Real Estate IRA's Yes or No and why?

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RealEstateIRA's picture
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I have been looking for an RIA firm that isn't affiliated and is truly independent.
   
I am a real estate broker who specializes in prospecting investment properties for my investor clients. I have learned that a self directed IRA or solo 401 is allowed to own real estate as an investment. These investments also include bank notes, deeds of Trust, mortgages, land options, rental properties, flips etc.

Adding these types of investments to a retirees portfolio creates a Win Win relationship for both the clients and advisors (RIA and RE Firms). These investments that I find can provide a high ROI as well as security depending on the area or the way the investment is leveraged.

for example,    I only present real estate investments that have an equity position already then order a rental analysis from a property manager. Conceptually, if it is determined after performing this due diligence that the investment is worthy then I present it to RIA' firm(s) to present to their clients as an alternative investment.   If I understand how an RIA's fees work, should the client decide to purchase the property, the Advisor would receive more income bc the clients total assets value increased equal to the price of the real estate asset they just acquired. Im sure there are also evaluation fees on behalf of the client. Also the client can leverage the property thru a non recourse loan, which is required in an IRA, they would only have to put down 30% of the cost of the asset but you charge on the total value.   

Why are these more appealing to retiree clients and RIA firms.   They can see and touch this investment. They know the area and are confident with the values and risks. They live right down the road from it.   They can hire someone else to manage it for a nominal fee. Their advisors such as an attorney, FP, RE Broker, property inspector, appraisal all show that this is clearly a good investment. The RIA advisor can say that they have literally looked everywhere even outside of the financial sector for a great investment for their clients. This builds trust.   Also if you think about it.
When is the last time you have ever financed a mut fund or a stock? Also when was the last time you purchased a stock with instant clear equity?

The reason for my dilemma is because I am looking into starting my own office that caters to retirees looking for alternative investments. We will look for these clients via RIA's and public education seminars. We want to inform people of their ability to invest in real estate with their self directed IRA or solo 401k and show them the benefits of this as a means of further diversifying their retirement portfolio.    

Hypothetical   I have an investor client who wants to buy a $1,000,000.00 apartment complex using $300,000.00 of his IRA monies as a down payment for a non recourse loan. Its worth 1.1 million and its fully rented for about 10,000 positive cash flow per month.   He wants to hold it in his IRA but his current custodian with (typical financial firm) does not allow these types of investments.   
      
So what do I tell this guy? Financial planners don't care about these types of investments bc they cannot make a commission off of them even though the IRS code allows for it. Or find an independent RIA that caters to these types of investment so that they can find you a custodian that carries these types of investments.    

By the way Pensco Trust seems to be one of the best custodians in this arena they have a great website explaining this rule as well.

Thought this would be a great place to start.   Any thoughts. be honest you wont hurt my feelings.

Morphius's picture
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You want honest feedback?  It sounds like you know just enough about this to be dangerous.  Where to start?First, regarding purchasing real estate within an IRA, are you completely aware of the repercussions to the owner of the IRA if they unknowingly violate one of the many IRS statutes regarding these types of accounts?  The entire IRA is disqualified, and all taxes and penalties (if the owner is less than 59.5) due.   There are many ways this can happen - are you aware of each one?It sounds like you are at least aware that they cannot buy properties using conventional mortgages, but you blithely describe non-recourse loans and 'leveraging the property' as if there were no risks or costs involved, just as you seem to take it as a given that all real estate is a good investment.  What hole have you been hiding in?Do you understand that income from a debt-financed
property within an IRA is subject to unrelated business taxable income (UBTI), and that clients IRAs would be required to file a separate income tax return and pay income taxes on
those ‘profits?'  Have you ever actually worked with clients who had to do this, and see their reaction when they realize they not only have to pay income tax on their IRA, but also have to pay someone to complete the tax return?Second, and leaving the product aspect aside for a moment, you need to understand that RIAs have a fiduciary obligation to clients, and what that means when it comes to your notion of recommending a specific property because "they live right down the road from it" and can "see and touch this investment?"  You don't even understand the range of ways that RIAs can be paid for their services (it is not limited to a percentage of the assets under management), or what their legal responsibilites to their clients are, yet you  want to use them as your primary distribution network?  You need to do your homework until you can clearly articulate the differences - especially from a legal and regulatory standpoint - between investment brokers (registered reps) and investment advisors (RIAs), and how a "financial planner" fits into that framework.I won't even get into your infatuation with what you feel to be the novelty of being able to finance real estate but not "mut funds or stock."  Perhaps you should read up on a very common thing called margin accounts before you open your mouth on that point again.I could go on but I'll stop there.  I'm afraid you need to do a lot more homework, although I'm not sure I'd waste much time on this.  The risks and hassles of this make it nothing more than a niche product, and a rather risky one to the typical IRA owner.  The only ones who really stand to "win" from this on a broad scale are realtors or those whose compensation is derived from the sale of real estate.

