The Seven Deadly Sins of Self-Directed IRA Investing

1.)  Paying too much. Experienced investors will tell you: Make your money when you buy. Not when you sell.

This means that whatever the investment, the best investors are buying assets at a discount to the intrinsic value of the property. Time and reasonable care and effort will result in unlocking            value, and you can profit handsomely simply by selling the property for what it is worth. You do not have to hope you find a foolish buyer willing to give you more than it is worth. That is not a        strategy. Find unloved properties, ugly ducklings and hidden gems that you can buy on sale, take a little care, fix them up, and you can rent or sell for a fair price.

2.)  Doing business with relatives. It is not a great idea in any context. But if you do business directly with the wrong relative in your Self-Directed IRA, it is actually illegal – and could        result in severe fines, taxes and penalties.

Congress expressly forbids owners of Self-Directed IRAs from using them to buy from, borrow from, lend to or sell to certain family members. Specifically, you cannot transact with these              individuals:

  • Your spouse
  • Your own descendants and those of your spouse
  • Your own grandparents and great grandparents and those of your spouse
  • Your attorney, accountant or advisor who advises you on your Self-Directed IRA in a fiduciary capacity
  • Any entities controlled by any of these prohibited counterparties.

3.)  Commingling funds.  You cannot involve your own personal funds in your Self-Directed IRA investment in any way. All purchases related to your investment must come from your Self-  Directed IRA account that contains the property. Technically, by law, you cannot even change a lightbulb in your property unless you bought the bulb with money from your Self-Directed        IRA account.

Self-Directed IRA owners should work closely with American IRA, LLC to ensure that all transactions related to your property are routed through your IRA account.

4.)  Accepting rent payments personally. If you are renting out a Real Estate IRA property, you cannot accept a rent check made out to your own name. Rents and all other payments          related to your Self-Directed IRA must be made out to the entity that holds the property, or to your Self-Directed IRA account itself.

Likewise, you cannot take a cash payment directly. Doing so risks having the IRS declare the payment to be a prohibited transaction, potentially triggering the disallowance of the Self-              Directed IRA’s tax advantages, along with tax liability, penalties and lots of legal bills.

5.)  Signing a personal guarantee for a real estate IRA mortgage. The law mandates that you cannot pledge your Self-Directed IRA asset as collateral for a personal or business loan      outside of the IRA. All mortgages on your Self-Directed IRA property must be on a non-recourse That means that in the event you default, the only course the lender can take is to foreclose          on the property itself. They cannot come after you, personally. If you sign a personal guarantee, or pledge non-IRA assets to secure the loan, the IRS could strip your account of its tax-                        advantaged status, resulting in significant taxes and penalties.

6.)  Forgetting about RMDs. Real estate is highly illiquid. But if you have assets in a Self-Directed IRA, Self-Directed Solo 401(K) or other tax-deferred savings vehicle, you will need to  come up with cash each year to make your required minimum distribution, beginning by April 1st of the year following the year in which you turn age 70 1/2.

Self-Directed IRA owners should plan ahead so they are not caught in a cash crunch, unable to quickly raise the money within the IRA to make the RMD.

7.)  Paying a high percentage each year just to hold the asset. Many Self-Directed IRA firms charge a percentage of assets under management to hold IRA properties on your behalf.      Many times this is needlessly expensive and inefficient.

For investors who tend to buy and hold over long periods of time, switching to American IRA’s flat-rate, menu-based fee structure, rather than a high expense ratio, wrap fee or other AUM                charge can save thousands of dollars each year on fees.

Interested in learning more about Self-Directed IRAs?  Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation.  Or visit us online at www.AmericanIRA.com.

Everything Realtors Need to Know About Self-Directed IRAs

For realtors, there is no doubt about it: the more people are interested in real estate, the better business will be. Yet many realtors do not know that real estate is one of the most popular retirement investments outside of the stock market—especially with those who run their own Self-Directed IRAs. An investor that uses their Self-Directed IRA to purchase real estate still has access to non-recourse loans. And though there are some limits on what an investor can do with real estate using a retirement account, it will only help realtors to know what is possible.

