Entrust New Direction Blog

The self-directed IRA is a wonderful vehicle for diversifying IRA or other qualified funds into ‘alternative’ assets like real estate, private placements, notes, precious metals, and more. The whole structure of a truly self-directed plan is different than what most people are accustomed to with their current bank or brokerage company. Most people are more familiar with working with an advisor or appointed financial representative. With that structure, the advisor/representative helps the client determine what the IRA is going to invest in and when. With a truly self-directed IRA there is no advisor or representative. You take on that responsibility as the ‘self’ in the self-directed IRA.

You are the one in control of everything that happens with your IRA. We need your initiative to do anything with the account. We can’t (and won’t) do anything without your direct, written authorization. We are here and accessible to do whatever you need us to do. However, in order to ensure the full security of your account, we do not take any action except upon receiving your direct written request.

As a general rule, if you are a client and you are thinking to yourself: “I wonder who is doing such and such?”—the answer is probably YOU! You decide what your IRA is going to invest in. You put together the details of the investment. You provide us with the investment direction forms, and you approve everything before we process it.

The great thing about working with a local company like Entrust New Direction is that we are available when you need to reach someone. We always answer the phone when you call, and you are able speak with a representative in the appropriate department to help with whatever you need.  Additionally we have a wealth of really good information on our website.

I am a visual person and I like analogies, so here’s an analogy for the self-directed IRA structure: Think of the IRA as a bus. You are the driver of the bus and Entrust New Direction serves as the wheels and sometimes the brakes. A bus without wheels is not going anywhere (you need a self-directed IRA administrator to provide recordkeeping and administration for the IRA), and a bus without brakes is extremely dangerous. Thus, our two roles are essential to the IRA. We will move when you direct the steering wheel of the bus in a particular direction and hit the gas. If you are clearly going the wrong way (i.e. towards a prohibited transaction) we will stop you. 

If you are not an Entrust New Direction IRA client and are working with another self-directed IRA company that doesn’t utilize their brakes, you may want to ‘trade in’ for a better bus. If you find a company that blindly does whatever you ask, without requesting documents or asking basic questions, you may want to separate yourself from that company. Unfortunately there are companies in our industry that operate without ever utilizing their brake system.

It is important to note that, at the end of the day, you are responsible for your self-directed IRA. Entrust does not approve or endorse any investments. We are capable of telling you what the rules are, however when it comes down to it, it’s your IRA and you are responsible for it. We’ve been doing this a long time and we are very knowledgeable of the rules for self-directed IRAs.

We can’t give advice or ‘approve’ your investments, however, if you are forthcoming and honest with all the information and you have a general question about whether something that you are looking to do is a prohibited transaction or not, we can generally answer your questions (or at least direct you to the appropriate section of the Code to research the issue). If we happen to see that the investment you are trying to make is clearly a prohibited transaction, then we won’t fund that transaction (i.e. we will use our brakes). We don’t want our clients to get into trouble with the IRS, that’s not good for anyone. We don’t want ‘bad assets’ in our system, and we certainly don’t want our clients getting into trouble and telling their friends what a terrible experience they had with one of those ‘self-directed IRAs.’

Our goal is to provide our self-directed IRA clients with the broadest spectrum of investment options while at the same time helping them stay out of trouble and maintain their IRA’s tax deferred status. If you know what you want to do with your IRA, and need an administrator that will allow for the flexibility to do it, give us a call. We would love to work with you. 

Photo Courtesy of Bill Ward.

We find that many of our event attendees know very little about self-directed IRAs before they find Entrust New Direction and start asking questions. As someone that teaches a lot of these classes, I often have the pleasure of seeing the excitement our prospective investors have when they learn about all the neat things you can do through a self-directed plan.

Several of our competitors have picked up on the fact that the ‘idea' of self-directed IRAs can attract a crowd. A couple of these companies have recently promoted investor boot camps or destination weekend workshops for which they charge a sizeable fee. The problem is the information they provide is the same information that we provide for free!