RealEstateIRA's picture
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Hi Morphius,
Thanks for your comments any feed back is good feedback
I am sorry that I left a lot out in order to keep it short and sweet. To start yes we are aware of the rules and regulations regarding PT or prohibited transactions. As a member of the small but growing IRAAA a non profit association, we all have taken courses on this specific subject in order to avoid such a disqualified investment or the occurrence of these in general. Though I am not allowed to represent these facts in front of a client without the counsel of a CPA or tax accountant will be providing a detailed list of PT and situational instances where an investment is disqualified in our educational seminars before we offer our prospecting and real estate services to our clients.

Yes we are also aware of the UBIT tax on leveraged properties and provide this cost into the ROI estimate.    These are included when the the property is leveraged in either a rental or a flip transaction. We will provide the client and their advisors an analysis of the due diligence on the investment to include the following:
   a rental analysis from a property manager for expense and current rental rate. A home inspection once the property has been identified. A truth in lending statement from the Non Recourse lender including closing costs and monthly payment with escrows, an appraisal. an insurance quote, Market condition report from the local association of realtors or the board of realtors. Demographic information and market trends showing growth or a decline in black and white. This detailed estimate is created for each property that we identify and then double checked by our CPA who will be on retainer and offering his tax reporting services to all of our clients at a reasonable fee. Before I forget we also recommend that the client hire an attorney to create an LLC owned by the IRA for benefit of the retiree to hold the investment in. for properties where several persons would like to partner on an investment like an apartment building this is a mandatory requirement.

I am not sure which part of the country you are from but this area is far from a "hole" that you throw money into. Though this maybe true from where you stand but my business will reside in the Triangle area of North Carolina where several of our small towns have been consistently voted in the top 20 best places to live in america, for the cost of living, growth in industry and real estate values.

I do not believe that all real estate is a good investment, that is why I work so hard to find the good ones either from foreclosure or Bank owned or a right of way Option Contract opportunity. Don't forget I can't be successful by just sitting around and waiting for a sale I get up just like you every day and check the lists of the court house and the MLS to Identify sound investments for my clients. If I just throw crap at my clients I get sued and no repeat business or referrals just like you.

I apologize about the financial planner comment it was not meant to be an insult. I get insulted when people call me an agent where I am a full broker.   I too have a fiduciary responsibility to my clients and I did not mean any disrespect to you with the financed investment. Actually I still don't know what the heck a margin account is but I will get right on that because I want to know. Thanks

As you can probably tell I am a novice in the framework of how a RIA is compensated. This is why I joined this forum so that I can understand an learn of course how your end of the business works and if there is a possible business relationship.   I do not want to waste my time either so if you feel inclined and can avoid just closing the door on me, is there a way for this to work on your side of this business.   If so what do I need to do my homework on. what do you need to see in order to approve of an investment and present it to your clients?   Im serious. I want to know. Can you help with this?    

Morphius based on your reaction are you saying that there is no benefit for an RIA to evaluate approve and present these to their clients? As long as the client understands fully what the risks are does this mean that there still is no benefit to you business if they buy something?   How do you get compensated if you don't take commissions. Does your custodian allow for non financial sector investments, and If so are there limitations.    In the last 3 years I have sold over 30 million in investment properties and I have never heard a complaint yet.   There are no investments that I have sold to clients that I wouldn't have bought my self If I could afford it.

Yes I am looking into this idea as a new source of income for me but I also believe that by giving the client all of the information that they will need in this niche they will benefit as well. I know a great deal when I see one and this potential business idea is exactly the same as usual for me with a different way of paying for and holding the investment for my clients.     I own several in my SDIRA and hold them under pensco trust as my custodian.      Yes it is a Niche market for me and those investors who already buy real estate and see its value as a wealth builder in retirement.   Did ya think I was going national with this? HA HA It would never work in the majority of the us today I agree.    