Why It Is Important Realtors Understand Self-Directed IRAs

The concept is simple: there is no reason to ignore one corner of the market where real estate is involved. By using Self-Directed IRAs for real estate investments, retirement investors can put aside wealth in the form of real estate with the tax advantages of any other retirement investment account. That provides additional incentive for any real estate investor looking to build long-term wealth to utilize one of these retirement plans for their own real estate investing purposes.

Self-Directed IRAs also allow individual investors to partner up and make real estate investments that way, there are plenty of options available to those who choose to self-direct. Realtors who know clients who self-direct may be able to bring more opportunities their way, especially when it comes to “investment” real estate that otherwise has difficulty finding enough potential buyers.

Alternative Funding Strategies with Self-Directed IRAs

Realtors who recognize an opportunity when they see it can offer alternative funding ideas to their clients. For example, because a Self-Directed IRA is expected to act as a separate entity from the individual, it is possible for an individual to partner up with themselves to muster the funds necessary—provided that the real estate investment itself still adheres to the rules of Self-Directed IRAs. For example, investors cannot live in the real estate in which they are investing with a Self-Directed IRA, whereas personal real estate purchases can also double as residences. Still, this funding advantage can offer a realtor a tremendous amount of flexibility in fully exploring the market for a given piece of real estate investment property.

Limitations of Self-Directed IRAs and Real Estate

Although it is important to be mindful of these tremendous advantages for investors—even as a realtor—it also pays to know the potential limitations. For example, you would not want to bring the idea of buying a personal home to anyone investing in real estate with a Self-Directed IRA—unless the idea was to go through the usual means, and not through the investment vehicle itself. Self-Directed IRAs can only be used on real estate if those investments are kept separate, as the accounts themselves are considered separate entities.

The good news? It is advantageous for any realtor to know that there are plenty of options—including non-recourse loans—for those who invest with a Self-Directed Real Estate IRA. Knowing these options can grant realtors access to a larger market than they ever thought possible.

Interested in learning more about Self-Directed IRAs?  Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation.  Or visit us online at www.AmericanIRA.com.

Best Flipping Markets for a Self-Directed IRA

If you are a property flipper, you already know some areas are better for Self-Directed IRA returns than others. Flipping is the practice of buying real estate, making improvements to unlock value in the property that may have been hidden to the previous owners and to other buyers.

It works well in rising markets, of course, but it is at its heart a market neutral strategy that can provide good results even in flat and falling real estate markets. The reason: Skilled flippers can add value through improvements faster than a falling market can suck value away.

A new survey from the National Association of Realtors lists the top ten markets for real estate flippers. And several of them are right here in the southeast, near many of our Self-Directed IRA clients in or near the Carolinas. And many of these metro markets are at reasonable entry prices. Do not have $758,800 to buy the median-priced home in Los Angeles? Head north to Fresno, or scout out properties in Nashville, New Orleans or Lubbock.

Here are the top 10 most profitable flipping markets this year, according to Realtor.com.   If you use a Self-Directed Roth IRA potential profits as stated below by Realtor.com would be tax free forever.

1.)  Nashville, Tennessee

Median home list price: $367,900
Ratio of flips to all home sales: 4.1%
Average flip profit: $87,200

2.)  Fresno, California

Median home list price: $311,700
Ratio of flips to all home sales: 3.5%
Average flip profit: $53,200

3.)  Palm Bay, Florida

Median home list price: $267,600
Ratio of flips to all home sales: 3.3%
Average flip profit: $71,500

4.)  North Port, Florida

Median home list price: $350,000
Ratio of flips to all home sales: 3.3%
Average flip profit: $85,300

5.)  Baton Rouge, Louisiana

Median home list price: $237,800
Ratio of flips to all home sales: 3.2%
Average flip profit: $70,000

6.)  Chattanooga, Tennessee

Median home list price: $257,500
Ratio of flips to all home sales: 3.1%
Average flip profit: $65,800

