Self-Directed IRA Investing – How Do YOU Want to Own Something?

David Moore: David Moore with IRA Advantage, iraadvantage.com, and today I’ve got Tina Colson from my firm joining me.

Tina Colson: Yes.

David Moore: It’s great to have you here, Tina.

Tina Colson: Hello.

David Moore: And it’s testing Tina, so fire away.

Tina Colson: Yes, as we get all the answers from David. He’s amazing at this.

So, a lot of the questions that comes up when you’re purchasing real estate is, how do I want to own that? Do I want to purchase it with my own funds, or can I tap into my IRA and use IRA funds to purchase real estate? Now when you’re doing that, I know if it’s my funds, I can work on the property, I can put that sweat equity in, and I don’t have any rules around that. When I tap into my IRA funds, now I’ve got some rules. I become a disqualified party and I have to hire people to do what I need to do.

Tina Colson: Question comes down to, what if I have enough money for a down payment out of my personal funds to purchase this real estate, but I want to cover the balance of that purchase with my IRA? Because I’ve got a really nice IRA sitting out there and I want to use it for these purposes. How does that break down and how is that going to affect me moving forward? How would I set that up?

David Moore: Sure. So we’ve got a variety of things to address in that question. But I guess first thing you got to look at is, when you’re looking at retirement accounts, and I’ve got my little four points for 1031s. It’s got to be an exchange, what’s give and receive, got to satisfy the napkin test, and we’ve got to have continuity investing.

When I look at a retirement account, I’ve got two main issues, and this why … I just think it’s so easy to get into the weeds with this stuff, and you got to just boil it down to the bare-bones basics and say, “Okay, what are these two issues you’re talking about?” One is, what do you want to buy? And by law, 401k plans can literally buy anything other than collectibles. IRA’s can buy anything other than collectibles, life insurance, contracts, or stock in a sub S corp. So rarely is the investment a problem. What triggers problems for people is transactions between or for the benefit of a disqualified party.

David Moore: So we think back about what Tina just asked and said, “Gee, what if I’ve got enough for the down payment, but I need more to do the project?”, let’s say. And it is not a prohibited transaction to own property or own anything jointly with your retirement account. You just can’t buy from, sell to, loan to, borrow from one of those things. And a lot of times, at the end of the day, as you know, we talk about distributions.

And a couple of these major Wall Street objections to using retirement money in real estate. One is the lack of liquidity, and they cite lack of liquidity is a problem. What happens when you get to RMDs, required minimum distributions? What happens you spend all the money? You’ve got to take that required minimum distributions, no money to do it with. Well, it’s not a problem. It’s potentially a great opportunity, you just take an in-kind distribution. Which leads to what? Joint ownership of a property, or joint ownership of the account.

So whether it happens that way, or we’re creating an investment vehicle to go buy something, it really doesn’t matter. If you want to jointly own a property with your retirement account, what’s the source of money personally? And if it’s via 1031, that’s going to require that we buy tenancy in common. So tenancy in common would be direct ownership, undivided ownership of the asset by your retirement account. And you personally coming in with the 1031 money, we’d need a TIC agreement, Tenancy in Common agreement. It’s just like an operating agreement for an LLC, but it’s going to spell out all the management, everything that’s going on, and that would allow that to get done.

David Moore: Furthermore, if we’re combining qualified money, IRA, 401k funds, and 1031 money, for example, if there’s debt, it’s got to be non-recourse IRA 401k compliant debt. So in a default, the only thing the lender can take is the asset. They can’t go after you, they can’t go after anything else. And by the way, for those thinkers out there, you can’t say, “Gee, I’m just going recourse to me on my personal ownership and non-recourse the retirement account.” That doesn’t work.

Bottom line is you got the asset because you allow that recourse, and that’s not okay. So one, you can buy jointly, you can invest jointly in things, as just structuring it correctly, that’s not a problem. But you cannot sell to, buy from, loan to, borrow from. And as you stated earlier, if the IRA owns any piece of the asset, you can’t work on. So you could do the administrative functions management, but you can’t go out and get dirty on the project.

David Moore: One of the other objections is why would you take your retirement account? Go buy real estate if you’re going to be giving up one, long-term capital gains, tax rates, which might not matter in another six months if our current group of politicians do what they’re threatening to do, eliminate long-term cap gains tax. Who thinks that’s a good idea?

But the other issue is that you wouldn’t have interest deductions depreciation and you can’t work on it. So when you look at objections from Wall Street, why you shouldn’t self-direct money into a hard asset real estate, for example, neither one of those is a good argument. I mean, I really think when you start looking at capital gains tax rates and say, “Well, gee, why would you buy real estate with your retirement account? Because you’ll lose out.” Well name something that gets that treatment your retirement account. Nothing does. So it’s an absolutely pointless statement.

David Moore: I know one of the big firms actually must have it in their argument against self-directed accounts, because I get that argument all the time. It’s just dead wrong. But the interest deductions depreciation, you might be in a situation where if you’ve got a leveraged investment, you are taking some of that. So even that’s not right. But if you’re looking at the benefits of personal ownership, as you said, if you personally own an asset, you get a regular loan, so money’s cheaper. You don’t have to worry about prohibited transactions, go work on it, do whatever you want as you want, when you want. Maybe it’s investment income. At the end of the day you’re going to have long-term capital gains tax, so you do a 1031.

