Unique Planning Opportunity for Successful Real Estate Investors and Agents

With the real estate market rebounding, most real estate agents who thrived during the downturn have built even bigger businesses today. As a result of their success, they have some unique planning opportunities. Real Estate Investors and those who buy and sell it everyday, know the business and are much more comfortable with real property than most people.

What is not well known is that with some very strategic planning, a real estate investor can use the assets in their existing IRA's and Roth IRA's to purchase real estate. Ideally, the process is fairly simple to implement. In addition, to using your IRA's and Roth IRA's to invest in real estate, you can also use funds from a Solo 401(k) with a Designated Roth 401(k) account to purchase a new business, a franchise or an existing business. However, you cannot use any of the funds to buy your own existing business or the existing business of a family member. However, you can use your Solo 401(k) with a Designated Roth 401(k) account to purchase a New business! It has to be an arms length transaction, not a transaction structured merely for the purpose of evading taxes.

Let's look at using your existing IRA to invest in Real Estate first. How does this work?

Real Estate IRA LLC

There are just a few steps involved. You need a tax attorney firm knowledgeable in this area of expertise, not fly-by-night promoters who are here today and gone tomorrow. We can refer you to a top flight tax attorney firm that handles this from start to finish.

The Self Directed IRA LLC involves setting up a new Limited Liability Company (LLC) that is owned by the IRA and managed by you. Alternatively, you can have any third party be the manager. As manager of the LLC, you simply open an LLC account at a bank and obtain check writing privileges. You do not need a custodian to approve every transaction. Since you are the manager of the LLC, this gives you wiring authority and checkbook control. Your IRA purchases your LLC as a security. You fund the LLC with the proceeds of your IRA in any amount that you choose up to 100% of your IRA. The IRA holds a position in the account which is your new LLC. The LLC position is treated as a security in your IRA.

For example, if you had $200,000 in stocks, bonds and cash in your IRA and you use the whole $200,000 to fund your LLC, then your IRA would own a new security, the LLC, which is now worth $200,000. This is a non-taxable transaction because it is done within your IRA.

When you are ready to purchase the real estate property, you simply wire the funds to the escrow agent from the LLC. Since you purchased property with the proceeds of your IRA that are now in your LLC, you now have an accurate valuation for your LLC security in your IRA account. This information can be provided to the bank for whom you have the LLC account and they will list the value of the real estate as the total all in price you paid for it. Of course it is a good idea to have an annual appraisal done for valuation purposes. It is mandatory when a distribution is made.

Growth of the real estate owned by the IRA via the LLC is tax deferred and just like if you were holding any other investments, you are required to start taking a distribution by April 1st of the year following when you turn 70 1/2. Of course, you can take withdrawals any time after your turn 59 1/2, too without the 10% early withdrawal penalty.

There are a few things to understand when purchasing real estate in an IRA. One is that you cannot deduct your real estate taxes from your tax return. Nor can you deduct your home mortgage interest if this is your second home. Further, you cannot take any depreciation on the property either. Lastly, you do not have a cost basis in your IRA when you start to pull things out. Everything that comes out is taxed as ordinary income. However, if you had $200,000 in stocks and bonds today in your IRA and you purchased $200,000 worth of real estate with an LLC Real Estate IRA, then you would be in the same boat from a tax perspective.

If you think of this in terms of holding one stock worth $200,000 in your IRA and selling it and buying another stock worth $200,000, then there is no tax consequences, because it is done within the IRA. It is the same concept with the real estate purchase. All you are doing is selling the stock for $200,000 and buying the LLC inside your IRA for $200,000 to replace it.

Real Estate Roth IRA LLC

You may be thinking... "What about a Self Directed Roth IRA LLC?" You would be thinking correctly. It would be better to buy real estate with the proceeds of your Roth IRA. Of course this is assuming that you have enough funds in your Roth IRA to make such a purchase. However, there are ways to solve this dilemma if you have a larger IRA that you can convert to a Roth IRA. Of course, when you convert your IRA, then you have to pay taxes. Fear not! There are ways to do this without feeling the entire tax bite all at once. Let me explain.

When you convert for example, $200,000 to a Roth IRA, then you add the $200,000 to your AGI and you are taxed on that figure. So, let's assume that you are taxed at the 33% rate. This means that you would owe roughly an additional $66,000 in income taxes. However, if you have a Home Equity Line of Credit (HELOC), you can borrow $66,000 and pay the taxes. This allows the full $200,000 to be used in our now new Roth IRA account. So, instead of having an Roth IRA worth $133,000, you have a Roth IRA worth $200,000 with a Home Equity Line of Credit obligation for $66,000. You can buy more real estate with $200,000 than you can with $133,000.