Thanks again and get back to me if you want about that homework.     

anonymous's picture
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Joined: 2005-09-29

This is out of my field of expertise, but I do have some questions/comments.
 
"Adding these types of investments to a retirees portfolio creates a Win Win relationship for both the clients and advisors (RIA and RE Firms). These investments that I find can provide a high ROI as well as security depending on the area or the way the investment is leveraged."
 
 
If you know that there is going to be a high ROI and securuity, why do you need clients?   Can't you just borrow and invest and become very wealthy?  That sounds like more fun than working.
 
Also the client can leverage the property thru a non recourse loan, which is required in an IRA, they would only have to put down 30% of the cost of the asset but you charge on the total value.   
 
Let me see if I understand what you are suggesting.  If I charge 1% on AUM and my client has $300,000, I'll charge him $3,000 on his stock portfolio.  If we have his IRA buy real estate and he borrows $700,000, his fee with me should become $10,000 or 3.3%.  This is on top of the commission on the real estate.  I understand how this is a win for me.  I understand how it is a win for you.  How does the client benefit from paying commissions on top of his fees and having his fees increase by over 300% and having to pay someone to manage the real estate? 
 
 
 
"They know the area and are confident with the values and risks."
Why should they be confident with the values and the risks?  Do you know something that we don't know?
"When is the last time you have ever financed a mut fund or a stock?"
 
Anybody who has any debt has financed the purchase of their mutual fund or stock.
 
One of my biggest concerns with real estate inside of an IRA is dealing with RMD's.  How is the retiree supposed to come up with the money for the RMD when the property isn't throwing off enough positive cashflow to cover it?  It seems like this is a major risk of these types of investments.

CALI123's picture
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Joined: 2009-01-30

I think your e&o would go through the roof -if this was even covered.

Morphius's picture
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I don't have the time to provide all the information and education you ask for, but I'll offer a few observations about the basic concept of buying real estate as an investment within an IRA from the perspective of an RIA who has evaluated this on a couple occasions and, on one occasion, obtained a new client with such an investment.

1. First, RE as an asset class has been hammered in the past couple of years, so your premise that RE offers a superior ROI or less risk than other investment alternatives is hardly a given, even in your highly awarded area (what were the growth rates in real estate values in your area the last couple of years)?

2. Even if someone was bullish on RE as an asset class, there are many available options for investing in RE that offer advantages over direct ownership, including liquidity, convenience, range of different options, diversification and cost. If they also were inclined to leverage their bet as you mention, there are leveraged RE ETFs available as well, in addition to margin accounts I mentioned earlier, or simply taking out a loan in order to invest.

3. Even IF someone wanted to invest directly in real estate, the hassles, costs (just look at the litany of professionals you yourself refer to in advising a client - cpas, attorneys, investment advisors, realtors, forming an LLC, etc.) and potential enormous consequences of doing so within an IRA are so severe that most people would never knowingly enter into those transactions, IF they fully understood the details. When all it takes is a small misstep to disqualify your ENTIRE IRA that you have been building over many years, one tends to question if the risks are commensurate with the potential benefits.

And remember - it's not enough that YOU understand and abide by the various regulations to avoid blowing up someone's IRA - the buyers THEMSELVES must know, and remember, and consistently follow these strict regulations. That is asking a lot of most individuals, as those of us (not only RIAs) who work with clients over the course of years know.

4. Then there are is the hassle factor, which the client surely cares about, as do those of us who continue to work with them. These include monitoring and paying others to manage your property, hiring a CPA to prepare and file a separate tax return for your IRA to report and pay your UBIT liability (your IRA is a separate legal and tax entity from you as an individual), and - if you have established an LLC - making sure you maintain the various required registrations and filings with your state. And handling RMDs present another entire challenge, which I'll not even get into as this is already going too long.

From the perspective of the RIA whom you envision serving as your distribution network, the combination of these factors, when weighed against other available options that would allow a client to gain investment exposure to RE in virtually any sector, does not make for a compelling argument.

