The Retirement Secret

[Will Barnard]

OK, its no secret, just a catchy title for attention! Nationwide Property Investments has educated many on ths topic in live workshops and seminars around the country. I hope this thread clarifies and makes for an easier understanding on this subject, your votes are welcomed and encouraged, lets see if we can get 20!

This thread topic is an off-shoot from Rich Weese's thread about wealth creation. Several people have asked me about self directed IRAs, how they work, how to set them up, and the do's and dont's so I thought a post on the subject was in order as to not hijack Rich's thread.

There are currently over 45 million IRA holders in the US and steadily climbing, but less than 4% of them are self-directed. Eight billion dollars are withheld each WEEK by employees IRA/401k's!

Basically, a self directed IRA enables you to choose the investment type and the only investments you may not invest in with your IRA are insurance policies and collectibles (although some government issued gold bullion, etc are now approved).

In 1974 ERISA (Employee Retirement Income Security Act) stated that you may invest your retirement funds in any vehicle you choose with the exclusion of teh two forementioned. You may refer to IRS publication 590, pages 40 & 41 as well as Section 408 of the IRS code.

You must keep in ind that an IRA, self directed or not, is a "seperate entity" from you. Looking at it in this way will keep you safe and within the regulations of the IRS (especially as a SDI is concerned.

Second, there are three major categories of rules in regards to an SDI. 1. Disqualified parties 2. Prohibited transactions and 3. Unrelated business taxable income/unrelated debt financing income

Let start with disqualified parties.
Your SDI may not involve or benefit any disqualified person. These people include (but not limited to) you as the owner, your spouse, ancestors (grandparents/parents), lineal descendents (daughters/sons & grandchildren), investment advisors, fiuciaries (those providing services to the plan), or any business entity in which any of the disqualified persons mentioned above have a 50% or greater interest.

Prohibited transactions:
Selling, exchanging, or leasing any property between a plan (SDI) and a disqualified party. In other words, you can not purchase property with your IRA you currently own or any other disqualified party owns.
Lending money or other extension of credit between a plan and a disqualified person. Example - you may not personally guarantee a loan for real estate purchased by your IRA and you can not loan money from your IRA to your children or any other disqualified party.
Furnishing goods, services, or facilities between a plan and a disqualified party. - You can not use persoanl furniture to furnish your IRA's rental property.
Transferring or using, by or for the benefit of, a disqualified person the income or assets of a plan.
Example - your IRA cannot purchase a vacation property you or your family intends to use.
Dealing with income or assets of a plan by a disqualified person who is a fiduciary acting on his/her own interest or for his/her own account. Example- you can not loan money to your accountant or third party administrator.
Receiving any consideration for a personal account by a disqualified party who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan. In other words, you can not pay yourself income from profits generated from your IRA's rental property and you can not pay yourself a property management fee from the IRA.

UBTI/UDFI: This third category is most confusing and you should consult with a very (and I mean very) experienced accountant or tax attorney familiar with SDI's and the taxations involved.
In a nut shell, this tax was formed to level the playing field between IRA owners and the general business public. For example, if I as an SDI owner, opened up a coffee shop next to Starbucks, I could provide the same qulaity of product and service at a lower cost because I would be tax exempt. That would not be fair and thus, whenever your IRA participates in an active business activity such as the example, your IRA is subject to taxation. In addition, if you utilize debt leverage (financing) to purchase a property, you could be subject to taxation from teh profits inside the IRA. There is a way around this by simply paying off the debt with the IRA funds 365 days before you liquidate and thus, no taxes are due.
Another example - flipping properties is a business that competes with others and thus may be subject to UBTI. This may or may not be a bad thing and again, a discussion with your tax attorney on the tax implications are in order!

Here is a short list of IRS approved investments:
Rental property, flipping real estate, pre-foreclosures, forecloisures, REO's, mortagages, loans, businesses, limited partnerships, franchises, notes, raw land (must be all cash, no debt financing is allowed on raw land), residential real estate, commercial real estate, lease options, LLC's, international real estate, multifamily units, tax liens and deeds, vacation properties (as long as you dont use them), private and public stock, mutual funds, hedge funds, and the list goes on . . . .

You may self-direct traditional IRA's, ROTH, SEP, 401k's, 403b's, HSA's, and more.

All these rules and guidelines (which can be complicated, but hopefully simplified for you here) were created by the IRS to ensure that the investment activity EXCLUSIVELY benefit the IRA and not any disqualified party. IF you participate in any prohibited transaction or involve any disqualified party, the IRS can and will immediately make you take full distribution of the IRA, pay the income taxes on the entire IRA value and additionally tack on a 10% early withdrawal fee. In essence, you lose half of your IRA or more. Example, if you had an IRA worth 1 million dollars and made a loan to yoru son for $20 from the IRA, the IRS would not just distribute the $20, but the entire $1 million and you would be subject to the penalties.