The interest on the Home Equity Line of Credit is typically interest only, so you only pay the interest on the $66,000. Suppose this interest was 5%, then you would owe $3,300 in annual interest. The strategy is to pay the HELOC interest for 5 years, then pay it off from the growth of the real estate in your Roth IRA LLC.

You see, once you converted the $200,000 IRA to a Roth IRA for $200,000, then the entire $200,000 is considered your Roth IRA cost basis. You can withdraw cost basis from a Roth IRA without penalty. After 5 years, with a wise real estate purchase or purchases, you can sell the property for a profit and use some of the proceeds to pay off the HELOC without any penalty or taxes due. The choice is to pay $66,000 in taxes in the beginning all at once, or use the growth of your Roth IRA to pay off the $66,000, thus only costing you the annual HELOC interest of $3,300 for 5 years.

You are using the bank's HELOC money instead of your IRA money!

Instead of paying $66,000 and kicking you up into a higher tax bracket, you leverage the HELOC and pay $16,500 ($3,300 x's 5 years.) You would stay in your current tax bracket which may be 28% or 25% which will save you in taxes if you do this instead of paying the taxes all at once on a conversion to the Roth IRA.

It doesn't take a smart person to figure out that $16,500 is much better than $66,000. Plus, do not forget to factor in the savings in taxes which could be another 8% on your current income that you had to pay because you paid for the IRA to Roth IRA conversion in one lick.

Does you financial advisor or for that matter, your real estate agent know this stuff?

This obviously works better if you are successful at flipping houses during that five years. See the next section on that subject.

House Flipping

You may be thinking..."What if I wanted to flip houses?" Not a problem. If you are successful at flipping houses, then you should be able to pay off the HELOC even quicker than 5 years. You would simply buy a property, flip it, receive the proceeds, then buy your next flip property. Each time you do a successful flip, the profit stays in your IRA or Roth IRA and gives you more money to flip with and pay off your HELOC sooner via a perfectly legal cost basis withdrawal.

There are some rules around contributing your own personal labor to the flip that can cause problems, so it is best to fully understand the rules around flipping houses and contributing yourself as "free labor" or the free labor of a disqualified person. The IRS could look at it as a business and not a security in your IRA or Roth IRA. If they do that, then you risk the whole account being disqualified. The best way to do flips is to hire out all labor and contractors and keep good records, then you will be fine.

Buying Real Estate with both an LLC IRA and an LLC Roth IRA

You may also be thinking... "What if I wanted my IRA and my Roth IRA to both own the real estate?" Not a problem, either. You would simply have two LLC members. The IRA would own a percentage of the real estate property and the Roth IRA would own the balance of the property. This is especially advantageous when you have a large IRA (and you do not want to convert it) and a smaller Roth IRA. However, when you add the total of the two, then you have enough to purchase the real estate in question.

Special Allocations with two LLC members

You can actually have special allocations built into your LLC operating agreements. For example, the IRA LLC member could get the Applicable Federal Rates (AFR) 130% of Mid-term rate which today is 1.44% interest for the entire time the property was held, then the smaller Roth IRA LLC member would get to split the balance with the larger IRA LLC member 50/50 after that. Wow! Wait a minute. Please explain more.

Suppose your IRA LLC was a member who contributed 75% of the funds to purchase the real estate and the Roth IRA LLC member who contributed 25% of the funds to purchase the real estate. Since the IRA LLC member contributed the most, they get a 1.44% interest contribution for the entire time the property was held before the Roth IRA LLC member gets a dime. However, once the 1.44% interest is paid to the IRA LLC member, then the Special Allocation says that everything is split 50/50.

Let's look at an example. The property purchased by the two member LLC's is worth $200,000. The IRA LLC member contributes $150,000 and the Roth IRA LLC member contributes $50,000. The property appreciates to $300,000 five years later and is sold. The IRA LLC member gets their original principal back plus the 1.44% interest on his $150,000 contribution for those 5 years, or $11,115.55 in interest, before the Roth IRA LLC member gets a dime. This operating agreement stipulates that the LLC members share 50/50 after that. So, for a $300,000 sales price, minus the 1.44% figure of $11,115.55 paid to the IRA LLC member, this leaves $88,884.45 to be split 50/50. So, an additional $44.442.23 goes to the IRA LLC member and then the remaining 50% share of $44,442.23 plus their original $50,000 goes to the Roth IRA LLC member.

