDIC insured.
What is the role of the custodian
o Holds your IRA assets
o Performs all IRA transactions
o Keeps all IRA records
o Provides all IRS required reports
o Keeps IRA plan in compliance
o Provides access online access
There are only three things your SDI can’t invest in and they are
o Collectibles/antiques
o Life insurance
o Stock of a sub-chapter “S” corporation (these are companies that are swopped publicly on the stock market)
As long as the dealing is for investment intents and you have not produced a “prohibited transaction” (will talk about later) the list of investments are endless.
The beginning of a long list of real estate you may buy with your SDI
o Foreclosures, Options, Pre-construction, raw land, apartments, offices, strip malls, mobile homes, public storage, any type of investment property
o Trust deeds/mortgage notes
o Privately held C-Corp stock, LLC membership
.
The rules on prohibited transactions
o Cant buy from or trade to a disqualified/prohibited person
o Cant make personal use of property
o Cant use SDI as collateral for personal loan
Personal use prohibitions
You can’t personally use a vacation home. Even if you rent it out for 354 days and spend one day in it, this is illegal. You can’t carry out maintenance on the property. You may hire a maintenance crew using the cash coming out of your SDI, but you can’t physically work on the property. You also can’t hunt on raw land, dock boat at a SDI owned boat slip. There was a person, who worked with Pensco, that purchased a specific area of a water fishing spot in Alaska. The person, couldn’t fish there, so she leased out the area to other fishermen and received profit.
More on disqualified persons
You can’t buy from a person supplying services to the investment. It has to be a clean slate. It can’t be business amongst employer and employee. If you have your SDI in an LLC and you want to buy property, you will not be competent to if you own more than 50% of the company. You can’t buy/sell to a fellow member of your family including spouse, ancestor, lineal descendant and any spouse of a lineal descendant. Meaning, not you parents, children, your son in law etc. But, you may buy/sell to a sibling. There can’t be a sale/exchange/leasing of any property or supplying a loan among a plan and a disqualified person. Lastly, you can’t buy something you already own (SDI can’t be employed for funds to pay off your mortgage. There will have to be no sensed direct or indirect personal gain to the account owner).
Basic rules
o Can’t implicate the account holder, his/her spouse a lineal ascendant/descendant of family nor the spouses of your children and you can’t use SDI funds to remunerate off a personal mortgage
o Can’t make personal use of property (must be for investment purposes only)
o Can’t personally guarantee the loan for your SDI nor use the SDI as collateral for a personal loan
o Can’t work for or take income from an SDI investment
o Can’t have your spouse, nor your family members (your siblings are ok) own the property prior to it is buy by your plan
o Can’t have your business lease or be located in or on any share of the property while it’s in your plan. You may receive any property as a distribution from your plan as a retirement benefit
What dealings are prohibited?
The following are specified as prohibited dealings when they implicate the account holder:
o Borrowing cash from the SDI
o Selling property to the SDI
o Receiving unreasonable compensation for managing sum totals for the SDI
o Using the SDI as security for a loan
o Buying property for personal use with the SDI
o Collectibles/antiques
o Life insurance
o Stock of a sub-chapter “S” corporation
50% rule
If a disqualified person(s) owns 50% or more collectively of an entity, then the SDI can’t engage in a dealing with the entity because the company is considered a disqualified person.
Using IRA as collateral
You can’t use your SDI as collateral for a loan. If you will get a loan it will have to be an unsecured loan. If you default in paying the loan, the lender can’t go get the cash out of your IRA, nor may they go after personal assets.