7.)  Los Angeles, California

Median home list price: $758,800
Ratio of flips to all home sales: 3%
Average flip profit: $169,400

8.)  Lubbock, Texas

Median home list price: $240,000
Ratio of flips to all home sales: 2.7%
Average flip profit: $46,000

9.)  Medford, Oregon

Median home list price: $410,000
Ratio of flips to all home sales: 2.7%
Average flip profit: $51,200

10.) New Orleans, Louisiana

Median home list price: $280,100
Ratio of flips to all home sales: 2.6%
Average flip profit: $93,400

The best thing: When you flip a property within a Self-Directed IRA, you do not have to pay immediate taxes on the profits. As long as the money remains in the account, you can execute an unlimited number of flips each year, and there will be no taxes due, except potentially unrelated debt-financed income tax on the gains or income attributable to money you borrowed to purchase or improve the property.

Interested in learning more about Self-Directed IRAs?  Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation.  Or visit us online at www.AmericanIRA.com.

Self-Directed IRA Tips: Conducting Due Diligence on Partners and Developers

Self-Directed IRAs are a proven wealth builder and income generator. No other asset class delivers such a potent combination of current income, capital gains potential, leverage – thanks to the possibility of increasing rents over time and finding additional revenue streams – inflation protection.  But of course, no real estate investment is a sure thing. Investment carries risk, and sometimes Self-Directed IRA investments fizzle. Due diligence is a critical skill for any real estate investor. This is especially critical if you are committing Self-Directed IRA funds to an investment along with others. Not only do you need to conduct a sober assessment of the value of the property and its potential for profitability; you must also assess your fellow partners and other stakeholders.

Ask these questions before committing Self-Directed IRA money to an investment.

Does the promoter have skin in the game?

Consider a ham and eggs breakfast: The chicken was involved. The pig was committed.

The difference is key: When you are investing in a real estate deal along with others, you want other partners and your managing partner to be like the pig, not the chicken. You want them as committed to making the deal work as you are.

Obviously, a professional real estate agent cannot be personally invested in every deal he represents. But real estate developers should be, or you should exercise extreme caution: If the opportunity is good enough for your money, why is it not good enough for them?

Real estate developers and promoters should eat their own cooking. Look for projects where the promoter and general manager (for limited partnerships and LLCs) has a significant portion of his or her own wealth invested alongside yours. You want a true managing partner, and not just a manager, at the helm.

Furthermore, if the investment goes south, a promoter with no equity of their own in it is not likely to stick around and make it work. They may just move on to the next project, leaving you and your fellow investors who actually do have your own money invested holding the bag.

What is the commission?

There is nothing wrong with sales commissions. But you should have your eyes open about how much you are paying when you are investing hard-earned Self-Directed IRA assets through a broker. If they take too much money up front in fees and commissions, you have much less money working for you in the investment, compounding for you over time.

Furthermore, it will take that much longer for you to recoup your investment, because you are starting out well underwater. It could take years to break even.

How experienced is the management team?

Have the managers been through the wringer before? What is their track record? Have they developed and managed properties of this type before? If this is their first venture, who were they working with before? Were they learning from some of the best in the industry, or did they leave a bad firm?

Also, where is the management team located? Are they near the property or do they have to buy a plane ticket to visit the property they manage?

How much are they borrowing?

Leverage is a powerful tool in real estate investing. But it is a risky one, too: The more money they are borrowing, the more even a small fluctuation in property values can hurt you, and even leave you upside down in your position for years.

It is important that the property meet your risk tolerance criteria, after accounting for leverage.

Furthermore, if the partnership or LLC is using a lot of borrowed money, you may not want to borrow money yourself, in addition to their own built-in leverage. That is just adding leverage on top of leverage. It feels nice in a strong market, but a downturn could be very painful indeed.

What is the exit plan?

Real estate is highly illiquid. It is the nature of the beast. But there should be some planning for a profitable exit, even if it is a few years in the future. The developer could have plans to sell the entire development at a profit after some wise investments enhancing the value of the property. They should be able to give you a rough timeline.