I don't doubt that a particular property could be a good fit for a certain client in certain limited situations, but the time it would take to try and evaluate multiple opportunities makes this something that few RIAs would mess with, especially when you layer in your fiduciary obligations on top of everything else (and if you think you, as a real estate broker, also have legal fiduciary obligations to a buyer, I suggest you review your understanding with your legal counsel). Take the same investment opportunity OUTSIDE an RIA and I'd be more open to it.

Finally, I can't possibly explain all the permutations about all RIAs in the context of this forum, but I will echo what ice told you that we can generally speaking be paid a fee in any number of ways, so long as all aspects of the fee are disclosed to and agreed to by the client. Your scenario would generally lead to hourly or flat project fees, although not all RIAs choose to even offer those payment options. It does not matter to me which custodian might be involved in such a transaction, so long as I am satisfied that it is a reputable, trustworthy custodian.

So strictly from a compensation standpoint, I see no problem with your business concept. It is the other issues that present the problem.

Listen, I understand you are looking for ways to increase your business and make more money, especially in this horrendous market, and I applaud your initiative. But like anonymous said, the only clear "win" is see in this the realtor. I don't doubt that with an effort you could find prospective investors and/or RIAs who may become buyers, but I think it will be, at best, a very limited niche market, as I said earlier.   

I hope this helps as I've already taken far too long on this and need to get back to work. Good luck.

RealEstateIRA's picture
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Dear Anonymous,
Thanks for responding. Ok I do borrow and invest in a few of these every year. However I can't buy all of what I see. For the most part Time is a factor and investable funds being the other factor.   I can only contribute so much to my IRA yearly. The current plan that I am running includes 3 properties that I have purchased at about $100,000.00 each and financed with a non recourse loan for 30% down on each. The ball park equity range of value on these houses is about 30% or When I purchased them for 100 they were market and appraised at $130,000.00.   Basically I pay the mortgage directed from my IRA with PITI and a management fee of 680 per month. The all rent for 1000.00 each which leaves me with 320 positive to reinvest on each.   In order to build wealth I place the positive cash flow back into the mortgage as principal over and above the mtg payment. This will lower the UBIT tax on a monthly basis as well as beat down the amortization on the mortgage.   for each property the UBIT will start at around $745 each and is re adjusted monthly with the reduction in principal contribution.
math
320 per month X 12 mos = 3840 subtract the first 1000= 2840 X leveraged percent .70 = $1988.00 then this amount is multiplied by the trust rate of 37.5% totaling the UBIT tax at $745 for each at the end of the year if I never applied anything towards principal.

Yes its is true the UBIT is not fun but It is a cost of doing business.   I pay the UBIT with my annual contribution of 4,000.00 where there is still a little left over to place into a cash position or in a Money market for reserves. This will buy me quite a few months if the renters leave. With each purchase I recommend a 10% reserve of the purchase price to be held for just in case situations. We seem to have a stronger rental market here bc less people are able to qualify for a home bc of the credit crunch and increased criteria for a mortgage. I have seen 750 credit scores with cash down turned away from a loan because they were stated income clients.

Also I do not charge a commission for a purchase this is usually paid by the sellers in NC. In most situations they will only pay a commission when they sell the property hopefully many years later when they can show a significant profit because the home is paid off or the market has appreciated positively. In some instances but not all we can attend the sheriff auction with our client. In this instance there would be a finders commission that would have to be paid by the client however this is a rare circumstance and is only available to the cash buyers. Typically If I find them a property and track it thru the foreclosure process and ensure that is free and clear of liens and has significant equity the client is more than willing to pay this commission of three percent. Also if you purchased a property thru my office we track the progress and send an annual market analysis for value and we discount our selling commission to around 4.4% instead of 6%.

I am not sure exactly what RMD or that term is unfamiliar to me is it risk vs managed debt? I will re state that we do not recommend properties that will be un able to provide a positive cash flow while rented to cover all of the cost associated whit this type of investment.   