Any type of prohibitions have penalties, if you violate them. SDI is no different. Here are the aftermaths if you do not comply:
o Loss of IRA status resulting from prohibited transaction
o Loss of tax immune status
o Income tax on account value
o Penalties and interest
o Possible audit to determine extent of prohibited transactions
If you genuinely want more info on the rules check out:
o IRS code 4975
o UDFI/UBTI: IRS code 598
o Department of Labor (DOL) 2004-8
Tax court cases
o Swanson 1997
o Rollins 2004
o Rousey v. Jacoway 2005
Ways to invest by using your SDI
o Property buy all cash
o Property buy using a loan (NOTE this has not always been the case where you may get a loan from a bank for your SDI. These past couple of years a few establishments are providing loans to SDI. I have those contacts, contact me and I will explore choices for you)
o As a fellow member of an LLC or “C” Corp.
o As a lender on a trust deed (mortgage note)
o As a collaborator in a joint venture
o As a Tenants in Common T.I.C. fellow member (if any of the terms I use are unfamiliar to you, look them up online)
o Make a private loan to an entity or person (hard cash loans)
To give you ideas of what investors have purchased through Pensco:
o Largest US massage school
o Cypress tree farm in Costa Rica
o Fish farm in Salinas, CA
o Interests in movies, plays
o Condo in Lithuania
o House on a private lake in Colorado
o Thoroughbred race horse
o Nudist resort in Virgin Islands
o Over 35 U.S. banks
o Napa Valley B & B
o Biotech company
Pensco’s top capitalist success story is going to amaze you on the potential your SDI may have. In March of 1999, four men opened up SDI accounts. They each invested on an individual basis and through their IRA’s in a company they were starting. They brought in other unrelated investors. That company is purchased out a couple of times. The company goes public and sells out in June 2002. Well how much did they make? CEO made $34 million (12,000% return). Chief scientist made $22 million. CFO make $17 million. Marketing VP makes $8 million (4,000 return) What is better than that? They all invested $2,000 through their IRA’s except the CEO who invested $1,800. Pensco explained the features of the 1 year Roth IRA and they all chose to invest with a Roth IRA. If the CEO gets an intermediate return of 12% until he is entitled to withdraw tax-free at 59.5 he will have $1 billion, $100 million tax free! Yeah that is right…show me the money!
Let’s compare
Real Estate Investing – with SDI
o Tax deferred growth on income and cap gains
o No 1031 requirement!
o No annual tax reporting
Taxable investments non SDI
o Tax deferred cap gains (if 1031)
o Tax on net earnings
o Annual reporting required
How it works
You have an account with Pensco (you may roll over your current IRA account to them) you tell them what you want to invest in, they do all of the paper work, make out the check and now it is in your trust account. All cash that is necessitated for disbursements and all profits go into/taken out from the trust account. The title of the property in your IRA will be kept with Pensco Trust as follows: “Pensco Trust Custodian, FBO (client name) IRA, (Acct #). All documents will be reviewed and initiated by the you (the IRA owner) and signed by Pensco Trust.
Introducing SDI on steroids in the neck…Solo 401(k)
A solo (k) is a combined salary deferral and net income sharing retirement plan for sole proprietors, little business owners with no laborers (other than share timers working less than 1,000 hours per year or their spouses).
Roth contributions may increase tax free $15,000 to %20,500 per year or 30k to 41k per married couple (for 2007). Unlike a Roth IRA, there are no income limitations placed on the contributor. You could be a zillionaire and it would not matter! Currently a single person making over 110k can’t bestow to their Roth married couple is 160k.
