Monday, December 5, 2016
Monday, October 31, 2016
Best Practices for Real Estate IRA Investing - How to Manage Your Real Estate IRA Investments
By Bill Humphrey
For those with a penchant for real estate investing, IRAs are a potent vehicle indeed. Outside of a tax-advantaged account, such as an IRA or a SEP IRA, rental income is taxable every year, as you receive it, and passive activity rules restrict your ability to claim losses from real estate. If you use a self-directed IRA, or a real estate IRA, however, you can accumulate all that rental income tax-deferred, or tax-free if you hold the asset in a Roth IRA. If you have the patience, liquidity and know-how to be a successful real estate investor, it can make perfect sense to leverage these skills in a self-directed IRA or other retirement account as well.
That said, there are some things that you need to be aware of that are unique to using an IRA or other retirement account for real estate investing, because if you don't comply with certain rules and regulations, you risk exposing yourself to unintended penalties and taxes.
Watch Your Cash Flows
Paying attention to cash flow is critical with Real Estate IRA investing. Remember, the law limits the amount of new money you can contribute to an IRA each year to $5,000 (or $6,000 if you are over age 50.) As any veteran property owner knows, property repairs and renovations can easily exceed many times this amount.
This means you can't intervene in your IRA-owned property with a massive cash infusion from outside your retirement accounts, no matter how badly your property needs the repairs. For anything over the max $5,000 annual contribution, you will need to pay for it from liquidity you have in the IRA itself, roll the money over from another eligible retirement account, or have your IRA borrow the money.
For this reason, it's generally best to have some liquid reserves - cash, cash equivalents, reasonably stable securities, or a line of credit your IRA can tap for this purpose. Your checking account won't do you much good when you have to pay for a $30,000 roof.
Set Aside Cash in Your IRA
Outside of an IRA, the tax code provides a natural means for investment property owners to set aside some reserves. This is part of the logic of depreciation deductions - you're supposed to set aside the savings to pay for expected repairs, maintenance, upkeep and eventual replacement. But you don't get a depreciation deduction in an IRA. You need to set aside reserves from operating income within your IRA or be prepared to transfer assets from elsewhere.
Understand Prohibited Transactions
Remember, you can't lend money to your IRA personally. If your IRA needs to raise cash in a hurry, you can't be the person to provide it, beyond allowable contributions and rollovers. The same applies to your descendants, your parents and grandparents, and any of their spouses. Ditto for any business entities they control. (The law does not specifically rule out your brothers and sisters, though).
The same people who can't lend to your IRA also can't borrow from it, for the same reason (though you can use your self-directed IRA to lend money at interest to whomever else you like.)
Likewise, you can't do business directly with your IRA, nor can any other disqualified individuals, nor can their spouses or any business entities they control. Some people try to open a property management company, or construction company, and have their IRAs compensate their companies directly for services rendered. This is prohibited by the IRS.
Understand Long-Term Tax Ramifications
If you hold a real estate investment outside a retirement account, and sell it at a profit, you pay tax at capital gain rates. If you held it for more than a year, your capital gain tax will be less than your income tax. However, if you hold the property in a tax-deferred retirement account, you will need to eventually pay income taxes on any gains, rather than the lower long-term capital gains rate. To avoid this, consider using a Roth IRA to hold real estate or capital assets in an IRA. You don't get a current year tax deduction, and you can't take depreciation deductions in either case. But any gains are tax free. Additionally, you sidestep the eventual problem of taking required minimum distributions when you get older, which can be a challenge if your retirement portfolio is in illiquid holdings such as real estate.
Don't Stay in the Property
Ordinarily, rental properties allow you to spend a couple of weeks per year in them without jeopardizing their status as investment properties. This is not true for IRA-owned real estate. You can't live in the property, even if you're paying rent. You can't even stay overnight in the property. What's more, you can't let your children, grandchildren, parents, grandparents, or their spouses stay overnight either. If you do, the IRS could consider it a distribution, and impose a tax equal to 100 percent of the amount involved.