Many of these companies will get you started by answering your basic questions for free but then tell you that you need the boot camp to take your knowledge to the next level. There is no hidden or secret information in respect to self-directed IRAs. The answers are what the answers are....the issue is whether the company you are working with will give them to you. Admittedly sometimes things do get complicated with this industry, and questions get a bit more in-depth, but that is all the more reason to work with a company that you can call for free to get answers to those questions.

Another frustrating thing that we've found is some of these companies, even after you've paid to attend their event, won't give you the information you seek. Instead they will try to sell you a book or a CD or a ticket to another event! How frustrating is that? You take the time, energy and money to get yourself to an event to learn about self-directed IRAs, and you walk away with nothing but an opportunity to invest more time, energy and money.

Just to be clear, I think generally speaking, investment bootcamps can be great. I've been to several and I always walk away with good information and new contacts. It is important, however, that you don't pay for a bootcamp when you could get the same information free somewhere else. The bootcamps that I've attended and enjoyed "sold" information that I otherwise couldn't get my hands on... and thus they were worth it.

It should be noted as well that just because you pay for an event doesn't mean the event is better. We will take the Pepsi Challenge with any self-directed IRA company when it comes to educating investors and providing in-depth information. And we will do it without charging and without forcing you to fly to Florida for the weekend boot camp. Our endgame is the self-directed IRA client that sets up an account and purchases an asset like real estate, precious metals, hard money loans, or even publicly-held stocks. Everything that we do leading up to that point is just part of the business.

We realize that there is a gap between what people currently know and understand about self-directed IRAs and what they need to know and understand to be comfortable enough to open an account and move forward. We try to fill that gap with free education and employees on staff that are available to answer your questions.

I should mention that I am not opposed to a company selling their product and making a buck. Good for them. Yea Capitalism! But for you, the individual that wants to learn about self-directed IRAs, do your homework up front and you can probably save a few bucks and get things started on the right foot. If you have questions, call your local experts here at Entrust New Direction IRA, Inc. We are here to help.

Image courtesy of Tobyotter

We have many prospective clients who call to ask about a ‘checkbook control
IRA-LLC'. When these people call, we generally spend quite a bit of time with them explaining what a self-directed IRA is and what a ‘checkbook control or single member IRA-LLC' is -- because there is a difference. If you want to invest in alternative assets like real estate, private stock, notes, gold, etc - you don't need an LLC. Some of our clients do elect to invest their IRA into a LLC. However, the vast majority of our clients hold their IRA investments directly in their IRA.

There are many companies which push the LLC structure; some will even go so far as to say you need an LLC. The fact is, your IRA is fully capable of holding alternative assets directly without the addition of an entity like an LLC. If a company tells you that you need the LLC, chances are that company is making money from some aspect of the sale of the single-member LLC. The structure is known by various names - the Checkbook Control IRA, the single-member LLC, the IRA-LLC - but they're all the same structure.

1) The IRA-LLC may not even be legal.

Many companies will try to convince the investor that an LLC makes investing simpler and easier. We've found that in some cases, the LLC involvement actually complicates matters. It is still unclear if it is even permissible to own an LLC with your IRA AND control that LLC personally (as the manager of the LLC).

There have been court cases and private rulings that somewhat cover the issue of funding a new entity with an IRA. However, none of these cases clarified what (if anything) the IRA holder can do as manager of the IRA-owned LLC.  For this reason, self-directed IRA companies require an independent attorney opinion letter specifically stating that this arrangement is not a prohibited transaction before they will fund the investment. The issue is a grey area at best.

We at Entrust New Direction IRA, Inc are not advocates of the IRA-owned single-member LLC structure, and won't be until the Department of Labor or the IRS come out and specifically state that the structure is permissible. Like I said it is grey... and we don't like to work in grey areas.

2) Checkbook Control IRA Costs more money to open.