Who may gain from Solo (401)k
o Real estate brokers
o Consultants
o Contractors
o Lawyers
o Electricians
o Any sole practitioner
o Even if you work full time for an employer and have a business on the side where you are a sole proprietor you may establish a solo K
The divergence is…
o You may borrow up to 50k (or up to 50% of balance, if less) from your Solo 401 k
o You may invest in life insurance
o You may invest in “S” corporations
o You may keep out of the way of UDFI and capital gains UBIT (UDFI and UBIT will be discussed later) when using leverage to buy real estate
o A share of your savings may grow tax free for life
o You may put away more cash rapidly and without delay with more spectacular contributions
o No income cap on contributing to the Roth component
o Above 50 year old employee has the option to put up to $20,500 per year away, to grow tax free
Why appealing
o Allows the sole owner funds to grow tax free
o While Roth IRAs grant similar contributions they are fixed to $4,000 in 2007 ($5,000 if over 50), and to those earning annual gross income of less that $110,000 for that year
o You may increase tax free growth chances by also contributing to a Roth IRA ($4,000/$5,000) in addition to the Solo (k) (15,500/$25,000), if you are entitled (check with Pensco for details)
o A married couple in business together may put up to $51,000 ($25,500 each ) per year of after tax cash into retirement accounts that will grow tax free for their lifetimes and those of their heirs (including $5,000 Roth IRA contributions) and another $59,000 ($29,500) each that will grow tax deferred. That is a total of $110,000 as a couple of which $51,000 will grow tax free (assumes each is over 50 and earns less than $100,000
o And there is no income limit on contributions
o May roll pre existent plans and IRAs into it
Types of purchases of SDI
All cash
Your SDI buys one property all cash. No debt, LLC, and partners. When you do this your SDI needs to have sufficient funds to cover buy price, all closing costs, custodial fees and ongoing property expenses. If you run out, you may loan your personal cash to your SDI (with interest and principal).
Multiple SDI – All cash T.I.C.
SDI may belong to any individual – even prohibited people. All SDI go on contract, and on title, as “tenants in common.” Ownership percentage ought to be identified and all costs and proceeds prorated correctly according to these percentages.
Multiple Parties – IRAs & People all cash T.I.C.
Same as multiple IRAs, as long as there is no loan (as an all cash deal) it does not matter who the SDI belongs to, or who the humans are. All names must be on contract and title for distinctive percentages.
All cash
Buy/sell, with/without, friends/family is by far the easiest and most mutual transaction. When this happens all income comes back to SDI, so having a1031 interchange is not required to defer taxes. The cash in your trust account is also employed to remunerate any disbursements incurred. Real estate investment related expenditures are paid out of the SDI.
Getting a loan to buy
In the past there were NO banks lending to SDI. Only until lately a few banks in the nation offer this service. The loan that is offered is a non-recourse loan. This is great news, because now investors could use leverage.
When you get a loan for your SDI you:
o Can’t guarantee the loan personally.
o Can’t co-invest with your IRA.
o Pay the tax on any income or capital gains derived from leverage.
o Increase the returns and growth of your SDI two to three times.
What is a “non recourse loan?”
o You are not personally liable for repayment of the loan. In the event of a default/foreclosure the lender may only recover the property and your equity.
o Typically requires 30-35% down payment. If there is low cash flow or the condition of the property is bad then they may require a more spectacular down payment.
Non recourse loan process
o After setting up the SDI, it will quintessentially close in 30 days.
o Cash out refinance: funds are propagated back into the SDI.
THERE IS NO PRE PAYMENT FOR A NON-RECOURSE LOAN!
Property Eligibility
o Single family residential
o Condo’s (100% complete, 33% or more sold, and HOA turned over by developer)
o Duplexes
o 4-plexes
o Multi-family (5 or more)
o Commercial property: including retail, warehouses, and office buildings
Ineligible properties include:
o Residential with huge acreage
o Raw land
o Farms
o Manufactured homes
o Hotels, condo-hotels
o Co-ops, timeshares
o Senior or assisted living facilities
o Non-franchise restaurants
o Entertainment properties
o Mini-storeage
Requirements for debt financing ought to be verified for buy along with reserves (10-20% loan amount).