Now let's look at how this benefits the each member. The IRA LLC member gets their original principal of $150,000 plus the 1.44% ($11,115.55) plus the 50% special allocation share of $44,442.23 for a grand total of $205,557.78. This is a 5.33% annualized return. Not bad!

The Roth IRA LLC member gets their original investment back of $50,000, plus the 50/50 split amount of $44,442.23 for a grand total of $94,442.23. This is a 13.56% return!

Without the special allocations wording in the LLC operating agreement, this would not have been possible. The ratio for future purchases between the two LLC members is now 69% to the IRA LLC member and 31% to the Roth IRA LLC member. The special allocation has allowed the Roth IRA LLC member a slight advantage.

Of course this is all contingent on good real estate purchases, but I think you can see the idea of how special allocations can allow you to leverage up your Roth IRA to get a little extra kick as opposed to a straight 75/25 split where the Roth IRA LLC member would have only gotten $75,000 instead of the $94,442.23 they could get with a properly drafted special allocation clause in the LLC operating agreement. The special allocations allowed an extra $19,442.23 to go to the Roth IRA LLC member.

This is why I recommend these experienced tax attorneys who know how to properly draft LLC operating agreements taking into account special allocations.

LLC with a Solo 401(k) for the Self Employed (Real Estate Agents)

You may be further thinking..."What if I wanted to buy a new business, a franchise or an existing business?" This is also permissible as long as you were not buying it from yourself or a disqualified person. It has to be an arms length transaction with an unaffiliated party. However, when you want to buy a business, a franchise or an existing business, then will want to have an existing LLC business, or new one where you establish a Solo 401(k) with a Designated Roth 401(k) account. Further, you want to be self employed with less than 5 employees, preferably however, it is much easier if it is just one, like a real estate agent!

You have to have both a pre-tax 401(k) and an after tax Roth 401(k) account in the plan documents, but our tax attorney firm will prepare all this for you. You have to have both the pre-tax and after tax feature, but you can allocate 100% of the contributions to one or the other, or split the contributions any way you like.

Once you fund your Solo 401(k), then you do something similar to above and establish an LLC that the Solo 401(k) owns. You fund the LLC with proceeds from your Solo 401(k) and Designated Roth 401(k) account, then purchase the new business, franchise or existing business.

Funding your Solo 401(k) in a hurry

You may be thinking... "What if I do not have that much in my Solo 401(k) at first?" If you rolled over a previous 401(k) to a Rollover IRA, then you can re-roll it right back into your new Solo 401(k). Depending on your eligibility, this can get you there in a hurry. Secondarily, you can make up to 100% of your income and put it in a Solo 401(k) up to about $56,500 for 2013. In other words, if your business paid you a salary of $60,000, then you could contribute $56,500 of that and put it in your Solo 401(k). You income would be reduced to $3,500 and you would owe no taxes and probably get a refund with deductions and exemptions.

Creditor and Bankruptcy Protection

Another benefit of the Solo 401(k) is that it has creditor protection in Florida. Further, it qualifies for full bankruptcy protection.

What's my angle in this?

I am a licensed real estate agent and can earn either normal real estate commissions for property purchased within an Real Estate IRA LLC or Real Estate Roth IRA LLC or a Solo 401(k) used to buy real estate. Further, if you prefer to use your own real estate agent, then I would charge a flat fee for each transaction, typically $1,000 or less either as a real estate referral fee or an investment advisory fee, one or the other.

Obviously, there is a lot more to these topics and I am sure that you might have some questions. Please feel free to contact me at 904-547-2913. I am here to help.

New Logos for My Firms

I recently had my logos re-done by Cheryl Mayo of Mayo Media. Their web site is www.mayomedia.com. Please visit their web site and contact Cheryl if you need any great graphic design work done. She is awesome!

For Marian Financial Services, Inc., I felt like the name of the firm was not allowing our firm to stand out among other firms. After all, what does "financial services" mean to most people? It means lots of different things and to me, causes confusion. So, instead of changing our name, I decided to promote our slogan instead of the name of our firm. The slogan speaks more to the issue at hand. We are The Right Answer. The Right Financial Adviser.®

I think this format for our logo makes much more sense for our firm. We are making a strong statement that we have the answers that people are looking for and also, we are the correct choice in seeking a financial adviser. I spelled Adviser with a "e" instead of an "o" because we are a Registered Investment Adviser with an "e".