Even if the developer plans to hold indefinitely, there should be some way for you to sell your interest at some point. If not, then you should be paying a lower price to compensate you for the lack of liquidity.

Larger projects have little trouble helping a small investor out of their position, in time. For smaller, less established firms, it is much more difficult.

Interested in learning more about Self-Directed IRAs?  Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation.  Or visit us online at www.AmericanIRA.com.

Prohibited Transactions and Disqualified Persons in a Self-Directed IRA

The Self-Directed IRA can be one of the most transformative tools any investor employs in their quest for a secure retirement. But while taking advantage of the tax protections in an IRA to invest in alternative retirement assets like precious metals and real estate can be incredibly freeing, it is important to recognize that there are also restrictions in retirement accounts—and those restricts are important to pay attention to if you do not want to be hit by steep penalties.

That is why we have taken the time to compile some of the common prohibited transactions and disqualified persons rules in the Self-Directed IRA. The more you know about your limits, the better you will be able to experience the freedom that comes with investing through a Self-Directed retirement account:

Prohibited Transactions in a Self-Directed IRA

What do we mean by prohibited transactions? These refer to those types of investments you will be expected not to make when you are using a Self-Directed IRA. Remember: while you can use an IRA for a wider variety of investment classes than stocks and bonds, there are some strictly-regulated and prohibited transactions you will need to avoid, including:

  • Alcoholic beverages. Wine is a particularly popular investment, as it keeps well, and rare wines can increase in value over time. But investors cannot use a Self-Directed IRA to protect wine investments, or any alcoholic beverages for that matter.
  • Life insurance. Putting a life insurance policy within a Self-Directed IRA is not possible.
  • Some precious metals. When you do invest in precious metals within a Self-Directed IRA, it is important to work with a reputable dealer and to double-check that the specific bullion or coins you are purchasing are in line with approved metals for an IRA.
  • Antiques and similar items could fall under the category of “collectibles,” making them prohibited transactions for the purposes of investing with a Self-Directed IRA.
  • Fine art is a popular investment for those who want to diversify their assets out of the stock market and other assets tightly tied to the global economy. However, these investments will have to be made without the tax protections of the Self-Directed IRA.
  • Using a Self-Directed IRA for loan collateral is another type of prohibited transaction. Sheltering retirement investments from outside influences also means sheltering them from the possibility of being collected after defaulting on a loan. Since collateral is not the purpose of IRAs, any such transaction would be strictly prohibited.

There is a great deal of freedom within an IRA to invest in the type of assets you want to own—but it is important to keep the above in mind before you get started.

Disqualified Persons in a Self-Directed IRA

In addition to prohibited transactions, there are prohibited individuals who are not allowed to take part in an IRA. What does this mean exactly? Let’s break it down:

  • You, your spouse, and descendants/ascendants or any entities they control can lend to your Self-Directed IRA or borrow from it.
  • Prohibited individuals cannot buy or sell assets directly to your Self-Directed IRA—including any entity they control.
  • The same rule as above applies to the buying or selling of services.
  • Using Self-Directed IRA assets for direct personal benefit—such as living within a house owned by the IRA—is strictly prohibited, and this rule applies to you, your spouse, and descendants/ascendants.

Understanding the limitations of the Self-Directed IRA maybe is not the most fun part of developing your own retirement strategy. But it is integral if you are going to do it the right way and ultimately take advantage of the fantastic opportunities offered within self-direction.

For more information on prohibited transactions and disqualified persons within a Self-Directed IRA, continue reading the information here at www.AmericanIRA.com or call us at 866-7500-IRA.

What investments can be done with a Self-Directed Real Estate IRA?

The much shorter answer to the question “What investments can be done with a Self-Directed Real Estate IRA?” is almost anything. In addition to actual real estate, you can instead purchase other investment vehicles such as tax liens, mortgage notes or real estate options. These investments allow you to profit from real estate without owning the land.

