There are a multitude of options available to modern families who want to begin planning for the best financial futures they can possibly have, but the self-directed IRA is one choice that has been gaining popularity. You might have heard them referred to as checkbook IRA accounts. Let’s take a look at the beginner’s basics of how they work.
What You Will Learn
- IRA and 401K investing basics
- What types of investments are permitted and not permitted with a self-directed IRA
- What defines a disqualified party for these investment types
Watch the video above or read the full transcript below:Read the Full Transcript
David Moore: Hello, David Moore, IRA Advantage, iraadvantage.com, and we’re just going to talk about extreme IRA investing basics, alright? IRA/401K actually. So when you’re looking at self-directed accounts, self-directed IRAs or solo 401K plans, these are investment accounts that allow you literally to buy anything the law allows. A truly self-directed account allows you to buy anything the law allows, not just something off some investment company’s menu of investments, alright?
Now, we at IRA Advantage, we don’t sell investments, we don’t offer investment advice. We’re just going to provide the investment vehicle to get you out of what you don’t want into what you do want, and once again, keeping your money yours, keeping it working for you. So if I look at an IRA investment or a 401K investment, I look at two issues, alright? One, what does the taxpayer want to buy? And IRA is by law… And the rules have never changed, self-directed accounts have always been a possibility, have been available since the mid-’70s when these accounts were started, but if we look at what you can buy with an IRA, by law, unless it’s specifically prohibited, it’s therefore allowed, IRAs can buy anything other than collectibles, life insurance contracts or stock in a Subchapter S company.
David Moore: So literally, you name it, you can buy that. Okay, 401K plans is even more liberal. The only thing you cannot buy with a 401K plan is collectibles. So if you’ve got a 401K plan that limits you, it’s not by law, it’s by plan document. If you’ve got restrictions on what you’re going to buy with your IRA today, it’s not by law, it’s by what that custodian or trust company or financial company is going to allow you to buy. And as I said, by law, IRAs can buy anything other than collectibles, life insurance contracts or stock in a Sub S. 401K plans can buy anything other than collectibles, period. Wide open, end of story, always been the case.
So rarely is the investment a problem. What triggers problems for people is transactions between or for the benefit of a disqualified party. If you call us up and you want to checkbook IRA with us, we’re going to… When you start coming up with names for that limited liability company, we don’t want to see your name on it, and we don’t want to see IRA on it either. We don’t want your name on it because I want it completely clear to you, totally transparent, when you look at that account, you know it’s not you.
David Moore: And I tell people all the time, “Don’t look at your retirement account as you.” One, we’re not pulling money out of the retirement account to do these things, we’re just changing from custodian A to custodian B or plan A to plan B, that’s going to allow you to do what you want to do. So we’re not pulling money out, we’re just changing the custodian, the trust company or the plan, alright? And two, don’t think of this stuff as yours, alright? It’s yours some day when you take it as distribution, but it’s not yours during the time it’s in that plan or in that retirement account.
So if there’s insurance, let’s say you go out and buy a piece of property and you need to insure it, it’s not on your homeowner’s policy, it’s not you. You name that LLC. We want that name to be something fun, something every time you look at it, you think, “Hey, this is not me, this is my IRA,” or “This is my 401K plan.” So make it blatantly obvious, keep it clear, that way you’re not going to have as much opportunity to commit a prohibited transaction because, like I said, the basics of this thing, one, what are you buying, two, who are you transacting between or for the benefit of? Any transaction between or for the benefit of a disqualified party constitutes a prohibited transaction. A prohibited transaction is not a good thing. A prohibited transaction with an IRA means total distribution of all plan assets as of the first day in the year in which that indiscretion occurred.
David Moore: Not a pretty thing. 401K plans, it’s a much easier thing to deal with, only the money involved with indiscretion is treated as a distribution. So that’s one of the reasons I like 401K plans. But if we’re looking at these things, what are you buying, who are you transacting between of the benefit of. Disqualified parties to your plan, if we’re talking IRAs, it would be you, your spouse, parents, grandparents, kids, grandkids, their spouses, or any legal entity owned in controlling interest by one of those. Now, what’s it mean to transact between or for the benefit of disqualified party? It would be selling to, buying from, loaning to, borrowing from, using it in any way.
Let’s say you go out and get a loan for your IRA or 401K, that’s got to be non-recourse debt, it’s not going to be attributable, your credit, your income, any of that stuff, you’re not going to be on the hook for it, period. The only thing the lender can do is take that asset, so that would… If you put your line on there as a guarantor, your name on there as a guarantor, that’s a prohibited transaction. We’ve got to be careful about these things.
David Moore: Now, I didn’t say anything when I gave you that list of disqualified parties. I didn’t say anything about siblings, aunts, uncles, cousins, did I? So what’s really funny is you can loan to or borrow from your brother or sister, that’s fine. Aunts, uncles, fine. Cousins, fine, but not any lineal ascendants, descendants or spouses or any entity on a controlling interest by one of those.
The other thing I did not say is, it’s a prohibited transaction to transact between or for the benefit of a qualified party. It is not a prohibited transaction to transact along with one. So what do I mean by that? If you want to go out and combine personal money and 1031 money into a common investment property, you could do that. It would have to be tenancy in common ownership.
David Moore: Normally I’d say, if you want to combine personal money and plan money and do a common investment with real estate, you’ve got two choices. Buy it in a limited liability company with both its common members or as tenancy in common.
I like tenancy in common better, because if we do the single LLC with multi-members that are disqualified parties, as soon as you fund that entity, it’s a static entity. We can’t have money coming in from a qualified source. If we’re doing a 1031 partnership, interests are specifically prohibited from 1031 treatment, so we have to use a tenancy in common structure in that case.
I like tenancy in common better anyway, just because during the life of the investment, if you did have something that was major, you could have the prorated money coming in from both sources of ownership and then upon disposition in the future, because you know as well as I do, you’re not going to own this thing forever. So if we use tenancy in common structure, when you sell it five years down the road, your retirement money, it’s going to go back in the retirement account, tax-deferred if it’s a traditional or tax-free if it’s a Roth, and then your personal interest is just going to go via 1031 or you can pay the tax. So once again, tenancy in common offers you the ability to exchange into something along with the retirement account, and upon disposition allows each source to go different directions.
David Moore: If we have common membership in the LLC with disqualified members, then we’ve got to over-fund the initial funding in the LLC to have enough to make the acquisition, covering carrying costs until the money piles up there, and then upon a future disposition, you’re either going to have to do an exchange for the entity, you personally are going to have tax exposure or you would do what we call in a 1031 world, a drop and swap, where you have a deed from the entity to the individuals’ tenancy in common, and then a later date, after seasoning, it goes different directions.
So once again, back to those two basic things with that retirement account. What are you buying and who you transacting between or for the benefit of? Those are the two issues. The most fundamental basic issues with IRA investing.
David Moore: If you’re buying Wall Street stuff, you don’t have the opportunity to commit a prohibited transaction in the IRA, self-directed IRA, and solo 401K world of self-direction. There’s really very few guardrails there, so you’ve got to really be careful when you’re looking at these things, but it’s not complicated. Every time, if you’ve got a checkbook IRA, you pull out that checkbook, “What am I buying with this thing, and who am I transacting between or for the benefit of?” Those two questions are the big questions. That’s what’s important, that’s what going to dictate whether you can or can’t do something.
David Moore: Once again, David Moore, IRA Advantage, iraadvantage.com. Hope you found this helpful. If you got further questions on this topic, please don’t hesitate to reach out, take care. Look forward to talking soon. Bye-bye.
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