Please visit our web site with our newly designed logo. www.marianfs.com.

My other logo that Cheryl did for me was for my insurance agency, Rick Johnson Family Office, LLC. I get bombarded with calls all the time from other investment management firms who think that I have a billion dollars in assets. I wish I did, but unfortunately, as of today, I do not.

I wanted to clear the air, so to speak, and put to bed once and for all what is it that I do with Rick Johnson Family Office, LLC. So, working along the same theme as above, I wanted to highlight my trademarked slogan, Keep Your Assets. Take My Advice® and minimize the company name in the design.

In addition, I wanted to add "A Licensed Insurance Agency" so there would be no doubt about what this firm is all about. I sell Life Insurance, Health Insurance and Long Term Care insurance. If someone begs me, I might sell an Annuity, but it is not a major focus of this firm. I prefer selling the insurance products that protect families from financial devastation and or insure that their families can continue their current lifestyle.

Please visit my insurance firm web site at: www.firstcoastplanning.com.

Thank you.

I must be really stupid

I must be really stupid or something. You see, I have done several things that would make me engaged in the future of my family. Most people are not engaged in thinking about their family and their future. Instead they want to focus on doing nothing and saving their money so they can spend it on themselves. They must be the really smart people. I have to be the stupidest idiot on the planet.

You see, I must be stupid because I have a pour over will and a living trust. Not only have I taken the time to have a will prepared, but also a living trust. In addition, I have amended my living trust as needed. Further, my wife and I have sat down and made the choices related to our health care, in case we become incapacitated. We have power of attorney documents for both financial and health care decisions. I must be stupid, because I paid an attorney to perform these services for my family. I am an idiot for not using an online service or software company to provide me a template and prepare these documents myself. I am even dumber for doing this while I was legally competent.

The smart people must be the ones who do not hire attorneys and pay them their fees. The really smart people must use online services or software companies and prepare their own legal documents. Or better yet, the really, really smart people must be the ones who do not have a will at all. These really, really smart people must be the ones who do not have a living trust, nor do they have living wills or powers of attorney documents, either. Boy I wish I was as smart as the really, really smart people.

You see, paying 3% in probate fees because you do not have a will must be a really smart strategy. Also, these really smart people know that if they go through probate, then everyone will know how smart they are, because everything about them becomes public knowledge.

Having to go to court and have a legal guardian declared to take care of your minor children must be a smart strategy, too. Instead of paying the attorney while you are alive, you pay the attorney and court costs when you are dead! The attorney has to file court papers for every year of your minor children's life until they turn 18 years of age. In fact, I know of a guy who remarried and had passed away without a will. He had remarried and had two minor children. He was so smart. A guardianship had to be established through the courts. He got to pay the attorney and court costs after he was dead.

The state law for those dying without a will in his state was that his two minor children got two thirds of his estate. The other third was fought out in court. His new wife sued the mother of his children. The new wife, you see wasn't in the will because there was no will, so she decided to hire an attorney to sue his estate in probate court so everyone could keep up with what was going on. It was all public knowledge by this time. This new wife even wanted to control the money for the minor kids that were not even her kids. You see this guy was real smart. He didn't have a will. He was so smart. He was even a doctor! Doctors are way smarter than I am. They go to college and medical school. That makes them way smarter than me.

You see, the really smart people do not want to have to make that "pulling the plug" decision with a living will. They have no need to worry about the future hospital costs, since they will be "veggin out" anyway. These smart people know that putting the "pull the plug" decision on the shoulders of their family members is no sweat off of their back. It doesn't matter that their family member may have regrets for the rest of their lives for having to make that decision. What's important is that the really smart person saved those darn attorneys fees. That trumps everything else. Nothing else matters when it comes to saving money for smart people.

You see, I must be really stupid, because I have life insurance and my wife has life insurance. This insurance is in place to help the surviving spouse in case one of us were to die prematurely. Yet, I must be stupid, because the smart people do not have any life insurance. How could I have been so stupid to buy life insurance when I was still healthy. If I would have only waited until I was uninsurable, then I could have saved all those life insurance premiums. Boy was I dumb.

