You may be wondering why I haven’t blogged about real estate investing in a while. There’s a very good explanation video at Nabers.TV for you to check out.

In the last post, you learned about how doing an active “entrepreneurship-ish” deal inside your IRA is an open invitation for the IRS to tax the hell out of you.

In this post, you’ll learn the solution.

• The solution is not to avoid doing active deals.
• The solution is not to stop pursuing massive profits or to lock away your talents and skill to be unused.

The solution is to structure both your active entrepreneurship and your passive investment activity in a way that that puts you in the most control. Put another way, avoid giving the IRS an open invitation to tax attack you.

I bet you can guess where this is going (one commenter had a pretty good idea on Part 1 of the post)…

Active Deal Structure

Run your active entrepreneurship activity (a.k.a. “business activity”) in your… (wait for it)… business! Your business can be a Sole Proprietorship or it can be more formally structured as an LLC or Corporation.

If your entrepreneurship needs a financial kickstart, borrow up to $50,000 (or $100,000 between you and your spouse) in the form of a “participant loan” from your pre-existing retirement funds. Do your business activity, generate massive profits, and contribute up to $54,500 (or $109,000 between you and your spouse) tax-deductibly each and every year. That adds up quickly.

Passive Deal Structure

Run your passive investments through your Self-Directed IRA or Solo 401k (a.k.a. your investment account).

My God, that sounds too simple to be effective, you may think. Hey now, don’t fall into the “scheming pit.”

Over 95% of the Self-Directed IRA conversations I see online are all about some sneaky structure to reign triumphant over the IRS, like a clever fox. Sounds like a good bubble to burst, so I don’t mind if I do…

The IRS doesn’t like being tricked. They can even be mean from time to time. I can’t help but to wonder how much profit would have been made if the millions of hours of sneaky scheming were to be replaced with taking action on making good investments with a non-risky tax approach.

Side Benefits

There are side benefits to this sound approach too.

Many Self-Directed IRA & Solo 401(k) investors are doing active real estate deals inside their retirement plan. That introduces further limitations, especially with debt financing, such as:

• Lower LTV (loan-to-value ratio) loan limits
• UDFI tax (if done inside an IRA) calculation, form preparation, and payment
• Less lenders and loans available in the marketplace
• Higher down payment (more cash investment required, which lowers cash-on-cash return)

Don’t get me wrong. Many healthy, profitable real estate deals are done inside retirement plans and with debt financing.

But, not all real estate deals should be done either inside or outside of a retirement plan. It depends on the circumstances.

If it’s truly a passive investment, go for it inside your plan. If it’s truly an active deal, go for it outside of your plan. If you want to pay cash or make a large down payment, that sounds fitting for inside your plan. If you want to invest as little cash as possible, that sounds fitting for outside your plan.

So, I hope this helps you get your mental strategery in order.

Like many lessons in life, the real progress is made in unlearning myths, deceptions, and bad information. I mean, it isn’t exactly earth shattering to stand up and say “Business activity goes in a business, and investment activity goes in an investment plan,” is it? Yet, after thousands of hours in the Self-Directed IRA industry, it may make a big impact.

——

Odds & Ends:

Don’t miss out on my year-end Solo 401k special promotion. Get on my email list to be notified when it kicks off.

]]> http://www.jeffnabers.com/2010/11/16/the-most-elusive-dangerous-self-directed-ira-practice-part-2/feed/ 7 http://www.jeffnabers.com/2010/01/19/get-5-steps-to-freedom-on-kindle-now/ http://www.jeffnabers.com/2010/01/19/get-5-steps-to-freedom-on-kindle-now/#comments Tue, 19 Jan 2010 12:48:20 +0000 Jeff Nabers http://jeffnabers.com/?p=1170

Finally! I’ve received many requests to make the book available in Kindle format. We started working on that about 6 months ago, and as of just a few days ago, it’s available.

Go here to purchase 5 Steps To Freedom on Kindle.

The book is more than financial education… it’s an action plan. And it’s more than only an action plan… it’s a proven action plan backed by over a dozen cases studies. It shows you true stories of friends and clients who have found massive success in their self-directed wealth management.

You’ll find that most case studies involved the use of a Solo 401(k) or a self-directed IRA LLC. If you’ve been brainstorming ways to make the most of a self-directed IRA LLC or Solo 401(k), then 5 Steps To Freedom can really pull things together for you in how it brings real success (and failure) stories to you. Knowing what works and what doesn’t can mean the difference between incredible achievements and embarrassing failure when using your self-directed IRA LLC or Solo 401(k).

Perhaps the most powerful information in the book is the simple exercises you can follow to remove the confusing “inflation goggles” and see what’s really happening to your wealth.

Check out the book in Kindle today and feedback is always welcomed!

Prohibited transactions is a chief topic when exploring self-directed IRA & Solo 401(k) investing. When a person first discovers that his retirement accounts have been chained to Wall Street brokerages without necessity, his mind starts to imagine the possibilities.