And then there is an issue with costs. I've heard the argument that our IRA administration fee is too expensive and that the SMLLC structure somehow saves the clients money. Let's examine the details. Our annual administration fee is $250 per asset, per year. Most companies that push the ‘checkbook control IRA-LLC' charge a sizable up-front fee to open the LLC. These fees can be anywhere from $2,500-$5,000, before any investment is made.

Let's take the low end of the LLC startup costs - $2500. That means without an LLC, your IRA can purchase 10 different assets before you equal just opening the LLC.

3) More difficult to find a custodian.

It is important to note that even with a SMLLC, the client still needs a self-directed IRA company to provide custodianship of the IRA that holds the LLC. We've found recently that fewer and fewer companies are willing to provide custodianship to IRA LLCs. The ones that are still willing to hold them are charging higher fees because these investments are considered ‘high risk' investments and the banks don't like holding assets that don't have clearly established values.

4)Annual Valuation can be expensive and annoying.

That brings us to another huge issue...valuing SMLLC investment. The custodial bank that holds your IRA is responsible for getting an annual valuation of the assets your self-directed IRA holds. We've found that banks are requiring more and more information from clients; particularly clients that have single member LLCs in their IRA. We will elaborate more on this issue in a future blog so stay tuned (hint: you are probably going to have to pay someone to appraise the LLC every year).

5)You might as well become a CPA.

If you elect to structure your investments through a SMLLC then you (as the manager) are 100% responsible for making sure every aspect of the company is handled appropriately. Don't underestimate the responsibilities that come with managing a company (particularly when you consider the company is owned by a tax-deferred or tax-free IRA). It is extremely important that you keep the IRA/LLC assets separate from your personal assets. You must understand that the rules which apply to the IRA also apply to the LLC.

A violation of the prohibited transaction rules can result in huge penalties to your IRA, or a complete distribution with the associated tax hit.  A self-directed IRA client working directly with Entrust New Direction IRA, Inc (no LLC involved) has the benefit of working with our asset acquisitions department when making investments. We see thousands of transactions a year and can assist in explaining what the IRS guidelines are for self-directed IRA investing.

The bottom line:

If you are an expert in self-directed IRAs AND you know how to manage the recordkeeping for a business AND are capable of keeping IRA/LLC assets separate from personal assets AND you've talked to your attorney and they are willing to provide an opinion letter specifically stating the entire thing is okay AND you want to pay 10X the starting costs.... then you might want to consider the ‘checkbook control IRA-LLC'. Anything short of that and you are most likely better offer working with the experts here at Entrust New Direction IRA, Inc. We've been doing this a long time and we can help you better understand the rules and protect your IRA's tax-deferred status.

Buying a short sale home has never been easy.  I've heard many real estate agents over the years say, "The banks take forever to get back to you, and they are completely inflexible regarding the deal.  If you have plenty of time to wait, and plenty of patience, go right ahead."  Often I heard people say that the bank would rather hang onto that property until it falls down.

No more. Thanks in part to the troubled economy, most banks are becoming more flexible and almost eager to sell their short sales to your self-directed real estate IRA.  Catherine Wynne, real estate investor for many years said, "I've never seen so many short sales move so quickly through the banks.  They clearly want to get real estate off their books." 

And now the Home Affordable Foreclosure Alternatives (HAFA) will hopefully make short sales even easier and faster.  The HAFA provides financial incentives: $1,500 to help relocate the borrower, $1,000 to the bank, up to $1,000 to investors who share a total of up to $3,000 of the profit with subordinate lien holders.

That last one could be especially helpful.  Often a junior lein holder will stop a transaction if they think a short sale isn't profitable enough or profitable at all.  The extra cash may help move that short sale into fruition. 

Another very helpful new aspect: Lenders must approve or deny the offer for the home within 10 business days of receiving the offer.

With your real estate IRA and mine buying up foreclosures and short sales, there will be less on the market, thereby strengthening the real estate market in general.  If your IRA can buy a short sale or foreclosure, and hold it as a rental property long enough to wait for the likely gradual upswing in the real estate market, your road to retirement can become a little shorter and a little more comfortable.

