How Lease Options Earn You Tax-Free and Tax-Deferred Money

Pay attention here! Not only are sandwich lease options highly profitable but they are completely legal and available investments tax-free and tax-deferred.

Many people incorrectly assume the only thing a retirement IRA can invest in is SEC approved securities. There is nothing further from the truth. Although 95% of IRAs are only invested in stocks and bonds, the main reason is that the average investor sets up their IRA through a financial planner or stock trading company. The only investments these companies allow are securities and maybe some gold. It is the investment company limiting your options, not the IRS or any law.

The IRS treats a retirement account owning real estate or lease options contracts exactly the same as a retirement account owning stocks, bonds, and gold!

I touched on this briefly in the blog “Baby Boomers, Stock Markets, Coronavirus, and Sandwich Lease Options.” Here I go into more detail.

Many People Invest Their IRAs in Real Estate and Lease Options

All-cash buyers are always the hottest buyers in the real estate market. One of the biggest reasons sellers offer a property at a deep discount is because they need the cash NOW. With cash, you can close a deal in two or three days when the seller needs cash NOW. Without cash, you need approval from a lender and have to fill out large amounts of paperwork that take weeks and weeks to process. If the seller is lucky, he or she might get the cash they desperately need about 45 days from now.

This is where a self-directed IRA that owns an LLC becomes highly attractive. With you as the trustee of the IRA, you have “Checkbook Control” of your IRA. When you find that deeply discounted property that needs to close the day after tomorrow, all you need to do is show up with a certified check drawn on your IRA or LLC account. No approval, no custodians, no fees. Just you and your self-directed IRA account.

You Have Multiple Retirement Account Choices Available to Control Lease Options

The Three Main Self-Directed Retirement Accounts

Self-directed retirement accounts have been used for decades and decades and decades by millions of people (usually wealthy people). They have been tested by the IRS in multiple court cases. Self-directed retirement accounts are so well established that the IRS has issued “Safe Harbor Rules” about how to best structure the accounts to avoid scrutiny by the IRS. There are many variations to these accounts but here are three of the most common:

Custodian controlled self-directed IRA. This is almost completely the same as any other Individual Retirement Arrangement (commonly called an individual retirement account). These insert a third party “custodian” into the transactions. One purpose of the custodian is to guard against you making investments that the IRS might question. This slows down those important fast-cash investments. This is why many investors prefer a Checkbook IRA that does not involve a custodian.

Checkbook IRA without a custodian. This is a version that has become popular over the past couple of decades because it gives you (the investor) full control over your IRA funds. It takes the custodian out of the picture. The general structure is for your IRA to establish and take full ownership of an LLC. The IRA gives directions to the LLC to make specific investments. As the trustee of your IRA, you are the person giving directions for the LLC investments. You sign the checks for both the IRA and the LLC. No custodian required. You simply research lease options and sign the check as soon as you make your investment decision.

Solo 401k for higher contributions and more benefits. A Solo 401k works exactly the same as an employer-sponsored 401k retirement account. The biggest difference is that you are the employer. You set up your own business (typically an LLC) and then you set up a standard 401k retirement account within the business that you own. The big advantage here is that you contribute to your retirement account in two different ways. First, you contribute part of your income to the 401k in the same way that you contribute to any employer-sponsored 401k. Second (and importantly), the business (that you own) adds the matching contribution. As the business owner, you decide how much the matching contribution is. This allows you to contribute much more to your retirement account each year. With more money in your tax-deferred retirement account, you follow the same process that an IRA uses to invest in lease options or any investment that you want to make. It’s important that you understand some rules controlling a Solo 401k. Important is that the business setting up a Solo 401k can only have one employee (you). However, there are ways it can be structured to include a spouse and a partner as employees.

This is how wealthy people use the IRS code to accumulate and preserve wealth. Many variations are available to custom-fit individual circumstances

The ROTH variation. Among the many variations available to each of these self-directed accounts are before-tax and after-tax contributions. The before-tax version allows you to contribute to your retirement account before taxes are withheld. That reduces the taxes you pay on your income each year. This is known as “deferred taxes” because you will have to pay taxes as you withdraw the money in your retirement years – when you expect to be in a lower tax bracket. The ROTH version makes contributions after you pay taxes on yearly income. However, there are no taxes due when you withdraw the money during retirement. What makes the ROTH version popular is that you do not pay taxes on all of the earnings that flow into your retirement account over the years. Not even when you withdraw the money during retirement. The ROTH version is known as “tax-free.” Many lease option investors prefer the ROTH IRA in anticipation of huge tax-free earnings that will be available in retirement.

Rollover and contribution variations. Something important to know is that if you want to get started immediately with tax-free and tax-deferred investing, you can rollover the funds from existing IRA and 401k accounts. If you have a current IRA with an investment fund that limits your choices to stocks and bonds, you can roll those funds over to a business that specializes in self-directed retirement accounts. These businesses offer several versions (including customized versions) of both self-directed IRA accounts and Solo 401k accounts. The contribution limits placed on IRAs and Solo 401ks also need to be understood when making this decision. For the tax year 2020, the maximum allowable Solo 401k contribution is $63,500 (includes over age 55 catchup contribution). You can double that maximum to $127,000 if a spouse is part of the Solo 401k plan. Also, this contribution limit does not include any money you rollover from an existing retirement account. A Solo 401k offers substantially higher contributions limits compared to an IRA, which for the tax year 2020 is capped at $7,000 if you’re age 50 or older.

Something else you might want to be aware of is that you can always invest in lease options with other funds outside of your retirement account. Earnings from these other investments are taxed but you don’t have to wait until retirement to spend your earnings.

Tax Sheltered deals are very attractive but you can also earn money outside of your retirement account. You can do BOTH!

Benefits of Investing in Real Estate with Self-Directed Accounts

Investing in lease options with retirement accounts have a lot more benefits than can be covered in this short article. A few others include:

1. The deferred taxes retained in your account significantly add to your compounding investment power.
2. You can borrow money from your Solo 401k and then pay the interest back into your retirement account.
3. Maximizing your retirement account contribution also maximizes the annual tax reduction on your IRS 1040 form.
4. Retirement accounts offer additional asset protection beyond an LLC.
5. There are many other versions of tax-free and tax-deferred accounts that can invest in lease options and real estate. Others include funding higher education for yourself or your children, health expense accounts, as well as wealth-preservation, and generational wealth-building strategies.