So clearly, if I have a choice and I can only own property one way or the other, I’m going to pull money out of my pocket. Because if the IRA or 401k owns it, I don’t get the … I can’t work on it, as you said-

Tina Colson: The flexibility.

David Moore: The flexibility. More expensive money to do it. No flexibility, really. You can’t work on the thing. At the end of the day, whatever you make on it, unless it’s Roth, you’re paying normal income tax on it. But once again, whatever’s in that retirement account is going to have the same tax treatment. So let’s forget that piece of it.

The only real question for you with your retirement money is what’s the highest best use for that money? Really, the tax treatment is irrelevant, because it’s all going to be hit the same way. In fact, I would argue potentially that you’re way better off going into hard assets through us with a checkbook IRA, because by taking in-kind distributions of that asset, you’ve got valuation and discounting that you can use, which you’re not going to get taking cash distribution.

So potentially what is looked at as a big problem is actually one of the biggest advantages of a self-directed account. So I just think that really there’s so much misinformation out there with regard to what you can and can’t do that. There’s been a whole education program that’s going entirely down the wrong path, it’s entirely wrong.

Tina Colson: Right. And when David is talking about the in-kind distribution piece, it’s simply saying when you are of that 59 and a half, and you can start pulling distributions from this property, you’re going to want to do it in-kind. Meaning that if you have an LLC, you can assign a portion of that interest over to the new LLC, but that is in your name, and/or you simply deed a portion of the property each year over to yourself, versus having it in your IRA.

Eventually, all of those components of that property are going to be pulled out and now you have full ownership. You can do with it what you like. You can sell it. You can 1031 exchange it. You can put any renter in it, it doesn’t matter if it’s a family member or not. So it really lifts those restrictions at that point in time and gives you more flexibility. But again, real estate, and the growth of real estate, we see it every day, the values are going up like crazy. And so for somebody holding real estate in their IRA, and they’re doing all the right things with that, it is still a fantastic investment to hold. And again, it just gives you more flexibility after you pull that out after you’re 59 and a half.

David Moore: So, so once again, I want to stress what she said about the in-kind distributions, because you can buy a property that you retire into. We have lots of people that buy properties that they love, and they don’t want to give them up. And their first question is can they buy it from their retirement account? And the answer to that question is a big, no, okay. You can’t buy a property from your retirement account.

So the only way you’re going to get it is via the distributions. And get that great team of people, that great tax person involved, your legal counsel, and start looking at this process, the discounting processes used in estate planning all the time with gifting to kids and so on and so forth. Anytime you’re looking at a minority interest transfer, you can apply the discounting and the distribution’s really no different.

David Moore: Now, the only thing that you got to worry about with an in-kind distribution is that you’re incurring a tax liability without receiving the cash to pay the obligation. If you take $10,000 in cash as a distribution, you’re going to lose, let’s say four of it to tax, right? If you take a $10,000 interest in that property as a distribution, it’s minority interest, maybe that’s treated as $6,000, but it’s still 6,000 that you didn’t receive any cash to pay the obligation for. So that six might cost you two plus in tax and you better have the money to pay that tax obligation.

So what’s an easy solution to that? Where can you get the money to pay the tax obligation? Well, take the property out two or three times, apply the discounting, pull the last distribution pre-tax return time, do a cash out refinance of the property. Now you’ve got the money to pay the tax obligation and the property is now yours. So I just love that whole thing.

And it’s just something that is really, like I said, it’s one of those things that a lot of people in the traditional finance world will bark at. They say, “Well, it’s the lack of liquidity, problems with distributions.” And I look at it, not a problem. I look at it as a huge opportunity. One that honestly isn’t available very often in that space.

Tina Colson: Right. And again, as David said earlier, you’ve got your IRA accounts, leave what you want on Wall Street, self-direct what you want on the other side for this real estate purpose. It’s a great way to diversify all across the board. And everybody’s happy. So thank you for answering those questions, David.

David Moore: So my answer is what is the best way there is in life, right? So the question with your Wall Street stuff, your IRA, 401k funds, really it’s just what’s the highest best use for that money? Invest in what’s going to give you the safest best return, period, doesn’t matter. We’re just here for more diversification.

And then obviously with the money out of your pocket, hey, I love real estate. So real estate is awesome because you’ve got it, you’re not banking on appreciation at the end of the day. Like I said, pay long-term capital gains or keep doing 1031s while we’ve got them and kick that ball down the road. And ultimately, what do you do? Swap till you drop. But once again, we’ve got to worry about stepped-up basis going away, but that’s something that’s been a foundation the 1031 world for 100 years now, actually. Can you believe 1031 is 100 years old?

David Moore: And one last comment on self-directed accounts too. When we’re talking about checkbook IRAs and solo 401ks, these are not new. Your ability to buy real estate with your retirement account is not new. It’s been there since the creation of those accounts. So we’re not talking about some new, crazy idea. This is something that’s always been possible. It’s just one of those things, it’s been kept a big, big secret, and it’s our job trying to dispel it. So bottom line is if you got questions, give us a jingle. We’ll be happy to go over those things. So you don’t have to wait for Tina to ask me, or you can ask me.

Tina Colson: Hopefully we have spurred some interest and thoughts around this, but you have to do what’s right for you at the end of the day. And again, thank you for joining us today. And with our YouTube channel, please hit like and subscribe. We would love that. And if you have further questions, we can always send you some information, we would love to have a conversation. Please call us at 503-635-1031, or join us on our website at iraadvantage.net. Thank you so much.

David Moore: Thank you. Bye-bye