I guess the tricky part is that typical people do not have the comfort level to investment in RE and some do. I will be catering to the Real Estate Investors as I always have. Im just looking to expand their portfolios into their retirement investment choices. When I talk about this option to them their ears perk up because they already understand the risks involved in RE and are used to managing this type of risk. They can see that by placing certain purchases into their IRA a not so good investment with capital gains after a flip could mean full profit in their IRA and retirement which is something that they should be thinking about anyway.
Thanks again for voicing your concerns. If possible can you please tell me what RMD is so I can understand your concern.

gvf's picture
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God...I just had a client call in yesterday about this....She sounded like she talked to an uncle/nephew/brother about this "hot" investment idea.  She got all bothered when I started telling her about all the trip-ups, restrictions, liabilities.And secondly, she has a BENEFICIARY IRA that she wanted to do this with....

RealEstateIRA's picture
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Thanks again Morphius
Your right it is an up hill battle.

anonymous's picture
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Joined: 2005-09-29

"If possible can you please tell me what RMD is so I can understand your concern."
 
RMD is a Required Minimum Distribution.  This is the minimum amount of money that must be removed from the IRA on a yearly basis.  It sure seems like trying to take an RMD from an IRA that is heavily invested in real estate could easily put someone in a position where they need to sell when the market is down.  It could also create serious tax issues if they can't sell. 

Morphius's picture
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anonymous wrote: "If possible can you please tell me what RMD is so I can understand your concern."
 
RMD is a Required Minimum Distribution.  This is the minimum amount of money that must be removed from the IRA on a yearly basis.  It sure seems like trying to take an RMD from an IRA that is heavily invested in real estate could easily put someone in a position where they need to sell when the market is down.  It could also create serious tax issues if they can't sell. 
If you're not aware of something as basic and common as RMD, which dictates when and how much people must withdraw from their IRAs, I really think you better think long and hard before you start actively prospecting for any type of investment inside an IRA.

I'm glad you asked for honest feedback, because it seems my first observation was right: you know just enough to be dangerous with this concept. You may know real estate, but it's not enough to only know about real estate here - you have to understand IRAs and how they work. As it is, you're playing with fire with this.

RealEstateIRA's picture
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Dear Anonymous, Thanks I did know what a minimum distribution was only I was thinking about wealth building and you guys are taking about distributions. Your both way ahead of me, about 29 and a half years to be exact, on this point. I Did look into the functionality of the IRA earlier only I didn't recognize Required Distributions in acronym form RMD, like when most people hear the words FUBAR and MILF. Hopefully you know what these mean. haha

Anyway OK, so I stated earlier that the Idea behind these real estate Investments is to buy them and pay them off.   I also think that having a separate IRA for real Estate is a good Idea. (One for FSI and one for NFSI) Part of my report of the investment before it is purchased is how much time will it take to pay this off if the client leverages the property. By paying the property off and waiting one year after this we can avoid the UBIT Tax if we decided to sell it while it was still in the IRA. Once the client is 59.5 they can take a distribution of the second IRA (used for real estate) back into their own account without selling it. I know that I would definitely want to take control of my paid off LLC real estate wouldn't you. Many people use this plan for their retirement homes.

For Example, if they were to buy a beach home and rent it out with the goal of paying it off before they retire and when they're ready just liquidate the ira by re deeding the property back to their names as a distribution. What would be the advantage of keeping a real estate investment in an IRA when you can distribute it back to your self for nothing and move in or sell it avoiding the RMD. Don't you have more possibilities and advantages with personal control over a property. Such as when planning your estate.

I am still trying to identify your concerns without playing with fire.    

I guess you are concerned if the property no longer creates income or there is no immediate liquidity and its still inside of the IRA and its also time to take a min distribution. I really don't see this happening. This is why we recommend a portion of that IRA be in a readily available form. I believe that a client should not invest more than 70% of their investable dollars into an investment.   So if they have 100K to invest we will only allow or will not help them if they want to invest more than 70K.   The client must always have some kind of liquidity for what ifs or vacancy or major repair or taxes. If a bill is paid and the liquidity decreases then the client must replenish that with their yearly contribution or income produced by the investment.   It doesn't sound like this is as bad a problem as its made out to be with a little added thought.    

Please Morphius I may be young but don't be so anxious to stomp on me when I leave my foot out there.    Sounds like you want to discourage me and others who read from looking at this further. If you don't like the concept fine. But I am here to learn from the experts and I don't think comments like your playing with fire can help any body but yourself in your task to squash something.

Does anybody else have any concerns so I can learn about it.    