Be Careful With Borrowing
Many people are confused by IRS prohibitions on lending to or borrowing from your IRA personally, or pledging your IRA as collateral for a loan, and think that you cannot borrow money for your IRA at all. In fact, your IRA can borrow money. But understand that it's your IRA that's borrowing the money - not you. This distinction is crucial. Your IRA can only borrow money from non-disqualified individuals and entities on a non-recourse basis. This means that if the loan should default, the lender can only come after the IRA to collect. Only assets held within the IRA can serve as collateral for the loan. You cannot pledge anything outside the IRA as collateral, nor sign a personal guarantee of any kind.
Beware of Taxes
Taxes? In an IRA? Alas, yes. While your IRA can defer income tax and is generally exempt from capital gains tax, you still have to pay property taxes if you own real estate in your IRA. Additionally, if your IRA employs leverage - as is common for real estate investing - your IRA may be subject to unrelated debt income tax, or unrelated business income tax, depending on the situation. New Directions IRA does not give tax advice, so you should retain the services of a qualified tax advisor, such as a CPA, tax attorney or enrolled agent, for advice specific to your situation.
Friday, September 23, 2016
When evaluating an investment opportunity, there are many characteristics that one can use to evaluate risk. A savvy investor needs to understand the quote above from a very wise mentor when evaluating investments. Reward is easy to measure. It's typically stated or promoted quite a bit.
Most novice investors focus on the reward alone, and with rose colored glasses ignore the downside risk of a particular investment. This is a very immature approach to investing.
There are several characteristics to consider when evaluating an investment. One of those is to evaluate whether the investment is secured or unsecured. A secured investment is when there is a lien on some underlying collateral. This makes recouping your investment much easier.
An unsecured investment means there is no underlying collateral to protect your investment, and you'll have to sue in order to collect. This obviously causes delay and additional expense. The better and more valuable the collateral the safer your investment.
Many people ask me if investing the stock market is unsecured or secured. That's a good question, and the answer is, the investment is secured. It's just secured to a volatile asset.
So ask yourself, would you prefer a secured investment or unsecured investment? It's up to you, there's no wrong answer.
Friday, September 16, 2016
Sunday, September 11, 2016
Einstein once said the power of compound interest was the 8th wonder of the world. What is compound interest? Let me answer this by way of illustration.
Here’s a question I’d like you to consider. Which would you like more? $100,000 cash or a penny doubled every day for 30 days?
Let’s look at the penny doubling every day example:
Day 1 0.01
Day 2 0.02
Day 3 0.04
Day 4 0.08
Day 5 0.16
Day 6 0.32
Day 7 0.64
Day 8 1.28
Day 9 2.56
Day 10 5.12
Day 11 10.24
Day 12 20.48
Day 13 40.96
Day 14 81.92
Day 15 163.84
Day 16 327.68
Day 17 655.36
Day 18 1,310.72
Day 19 2,621.44
Day 20 5,242.88
Day 21 10,485.76
Day 22 20,971.52
Day 23 41,943.04
Day 24 83,886.08
Day 25 167,772.16
Day 26 335,544.32
Day 27 671,088.64
Day 28 1,342,177.28
Day 29 2,684,354.56
Day 30 5,368,709.12
After 30 days, you’ve accumulated over $5 Million dollars! However, this assumes a tax-free environment. Let’s look at a more realistic environment of 15% tax. This is a conservative tax bracket and represents a short term capital gains tax, such as if you bought and flipped a house (you’d be subject to this capital gains tax). In addition, since it’s income you’d be taxed on the income later as well. However, for now, let’s look at how this realistic tax environment has an effect on your bottom line.
Day 1 0.01
Day 2 0.02
Day 3 0.03
Day 4 0.05
Day 5 0.08
Day 6 0.14
Day 7 0.24
Day 8 0.41
Day 9 0.70
Day 10 1.19
Day 11 2.02
Day 12 3.43
Day 13 5.83
Day 14 9.90
Day 15 16.84
Day 16 28.62
Day 17 48.66
Day 18 82.72
Day 19 140.63
Day 20 239.07
Day 21 406.42
Day 22 690.92
Day 23 1,174.56
Day 24 1,996.76
Day 25 3,394.49
Day 26 5,770.63
Day 27 9,810.07
Day 28 16,677.11
Day 29 28,351.09
Day 30 48,196.86
Look at that 30-day number! It’s only $48,196 after 30 days. This is in a tax environment, not tax-free or tax-deferred. This is well over $4.9 Million less than the example above.