I know of one guy who had two dads. One of his dad's, his biological father had little to no life insurance, even though he had four kids. The other dad, who was this guy's step dad, also had four kids, including his step son, but he must have been stupid. He bought $1,000,000 worth of life insurance. Both dads died prematurely. However, the step dad had to be stupid to buy $1,000,000 of life insurance. Are you kidding me? The sacrifice for the life insurance premiums must have been enormous. What kind of idiot would care enough about their four kids, even when one of them wasn't even his own, would spend money on life insurance? That step dad must have been really stupid. Just like me.

I know for a fact that I am really, really stupid, because me and my wife have a Long Term Care insurance policy. The really smart people must be the ones who do not have Long Term Care insurance. These smart people know that Long Term Care insurance is expensive, therefore they are smart enough not to buy any of it. They are smart enough to know precisely when they are going to die. They know for certain that they are just going to keel over one day and they will never need it. Either that, or they believe that their adult kids will not mind dropping everything in their own lives to care for them. This is obviously the smart way to take care of  Long Term Care issues. Put it all on the shoulders of their adult kids. Boy these people are so smart. I must be stupid, because I am paying for Long Term Care insurance. I am such an idiot. I could have saved that money and let my kids take care of me.

My conclusions for being stupid beyond a shadow of a doubt are that I paid for attorney fees to plan for me or my wife's early demise. I paid what most people would consider to be too much in attorney's fees. I paid for and continue to pay for life insurance and Long Term Care insurance. Pure stupidity. I could have saved all that money and the money that I have to continue to pay in the future. I am not selfish and self centered like all the smart people. That is a bad character flaw that I have...that is not being selfish and self-centered. I need to work on being more selfish and self-centered, then I might be one of those really smart people.

You see, smart people will read this blog post and receive confirmation on how really smart they are compared to me. I must be really stupid.

If you want  to discuss how hiring an attorney and paying Life and Long Term Care insurance premiums has made me so stupid, then feel free to give me a call.

Inightful Intuition or Luck

Often when I write about a particular subject, whether it be via a tweet or on this blog, there is often confirmation of my views in major publications that follow. For example, I have been harping against Non-Traded Publc REIT's for years. These so-called investments are sold to individual investors who in most cases are not sophisticated enough to understand what they are buying. The other day, I read an article in the Wall Street Journal where the Financial Industry Regulatory Authority (FINRA) was tightening their oversight of these investments. Apparently brokers have not been accurately disclosing the risks. Here are the risks:

1. You can lose a significant portion of your principal.
2. The General Managers take 11 to 13% right off the top on day one.
3. Your income is a return of capital. (This is why they tout them as tax efficient.)
4. Your broker can earn 8.5% in sales commission upfront upon your purchase.
5. You have no liquidity after you buy it.
6. You have to hold the investment for 10 to 12 years and sometimes longer.
7. Your investment can be rolled into another poor performing portfolio.
8. Your dividend can be lowered, temporarily stopped or discontinued altogether.

The odds are that if you ever bought a Non-Publicly Traded REIT, then you had no idea of these eight items above. Why? Because, brokers do not have any duty to do things in your best interest. They do not have to tell you much of anything, except "sign here".

I see this often where I write about it and later on, I read an article basically repeating some of the issues that I have already raised. To me, this is insightful intuition based on my dedication to learning. It certainly is not luck, because it happens way too often.

Common Sense

In my last blog article I wrote about how insurance companies were having troubles with their annuity products. Lo and behold, in today's Wall Street Journal, there is an article on insurance companies having trouble with these annuity products. Specifically, these insurance companies are having to withdraw their guarantees. In addition, they are now refusing to accept new deposits into these once lucrative contracts. As my dad would say, "That was the old deal. This is the new deal."

To me, this is all just plain old common sense. How in the world can an insurance company guarantee to pay you 7% per year on an annuity, year after year for life? Guaranteed? As they say on ESPN, "Come on man!" Common sense would tell you that they cannot guarantee that, yet people bought these in droves from insurance agents. Now they are finding out that was the old deal. This is the new deal.

The Truth

Ask yourself this question whenever you invest your hard earned money. "Is it true? Is it true that this Non-Publicly Traded REIT is a good investment compared to a Vanguard REIT ETF that has none of the negatives described above?" The truth will answer the question for you. Always ask yourself, is it true? If you do not know, then do your due diligence or research on it. If you do, then you will make better decisions.

If you are not subscribing to my blog, then perhaps you should.