Sportsfreakbob's picture
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I didnt read this entire thread, just skimmed it, too long, so maybe i missed something and this was mentioned.But, there are firms that do this. They specialize in setting up IRA;s that hold real estate and helping the owner stay fully compliant. There is one in Chicago that my firm recommends, whose name escapes me, but i am sure it can be found using Google. Anyone who does this without using a plan designed by a company like this is out of their minds. One question arises....if you do this, isnt it a big disadvantage that you end up paying ordinary income tax rates on the profit when you draw the money out, vs Cap Gains?Of course if you held it a few more years, by the time Obama gets done, the Cap Gains rate will probably be 50%, but thats a different thread

RealEstateIRA's picture
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Hi Sports Freak Bob

Now I am not a CPA but I don't know of any type of tax for properties placed into an IRA and purchased for cash. As long as you buy it with the IRA and Sell it in the IRA and leave the income in it, there is no tax. There is however a UBIT tax on leveraged or mortgaged investments. If it is leveraged you will pay a tax on rental income and when you sell it based on the leveraged amount minus qualified expenses. You should ask your CPA to confirm this. I feel as though this is manageable. As you probably know there is a penalty if you should take any of the renal income or profits out of the IRA before you are eligible for a distribution.   Depending of weather or not your IRA is a ROTH or Traditional will determine if you have to pay a tax on the distribution. A distribution for a traditional is taxable on your tax bracket I think.   I would do a ROTH for a RE IRA.   Again this is not my area so I cannot ensure this statement.    Any CPA's out there?   

I agree there should be an IRA administrator or an RIA too. If its an administrator like entrust They hold the investment with a Regulated Custodian, and have attorneys and CPA that can advise on the subject matter. However they are not allowed to recommend or prospect for these investments.   Usually they will get the client set up with their Self Directed Roth IRA, Set up an llc owned by the IRA to hold the investments in. Once the client has found an investment the admin will charge fee and review the clients information provided by the RE Broker for analysis of ROI and risk. Only the client makes the decision to move forward. These advisors only review and ensure the investment doesn't fall into a Prohibited transaction status before the investment is purchased then set up management of the asset accordingly.   The accountant on staff will review the investment and create a final ROI estimate to include UBIT if it is included in the transaction they will charge a fee to hold the ensure the proper reporting as well. Since the client has the ability to create a Prohibited Transaction or cause liability problems many firm will require a waiver of liability in the instance of PT and become the main source for answers on these subjects.

This can also be done with the clients RIA to review the investment. Admisistrators are very good for the office work on one of these investments. Many of these firms only have the authority to ensure that the liability and regulatory reporting are taken care of. Most do not have a RIA on staff though it is beneficial for them to have one or two.

The problem with this is that once the client is set up and ready to go it is left up to them to find the real estate or other NFSI to purchase. This is where my proposed business will come into play. I prospect for these types of investments every day. Most realtors do not have experience in true investment real estate. Most have never heard of a REAL ESTATE IRA. By educating our clients and recommending and obtaining a good crew of servicers, the client will be in better hands and unmistakably more successful with these investments.   It is possible and feasible for me to recommend a RIA or Attorney or CPA to handle the reviews, llc set up and regulatory reporting.   Though it is not recommended the client can obtain a custodian on their own and hold the investment there however it is much cheaper and easier to just send them to an RIA or an administrator who handles these investments.

Thanks again Sports freak bob. Hope this covers your question. but you should definitely consult a CPA for your taxation question.   

Sportsfreakbob's picture
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My post was a comment, not a question.Entrust was the firm i was thinking about, thank you.Money goes into an IRA pre tax. It comes out as taxable ordinary income. If you buy the property with after tax money, you pay cap gains tax on the gain. If you buy it in the IRA you pay ordinary income on the gain, at the time it is removed from the IRA.Now, you do bring up an interesting concept - if you did it in a Roth, i suppose the profit would be withdrawn tax free, as long as it is not a premature distribution.

Morphius's picture
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Sorry if my comments hurt your feelings. I apparently misinterpreted your initial post when you actively solicited feedback by saying:
RealEstateIRA wrote: Any thoughts. be honest you wont hurt my feelings.
While I hate to burst anyone's bubble - or stomp on anyone's foot - I am far more concerned about the possibility that you might unwittingly blow up someone's IRA than I am with your feelings.