The IRS does not publish a list of permitted investments, but only the short number of fellow investors or people you may not do business with who are called “disqualified persons.” These forbidden people are yourself, your spouse, parents, children, grandchildren and spouses of your children or grandchildren. However, because IRAs are legally independent entities, you may do business with anyone’s Self-Directed IRA. Also, neither you nor any disqualified persons may benefit from the property in any way. This includes staying there, even for one night. A disqualified person cannot stay on the property even if that person pays rent. You also cannot directly buy from or sell any property to a disqualified person nor employ them for any reason such as maintaining or managing the property. Neither you nor any disqualified person can perform any services on this real estate, even if you do it for free. This labor would be seen as benefitting the Self-Directed IRA through an in-kind transaction, so it is forbidden.

However, certain family members such as siblings, aunts, uncles, and cousins are not considered to be “disqualified persons.” Therefore, they can invest in, purchase, use, or work on the property held by your Self-Directed Real Estate IRA without any restrictions.

All income from the property or expenses to improve and maintain it must also be paid by the Self-Directed IRA, not from your personal funds. Legally, you never see any of this money, as it all remains within the Self-Directed IRA. Although you may not do any business with a disqualified person, your Self-Directed Real Estate IRA can “partner” with them when investing in it. The purpose of partnering is to increase the amount of capital which the Self-Directed IRA has access to. However, when partnering all funds must be kept separate from each partner when buying, selling or using the property in any way. This prohibition also extends to changing the percentage of ownership controlled by any investor, as that is considered a sale or purchase.

Although there are significant tax benefits from using a Self-Directed IRA, there are some taxes which do have to be paid. As they say, nothing is perfect. For example, you may have used financing for the investment in your Self-Directed Real Estate IRA. Such financing is permitted as long as the loans are non-recourse. This type of loan is secured by collateral, such as property. Should you default on the loan, the lender may seize the property, but cannot look to the borrower for any other compensation if the value of security is insufficient to pay the entire loan balance. This protects the rest of your Self-Directed IRA assets from being seized by the lender.

Although you are prohibited from personally benefitting from property held in your Self-Directed Real Estate IRA while you are still of age to deposit into the account, after you retire you can then use the real estate as a home or benefit from it in any way. Also, after you begin making withdrawals from your Self-Directed Real Estate IRA, you can take real estate as an “in kind” distribution instead of cash.

Interested in learning more about Self-Directed IRAs?  Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation.  Or visit us online at www.AmericanIRA.com.

Using Private Stock with Self-Directed IRAs

One of the most attractive aspects of using Private Stock with Self-Directed IRAs is the diversification it brings to your retirement portfolio. The IRS does not put many restrictions on the assets that are allowed in your Self-Directed IRA—life insurance, jewelry, collectibles and some precious metals are not permissible—but your custodian might not give you access to the widest range of investments.

With Self-Directed IRAs, you open yourself to alternatives like real estate, tax liens, precious metals and, of course, that asset class that is usually available only to the wealthy: private equity.

It is a basic tenet of investing that you never put your money into anything you do not understand. So, here is a primer on using Private Stock with your Self-Directed IRA. Your custodian will fill in any blanks and help you get started:

How does private stock differ from common stock?

Unlike common stock, private stock cannot be purchased by the public on the open market. Typically, the offerings are made to pre-qualified individuals, and these offering must comply with the securities Blue Sky laws in the state in which they are issued.

While publicly traded securities are subject to public disclosure laws, private equity is not. This means that private equity investors must utilize their research skills, personal knowledge, and experiences before choosing a private company.

Be sure to study the offering materials carefully and seek out professional help if you are not clear on any parts of them.

What are the benefits for the investor?

Private Stock with Self-Directed IRAs provide the same tax advantages as Traditional or Roth IRAs. Furthermore, as mentioned earlier, investments in private companies add true diversification to your retirement account.

From an investment standpoint, private equity can be financially rewarding. According to recent studies, private equity outperformed the Standard & Poor’s 500 Index by over 5% from 2005 to 2015. But even though it diversifies your retirement savings and can be quite lucrative, it is critical that you understand where private stock fits in with your risk tolerance.

