A New Way Forward.
In the last 10 years, investors have been through quite a roller coaster ride. The ups and downs of both real estate and stock investing have given many reasons to pause and reflect on just why and how they are investing. While many still rely on professional investment advisors, others look to the emerging ‘Self-Directed Retirement Account’ as a way to have more direct control over their investment future. They see the self-directed option as a way to manage their own traditional or Roth IRA account, SIMPLE account or Solo 401(k) and make their own choices.
With a Self-Directed Retirement Account, you’re the one in charge, not a faceless broker miles away to whom you are just an account number. Self-directed accounts may invest in a wide array of vehicles - with only three (3) exceptions. They may not invest in collectibles, insurance contracts or the stock of subchapter ‘S’ corporations. However, almost everything else is fair game.
Your account may invest in commercial and residential real estate, raw land, ranches and farms, property tax liens, commercial paper, stock in publicly-traded copanies, LLCs, corporate and municpal bonds, mutual funds, foreign currency exchange and much more. Whatever your investment preferences, a limited number of IRA custodians will allow investors to hold real estate inside a Self-Directed IRA or Solo 401(k). Given the math involved, investing in this way can add considerable wealth momentum to your retirement accumulation if you do it right.
Only a handful of custodians seem to the right amount of guidance on how to avoid tax and compliance problems. Two factors in particular are worth paying attention to:
- Self-Dealing Compliance Issues
- Leveraged Real Estate Acquisition
Doing it Right the First Time.
Though the language of the Internal Revenue Code can be convoluted, prohibited transactions include doing business that enriches yourself personally in a prohibited way outside the account while using the retirement account’s funds to do so. Prohibited transactions can lead to heavy penalties and in some case losing your retirement account’s tax-exempt status.
Buying a personal residence for yourself, for example, is prohibited. Transplanting a property you already own (such as a pre-existing rental house or office building in your portfolio) into a self-directed account is prohibited. Your IRA or Solo 401(k) would need to buy its property from unrelated parties, not you personally. Renting to or from your IRA is also considered ‘self-dealing’ as is buying from or selling to your IRA. If you stay in touch with your IRA custodian’s account representative and work with them in the course of self-directing your account, you have a greater likelihood of avoiding self-dealing.
As you’d expect, most IRA or Solo 401(k) custodians are careful when it comes to doing transactions. And wisely so. They want to avoid compliance complications for your IRA or Solo 401(k). Since they won’t allow borrowing with your IRA or Solo 401(k) the way to solve this is form a Limited Liability Company (‘LLC’) with your IRA or Solo 401(k) as the sole ‘member’ (owner) of the LLC. Then the LLC (and not your retirement account) can borrow the real estate purchase price amount from the lender, and the loan will be secured by the property itself and not by your retirement account. The LLC (owned by your retirement account) can also help minimize your liability exposure in the event of a lawsuit.
Playing Well With Others.
Your IRA or Solo 401(k) can be the sole ‘member’ (owner) of the LLC. You could be the manager yourself or for greater financial privacy you could use a nominee manager of the LLC with you designated as the sole agent responsible for finding all investment properties under the LLC’s Operating Agreement. That way, your name would not appear on any public record (in states like Nevada where the law offers better privacy protection) but you would have sole authority to select the investments.
Some of my wealth preservation clients who are real estate oriented decided to work banded together as co-investors, to achieve more with the synergy of a group than they could as individuals. The LLCs owned by each of their respective retirement accounts invest together in bigger properties with more units, and as you might imagine, have the opportunity to produce greater results. In some cases, each of their LLCs might become individual members of a new ‘group LLC’ – with the members of that ‘group LLC’ being their individual LLCs (owned in turn by their respective self-directed IRAs or Solo 401(k) accounts).
If you’d like a list of lenders who will do loans with your self-directed IRA or a list of preferred self-directed IRA or 401(k) account custodians who will keep you on the right track, e-mail me and I’ll send you a list.
© Copyright 2007 Wealth Preservation Advisors. All rights reserved.
ABOUT THE AUTHOR: Michael Potter, Esq. is a familiar face to business owners and investors who’ve seen him speak at business or investor workshops in the USA and abroad. His Integrated Planning law practice is focused on Business and Estate Planning, Asset Protection, Tax-Advantaged Wealth Accumulation, Accelerated Retirement Planning and Multi-Generation Legacy Planning. Michael's e-mail address is WealthPreservation@cox.net