As I've said before, the basic strategy is an interesting one, and I'm sure it's a good fit for some. But certainly not many. The issue I have is your refusal to at least acknowledge the very real and serious risks ("I am still trying to identify your concerns without playing with fire") which tells me you either don't fully understand the issues, or that you understand but choose to ignore them. Either way, it's not good.

You have shown you are unfamiliar with some very important yet basic IRA regulations, until they are explained to you, at which point you remember that you knew that all along. So be it. Let's say you really do know everything you should know about IRAs, but are just a bit rusty on all these terms and definitions and stuff.

Let's peel back the onion a bit more, so as to not leave ourselves or others here unduly confused.
RealEstateIRA wrote:I did know what a minimum distribution was only I was thinking about wealth building and you guys are taking about distributions. Your both way ahead of me, about 29 and a half years to be exact, on this point.
This is another example of our completely different perspective, and I am not just talking about our age differences. I know the initial purchase is important, especially since that is how you get paid, but from the client's perspective (and mine) it has to make sense as part of their overall long term retirement strategy, i.e. net AFTER distributions and taxes.   This is a critically important part of any retirement plan, regardless of what type of asset makes up the portfolio. Clients certainly are focused on this aspect, and I doubt it would be of much assurance to them if they were to learn that they were "ahead of you" on this important point. I know it isn't of much comfort to me.

RealEstateIRA wrote: By paying the property off and waiting one year after this we can avoid the UBIT Tax if we decided to sell it while it was still in the IRA. Once the client is 59.5 they can take a distribution of the second IRA (used for real estate) back into their own account without selling it.
If this is really how you present the strategy to a prospect, it is a perfect example of what I am referring to when I say you know just enough to be dangerous. Are you really recommending a distribution, which would result in the entire amount being immediately subject to ordinary income tax, or are you again a bit foggy on your terms? And if you are foggy on your terms, why would you expect a client to know more than you do, as the expert on this issue?

RealEstateIRA wrote: For Example, if they were to buy a beach home and rent it out with the goal of paying it off before they retire and when they're ready just liquidate the ira by re deeding the property back to their names as a distribution. What would be the advantage of keeping a real estate investment in an IRA when you can distribute it back to your self for nothing and move in or sell it avoiding the RMD.
The problem with your reasoning, as I alluded to above, is that it is fundamentally wrong: they CANNOT "distribute it back to your self for nothing." Any distribution from an IRA will be subject to ordinary income tax.

What puzzles me is that you, as a realtor, must surely know that someone could dramatically increase their net after tax proceeds by owning the property outside their IRA, so that all gains would only be subject to the much lower capital gains tax rate, including the very significant ($500,000 for a married couple)homeowners exclusion amount if they were to simply make this property their primary residence for the required period of time before selling it.

Instead in your scenario, the entire gain is subject to the ordinary tax rate, which depending on the individual's marginal tax rate would likely at least double their tax bill.

RealEstateIRA wrote:Don't you have more possibilities and advantages with personal control over a property. Such as when planning your estate.
Such as? You're the real estate expert - please enlighten us with specifics so that we might learn something new.

RealEstateIRA wrote: I guess you are concerned if the property no longer creates income or there is no immediate liquidity and its still inside of the IRA and its also time to take a min distribution. I really don't see this happening. This is why we recommend a portion of that IRA be in a readily available form.
Once again, you demonstrate my main concern with this: YOU "really don't see this happening," and so you apparently dismiss the risks and consequences that would ensue if you were wrong.

But what if it DOES happen? What can the client do THEN to avoid blowing up his entire IRA? And exactly what "portion" do you recommend keeping liquid as being sufficient?

Or for that matter, what happens when 10 years from now the client (being forgetful of technicalities as they tend to be) does a little easy work on the property to save a few bucks, or without thinking buys something for the property out of his personal funds rather than using funds from the RE IRA? As you probably know, both of these sorts of errors have actually happened on more than one occasion.

What then??

Until you address this IRA nuclear bomb scenario directly, how can any client - or advisor - feel that you even recognize the risks?

RealEstateIRA wrote: I believe that a client should not invest more than 70% of their investable dollars into an investment.
70%? In ONE investment? If that really is the investment advice I'm relieved you did not go into the business of providing investment advice.