Are there risks associated with private stock?

There are risks with every investment. Even certificates of deposit have inflation risk (your interest rate is lower than the inflation rate) and interest-rate risk (you are stuck in a long-term CD when rates go up). So, “risk-free” does not exist in the world of investing.

But, those investing in Private Stock with a Self-Directed IRA will be raising their risk profile. The higher risk is offset somewhat by the possibility of a higher reward, but it is still important that a portfolio that contains private equity should be balanced with more conservative investments.

Be sure to follow the rules

Aside from the limits and rules that govern all IRAs, here are some rules specifically for investing in Private Stock with your Self-Directed IRA:

  • The Self-Directed IRA, not the IRA holder, is the owner of the private equity
  • Your Self-Directed IRA cannot purchase private stock that you already own
  • The Self-Directed IRA holder participates on behalf of the stock that the IRA owns
  • All investment earnings must flow into the Self-Directed IRA account
  • Disqualified persons, which includes the Self-Directed IRA holder, may not be employed by the company

While this list of rules is not all-inclusive, it should prompt you toward due diligence before you invest.

Purchasing private stock

Investing in Private Stock with a Self-Directed IRA is not all that difficult. Open an account with a reputable and experienced custodian. Identify the business you want to include in your portfolio. Direct your custodian, using a buy direction letter, to purchase the shares on behalf of your Self-Directed IRA. That is all there is to it.

At American IRA, we have the experienced professionals to make your private equity transactions go smoothly and quickly. With our simplified process, you can effortlessly diversify your Self-Directed IRA account with any private stock you wish to own.

For more information on purchasing Private Stock with Self-Directed IRAs, call us today at 866-7500-IRA (472) or visit us at www.AmericanIRA.com.

Everything You Need to Know to Get Started in Self-Directed Gold IRAs

Gold is not your typical investment. As a matter of fact, some financial gurus will tell you it is not really an investment at all. Because it is a tangible asset, they say, you could look at gold more as an insurance policy. You hold it in case there is a financial crisis, and your other investments are in turmoil.  No matter how you choose to look at gold—investment or insurance—it should be part of your portfolio in a Self-Directed Gold IRA. Hard assets, which could also include other precious metals like silver and platinum, can provide a hedge against inflation. They are negatively correlated with traditional investments like stocks and bonds. In other words, when stocks and bonds take a downturn, tangible assets such as gold tend to appreciate.

While no one can say what percentage of your portfolio should be in a Self-Directed Gold IRA without first looking at your situation, typically you will see hard assets taking up from 5% to 20% of an investor’s retirement portfolio. But regardless of the amount you hold, the arguments for having some of your retirement funds in a Self-Directed Gold IRA are compelling.

Here are a few:

Diversification

Diversification is always first on the list of suggestions for protecting and growing your retirement funds, which makes it essential that a Self-Directed Gold IRA be part of your strategy. Hard assets offer true diversification by working in a different direction than your financial assets and helping you create a tactically-balanced portfolio.

It is easy for investors to feel comforted because they have their stocks spread over various sectors or asset classes or their bonds split between Treasuries, corporates, and high-yield offerings. In truth, these methods provide only limited diversification. The lack of correlation that comes from tangible assets adds a much more diverse element to your account.

Potential for Growth

The same economic factors that cause stocks and bonds to diminish can help gold to increase in value. For example, over the last 15 years, gold has increased by 315%. Over that same period, the Dow Jones Industrial Average went up 58%, and investment-grade bonds returned 127%.

Taking a longer look, however, gold has gone up 335% over the past 30 years, while the Dow has gained 1255% and bonds have returned 672%. All of these figures show the growth potential for gold, but, even more importantly, underscore the need for diversification within a long-term portfolio.

Tax Advantages

A Self-Directed Gold IRA provides the same tax benefits as a conventional IRA. Contributions to your Self-Directed Gold IRA may be claimed as tax-deductible, depending on your tax bracket, of course.