Documentation required for loan approval:
1. Completed loan application
2. Most recent asset statement verifying IRA pluses for buy and reserves.
3. Purchase sales contract
4. Acceptable real estate appraisal for the property to be financed. The appraisal ought to come from lender.
5. Copy of drivers license
6. Property insurance will have to read the IRA/LLC as the insured
Income requirements for homes
o The furnished property will have to generate sufficient net operating income to exceed debt service payments by:10%single family (less then 10% or negative cash flow is adequate for the purpose with sufficient reserves on SFR). For 2-4 unit properties it is 10-15%
o IRA sum totals ought to be verified for buy along with reserves
How the closing procedure works:
1. Title company prepares closing documents.
2. SDI proprietor initials for approval.
3. Originals sent to Pensco for execution by the tile company or broker.
4. Pensco signs, notarizes and returns package. They during one night and wire remainder of funds for closing.
5. Title company forwards recorded concede deed to Pensco.
6. Through your trust, you now own the property.
Another way to invest using IRA
This is a unfeigned story from a Pensco client. One capitalist wanted to buy a property in San Francisco. They buyer didn’t have all of the cash for a down payment. So, he neared his friend and asked in regards to him if he was mesmerized in earning a sure share return on his IRA. He agreed. So, the buyer took his share and combined it along with his friends SDI, to buy the property. His friends SDI issued him a second on the property. This formulated a “win” circumstance for everyone. The buyer gets the property. His friend gets a great return on his IRA (that is secured by real estate) the sales agent wins because the deal closed. The owner of the property is happy, because they sold the property. The bank, is happy because they are making a return by giving a loan. All of this is possible because the SDI was used.
There was another person, who used his SDI to buy pre construction property. In Las Vegas, there was a developer who was forming a community. The capitalist neared the developer and solved a problem for them. Apparently there were galore fall outs with buyers. The investor, said (paraphrasing) “I will buy any homes that fall out of escrow for a discount.”
If you would like to read upon an capitalist who used their SDI, look up: Time June 14th 2005. Investor applied $195,000 to invest in property on Marco Island FL. Sold resulted in a $500,000 net income going directly to IRA
Rental property purchases
Question:
I want to buy a rental property for $100,000 may I use:
o A. $30,000 of my IRA funds
o B. $65,000 of my personal funds
o C. $5,000 loan from my brother to do this?
o D. All of the above
o Answer: D
In the begging of this E-book, I indicated that using SDI has been kept a secret. One of the reasons is because of misinformation from “professionals” is from CPA’s. Some CPA’s say not to use an IRA to invest in real estate because:
o You will lose tax gains e.g. disparagement (not quite)
o Using SDI “destroys” tax deferred compound growth in IRA (wrong)
o You have to pay popular income tax versus capital gains tax at the end of the line (true just like any other IRA investment)
Some CPA view points do not take into thoughtfulness the following:
o They do not address need for diversification in the retirement portfolio to hedge versus other assets
o Broadly implies that even if you know that you may get better results laying out capital in real estate through your SDI you shouldn’t do it
o It is IRRELEVANT if real estate out performs other IRA investments
o IGNORES the facts that 44% of net worth in US is in real estate
o Does not recognize that after tax yield is the essential goal of the investor
Unrelated Business Taxable Income (UBTI)
If your SDI develops income from action not “substantially related” to the immune status UBTI comes into play. The intent of UBTI was to alleviate unfair contest by immune organizations with taxable enterprises. Basically when you conduct business and it is not passive income, you come all over UBTI. Further explanation; if your SDI is going to open up a restaurant, you are going to have general income. The IRS feels that is reasonable that you pay tax on the cash you make everyday. Because it is not reasonable for you to open up a restaurant and for an individual else to open up a restaurant down the street, but you don’t remunerate tax. If it is “ordinary income” UBTI applies. If it is passive income UBTI does not apply, such as rent, interest and capital gain.
Unrelated Debt Financed Income (UDFI)
Income generated by action that had debt financing. Tax is applied to that share of gain/income that is debt financed. Most “passive” investments income such as rents from a property are ordinarily excluded from taxes, but such investment income is going to get taxed if derived from debt furnished property (UDFI). Basically, if you buy a property for 5 million. You have your SDI, put up 2.5 million and you get a loan for the other 2.5 million. Well the gains you get from the borrowed 2.5 million from the bank will get taxed (UDFI). You will not get taxed on the percentage that comes out of your SDI.