Real Estate? Yes.
Private Businesses? Sure.
Precious Metals? Absolutely.
Getting my hands on my retirement money now? Slow down there.

There are two types of limitations on the average retirement account. One is an unnecessary restriction of investment options to securities products. That can be eliminated through restructuring your accounts and funds. The second limitation is legal and cannot be removed.

Setting up a self-directed IRA or 401(k) is about removing limitations. Once you have it setup outside the nearly monopolistic network of securities dealers, you can invest in almost anything… but you must fully understand the legal limitations.

The general premise behind prohibited transaction rules is that the government wants you to grow your retirement account as big as possible because they plan to tax it later on when you distribute the funds to yourself for spending. Without prohibited transactions rules, anyone in their right mind would grow their retirement account and then make “losing investments” that actually put their retirement funds into their own hands.

For example, imagine you grow your IRA to $1 million and now you’re ready to get that money into your own hands so you can spend it. You could distribute it to yourself and pay ordinary income taxes on the distributions. Or you could invest it into your business that you personally own and operate. The latter could be an “investment” from the IRA. Once the money is in your business you could do whatever you want with it. And maybe your business doesn’t pay anything back to your IRA. Maybe it was a “losing investment” for your IRA. Taxes avoided. Woo hoo!

The only problem with the above scenario is that the real loser isn’t your IRA–it’s the government who didn’t collect distribution taxes because your IRA “lost” all its money. For this reason, the prohibited transaction rules make the above scenario illegal. The government made the PT rules to ensure that you don’t end up “losing” your retirement money. There are six PT rules. Four of the rules are commonly quoted, written about, and understood easily. The remaining two rules seem to elude or mystify most people, so let me bring clarity to the matter.

In order to be legally compliant, every retirement plan transaction must involve a genuine effort to benefit the retirement plan itself without benefiting the plan owner or his relatives. Let’s go ahead and knock out the most common strategies that are wrongly believed to successfully “get around” the rules:

Benefit Swapping

Joe & Frank are friends and each of them setup a self-directed IRA. Joe’s IRA loans $50,000 to Frank and Frank’s IRA loans $50,000 to Joe. This doesn’t break the 4 rules that are most focused on, but it does break the usually-ignored rules. For each loan transaction the borrower is not a “disqualified person” for the IRA to transact with, but the loan is a conflict of interest for the IRA owner because he expects to receive a loan back from the other person’s IRA. Because his decision to extend the loan from his IRA involves the expectation of a chain of events that is designed to benefit him personally, this is a prohibited transaction.

Another example would be if Joe’s IRA and Frank’s IRA each bought a vacation condo, and each IRA let the other person stay in the condo. Real estate is a popular investment for self-directed IRAs, but if an IRA owns real estate its owner (and his relatives) are not allowed to make personal use of the property, regardless of whether fair market rent is paid. If Joe vacationed in property owned by Frank’s IRA and Frank vacationed in property owned by Joe’s IRA, it would be a prohibited transaction. Just like the loan swapping, what makes it prohibited is the fact that when the IRA owner made the decision to enter into the transaction, he expected to receive a personal benefit as a result of the transaction. This applies to direct benefis and indirect benefits that come about as an expected chain of events.

Strawperson

Joe wants to sell his house, but he can’t find a buyer. His IRA has enough money in it to buy the house from Joe, but that would be a prohibited transaction because Joe is a disqualified person. So Joe arranges for his friend Frank to buy the house from him who will later sell the house to Joe’s IRA. Joe thinks he didn’t break any rules because Frank is not related to Joe and thus is not a disqualified person. In this scenario, in the eyes of the law Frank is a “strawperson”… a person who is not involved in the transaction for genuine reasons. Frank doesn’t really want to buy and then own Joe’s house. He is just entering into the transaction to add separation to the real transaction. The law removes the strawperson to examine the real transacting parties. In this case the real parties are Joe and his IRA. Effectively, Joe sold his house to his IRA. That is a prohibited transaction and it remains a prohibited transaction even with Frank the strawperson inserted into the chain of transactions.

The same strawperson strategy fails the test no matter how it is constructed. If Joe’s IRA loaned money to Frank and Frank subsequently loaned money to Joe, it would violate the PT rules.

The lesson

Setting up a self-directed IRA or Solo 401(k) brings your retirement funds to an unlimited investment platform in the sense that you can invest in virtually any type of asset. You will save yourself a lot of time and headache (and possibly tons of money) if you clearly understand the remaining limitation: you must invest solely to grow your retirement account without engaging in conflicts of interest.

Now that’s not so bad is it? The merits of whether the income tax is good for our country in the first place is a topic for another discussion. But within our current system, it’s not so much to ask that you avoid all conflicts of interest. Use your retirement account for its intended purpose–to grow massive wealth. There is a whole world of opportunities out there that don’t involve a potential conflict of interest!