RealEstateIRA wrote:The client must always have some kind of liquidity for what ifs or vacancy or major repair or taxes. If a bill is paid and the liquidity decreases then the client must replenish that with their yearly contribution or income produced by the investment.
Replenish with their yearly contributions? Your multi-year projections of vacancies, rental income and capital improvements and maintenance better be awfully accurate in order for a client to rely on "replenishing" their IRA with the low annual IRA contributions allowed the IRS. I would be very happy in my single family home if my capital improvements alone were consistently below the levels of the annual allowable IRA contribution amounts for me and my wife. So again, EXACTLY how much do you recommend clients keep liquid in order to have "some kind of liquidity?" sufficient to weather prolonged vacancies, unexpected expenses, or both?

RealEstateIRA wrote: It doesn't sound like this is as bad a problem as its made out to be with a little added thought.
I agree with this statement, excluding the word "doesn't"

Here's the thing: if you succeeded, as is your stated wish, in securing a meeting with me and one of my clients who perhaps asked me about this strategy after hearing one of your seminar pitches, you better be able to quickly and clearly answer questions like those asked above - immediately and confidently and without any outside help with definitions - or your opportunity would be over before it ever began.

I think that would hurt more than getting your proverbial foot stomped on in an anonymous forum.

san fran broker's picture
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Thanks to both of you for what has been an excellent and extremely educational argument.  This is the kind of content that brings me to this board.

Mucho de Tejas's picture
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san fran broker wrote:Thanks to both of you for what has been an excellent and extremely educational argument.  This is the kind of content that brings me to this board.
 
Man, no lie.
 
I am surprised that the government hasn't addressed retirement funds as a way of quickly stemming the death spiral in real estate. I could see this being advantageous in many ways if some of the rules were changed.
 
Thanks for the interesting discussion.

Sportsfreakbob's picture
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Advantageous to real estate brokers, not Financial Advisors.

RealEstateIRA's picture
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Sorry I was under the impression that with a Roth IRA any profits or gains via appreciation and rental income was tax free as long as you don't finance it or take it out before you are elligible.    In other words if they bought the investment property and paid cash for it with IRA funds, in 15 years or so after collecting rental income and asset appreciation would be able to not pay taxes for the investment if they sold it while still inside of the IRA. After,59.5 they would take their distribution as a whole to kick off their retirement with a large cash boost.   this is why I sugguested they start a separate IRA for Real estate Investments and one for financial sector investments.    I figured your clients would benefit from this and financial professionals such RIAs could incorporate this into their services for the evaluation, progress reports ect for a fee.    I guess all of the tax accountants I spoke with were wrong. I will have to go back to the drawling board. Thank you all so much

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RealEstateIRA wrote: I guess all of the tax accountants I spoke with were wrong.
Assuming you are being facetious instead of contrite, maybe you should consider the other obvious conclusion: that you have such an incomplete understanding of basic IRA regulations - quite aside from any real estate being involved - that you are misinterpreting or misunderstanding what you think "all the tax accountants" told you. But therein lies your problem: you want to recommend a strategy that is intrinsically and inescapably dependent on a very, very thorough understanding of all IRA regulations, and yet you clearly - and undeniably - have a very poor and confused understanding of those very regulations.

You cannot hope to approach this in a halfway manner, as you seem to do here, by on the one hand positioning yourself to clients and RIA intermediaries as the expert in this type of transaction, while on the other hand responding to basic questions by saying you are not the expert and that the client should consult his tax accountant. It's simply not enough to know the real estate angle of this, because the client's results depend on much more than that. All the more so when one small misstep could lead to the disasterous result of blowing up one's entire IRA - hardly a risk to be taken lightly.

At least with your latest shift in recommended strategy to use a Roth instead of traditional IRA you are at last recognizing and coming to grips with the serious problem of paying higher taxes on the same RE proceeds when they come out of a traditional IRA. But you again show your ignorance and inexperience by failing to recognize the reality there are very few Roths accounts compared to traditional IRAs, and those that exist with significant balances adequate for buying RE are even more rare. There are plenty of reasons for that, but surely the main one is that most large IRAs resulted from 401K rollovers, and few 401Ks even offered Roth options until very recently.

So the idea is now at least sound from a tax standpoint, but you are left with the mother of all niche strategies. Good luck trying to make a living targeting that market.

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