And any gains made from selling gold within the IRA are not taxed until you take a distribution. In many cases, investors will see higher after-tax returns with a Self-Directed Gold IRA than with a conventional non-retirement brokerage account.

Financial Insurance

Financial assets like stocks, bonds, mutual funds and cash will make up the lion’s share of your retirement portfolio. So, holding a portion of your retirement account in physical gold can be viewed as taking out an insurance policy on your retirement.

That is because gold, unlike common stock in a company, can never be worthless. Gold does not go out of business, and that helps to offset some of the risks in your non-tangible assets. And, while stocks and bonds are vulnerable to inflation, gold acts as a hedge against it. Yes, you could call it an insurance policy–insurance against the inflation that could eat away at the future buying power of your retirement account.

Under your Control

“Self-Directed” says it all. You are in control of your asset mix rather than having it pre-determined by a fund manager. You have the flexibility to add a Self-Directed Gold IRA to diversify as you see fit and the opportunity to take control of your retirement savings with a wider range of investment options.

At American IRA, we have the experienced professionals to guide you through the simplified application process and get you on your way to earning tax-deferred and/or tax-free income within your retirement account.  To download your free Self-Directed Gold IRA guide, click here.

For more information on opening a Self-Directed Gold IRA account, call us today at 866-7500-

C Corporation UBTI (Unrelated Business Taxable Income) Blocker Technique May Help Reduce Self-Directed IRA Taxes

The Tax Cuts and Jobs Act – the sweeping series of Tax Cuts Congress passed at the tail end of December 2017 – included a bit of Christmas cheer for dedicated Self-Directed IRA investors.

Normally, as most readers are aware, there are no current year tax consequences for dividends, rental income or capital gains as long as the money remains within a Self-Directed IRA of any type. The income or gains continue to grow tax-deferred, or in the case of Self-Directed Roth IRA accounts, tax-free (as long as it stays in the account at least five years).

But that tax benefit does not apply to income or capital gains that are attributed to borrowed money. Instead, a special tax on what is called UBTI (Unrelated Business Taxable Income) applies.

You see, you only get the tax advantage on your own invested money – not on money you borrow from other people!

So, if you have 45 percent equity in a given property within a Self-Directed Real Estate IRA and you have a mortgage covering the other 55 percent, then 55 percent of your income from the property, and 55 percent of any capital gains from that property are federally taxable – at a punitive maximum rate of 37 percent!

The same principle applies to stocks and other securities in a Self-Directed IRA that are bought using a margin loan, and in certain cases, investing in an active business or trade via an LLC or other pass-through entity, such as a limited partnership. (S-corporations are pass-through entities, of course, but you cannot own them within a Self-Directed IRA, so they do not apply to this discussion).

Some Self-Directed IRA investors try to limit the impact of taxes on UDFI (Unrelated Debt Financed Income Tax) by creating a C corporation, and then using the C corporation to make the investments. It is a tax planning tool called a C corporation blocker.

Here is how it works: C corporations benefit a great deal from the Tax Cuts and Jobs Act, which reduces the corporate income tax rate from 35 percent to 21 percent. The corporation itself releases the dividends to the retirement account, rather than to the taxpayer directly, and they do not come from the property itself.

Obviously, there is a big difference between a 21 percent tax rate and a 37 percent rate, or even the old maximum income tax marginal rate of 35 percent.

Meanwhile, the real estate or other leveraged investment does not pay its income and gains directly to the Self-Directed IRA. Instead, they go to the C corporation.

When set up correctly, this is a big improvement compared to paying the marginal rate on your personal income tax returns, which is where your unrelated business income tax would wind up.

American IRA, LLC does not provide individualized tax advice. The information in this article is for general informational purposes only and should not be construed to be tax advice in your individual case. Readers should engage the services of a qualified tax professional, such as a CPA or enrolled agent before taking action.

Interested in learning more about Self-Directed IRAs?  Contact American IRA, LLC at 866-7500-IRA (472) for a free consultation.  Or visit us online at www.AmericanIRA.com.