If you do some quick research on the Internet, you’ll soon realize that taxes will be the largest expense and have the largest effect on your wealth over the course of your lifetime. In fact, the bureau of statistics claims that American’s will spend 30%-40% of their entire lifetime’s income on taxes. From the above example, you can see how detrimental taxes are on wealth creation.
The solution is to invest tax free or tax deferred is to use a qualified retirement vehicle such as a 401k or IRA or Roth IRA or HSA.
However, most people just think that “investing” means investing in the stock market only. However, there are 100s of different types of investments, and the IRS allows you to use any of these qualified accounts for these investments, including investing in real estate. That’s right, you can invest in real estate using your IRA, and it’s quite simple actually.
The most challenging part of investing in real estate with your IRA is finding a custodian that will allow this type of investment.
If your custodian is Fidelity, or Charles Schwab, or Edward Jones, or UBS these are traditional custodians and they will only allow investment in the equities market. This is so sad really because there are so many more profitable investments outside of the equities market.
So the first challenge for you will be to find a custodian that allows investment in the asset or investment that you’d like to invest in. This can be real estate or anything else that you can think of such as startup companies, joint venture partnerships, commodities, and really anything you can think of in the world.
Each self-directed IRA custodian will have their own investing forms and protocols. Companies such as Equity Trust Company, New Direction, Qwest and others will help you roll over your IRA into their company, of which then you can invest in anything you would like to invest.
There are many ways to do it wrong. We’ll discuss these pitfalls in an upcoming blog post.
Friday, September 2, 2016
That idea that money as a product, is the foundational premise behind our business. Money sells itself because everyone needs it.
The challenge for the Managers of that money is to invest it wisely. The old idiom, a fool and his money are soon parted, is true. You must be wise, prudent, skeptical, and cover the downside in order to survive and thrive. Too many investors just look at the potential; however, the prudent Manager must first look at covering the downside. Remove the risk and let the profit take care of itself.
Each year, Dalbar publishes a research paper on how investors underperform as compared to the index fund for the S&P 500. Once again the 2015 study shows that the average mutual fund investor makes 8% below what the index fund makes. The average return is close to 5.5% APR.
#1) That's an incredibly low return. How can investors stand for that?
#2) This does not take into account inflation, opportunity costs and taxes.
What's the current level of inflation? According to our government it's closer to 1.5%-2%. According to ShadowStats.com the rate is closer to 10%.
In either case, you're either barely keeping up with inflation, or you're purchasing power is falling behind.
How do we solve this? We need to move to what my friend George Antone calls the right side of the equation.
We'll talk more about these next time.
Monday, May 23, 2016
I'm loving the election series. Here's what I see. Donald J Trump vs the Democratic Party, most likely Hillary Clinton but Bernie Sanders might pull it out on an upset victory at the convention. My vote is for the Constitution. My vote is for liberty and independence. The debt unfortunately needs to be addressed. Mistakes happen and it's time to rebuild and restart. I propose a new plan for build outs of manufacturing plants and smoother commerce and easier entry to business. More appointments later.
Run it like a business.
Tuesday, March 8, 2016
Yes, that's right Donald Trump knows how to meet an objective, by making deals. In fact, I think he has made a deal with Mexico to build the wall. However, it's not going to be a wall between the US and Mexico. Nope. What would make more sense is that Donald has already negotiated a deal to buy Mexico. The wall he'll negotiate getting built will be between Mexico, (which will now be called "Old Mexico"), and Guatemala and Belize. A much shorter distance, and then that will solve the immigration problem and give us more natural resources to boost our economy.
How will he get the money? From China of course. He'll discount the debt on our country or maybe just sell more debt. It's an easy path to boosting the economy and creating a larger free robust economy.
This will solve several topics: immigration, minimum wage, manufacturing, trade, national debt.