It is with great joy that I am able to report that over $2 Million in commissions have been paid to real estate professionals through IRA investments administered by our office.  Real estate professionals who know about self-directed retirement plans have been brokering deals involving IRAs purchasing or selling real estate for their clients for years.

Entrust New Direction has overseen over 900 real estate transactions for clients. With each deal paying an average of 4% to the buying agent and 3% to the selling agent, that adds up fast.

As a self-directed plan administrator, we are not allowed to give investment advice, make recommendations, or sell any products. Being a marketing person, our limitations put me in an awkward spot at times. Potential clients call, are excited, and want to know how to find that first piece of real estate for their IRA. I can’t help them with that. That’s why we spend so much time building relationships with professionals who can.

The key for professionals is just letting clients know that they can make these investments and then following up with listings of available investment properties. Knowing how to analyze the investments for the client’s retirement plan is key. This education can be a cornerstone to building sales and catering to investor clients.

Many professionals are just starting to realize what this growing market of investors could mean for their business. We continue to try to reach these professionals through continuing education and other events in the metro area and teach them how to use the tool to build sales. Entrust offers education both online and in their on-site classroom and has several events planned for this fall. For a full list of upcoming events, visit our self-directed IRA events page.

Agents and brokers can take the MRE approved course online through Van Education at www.vaned.com. Entrust New Direction will also be the featured course author in Van Education’s booth at the Colorado Association of Realtors convention in Colorado Springs from 11am - 3pm at the Broadmoor on October 19^th in the 'Africa' zone in booth #551.

Two follow-up classes are planned after this event and qualify for 2 hours of Continuing Education credits. The Introduction to the Real Estate IRA offers an overview of how it all works and how professionals can incorporate self-directed investment tools into their business to help sell properties. It will be offered on October 28^th from 8:30am – 10:30am and again on November 12^th again from 8:30am – 10:30am. Both classes will be held in Entrust New Direction’s classroom, registration is available online through vaned.com.

Many Realtors® and Real Estate Investors have been upset and up-in-arms this summer about bill HR1728, which passed in the House and is in process in the Senate.  This bill has admirable, if late, aspects aiming to prevent predatory lending.  That's not what makes many Realtors' stomachs churn.   The bill also takes on seller financing, which is increasingly utilized in a credit-desert environment like ours today.

Seller Financing allows the buyer and seller to work out a deal on payments, frequency of payments and interest rates, independent of banks or professional mortgage companies.  Seller Financing is what allows a self-directed IRA owner to lend money on real estate and create passive income for their IRA.  These deals happen thousands of times each year by real estate investors, IRAed or not.  Many real estate sales could not have happened in this credit-crunch environment without seller financing. Under this bill, an individual is only allowed one seller-financed deal every three years, or else register as a lender.  This is, to say the least, a complicated process.

The National Association of Realtors® initially supported the bill.  From their newsletter May 11, 2009: "NAR is supportive of this bill because it protects both the consumer and housing sector."

However, the NAR swung on this issue.  The latest "news" comes from correspondence from NAR clarifying their position.  The NAR reports that the Senate Banking Chairman, Chris Dodd, indicated that “this issue is not on his ‘mustdo list’".  

I would like you to take the following two messages from this e-mail and NAR. First, the bill looks like it will die due to inactivity in the Senate. Meaning, these requirements, which are not in effect, will not go into effect anytime soon. Second, if the bill begins to move in the Senate, NAR will work diligently to have a full exclusion for seller financing added to the Senate's version of the bill, or increase the limitation so it does limited harm to consumers that have to utilize this type of financing.

This is one case where congress's tortoise pace might be to our benefit as real estate investors and Americans.  

Photo courtesy of MiiiSH.

Locavore, the Oxford American Dictionary word of the year, 2007, and now in Webster's Dictionary, is defined as "one who eats foods grown locally whenever possible."  You, dear self-directed IRA holder, could become a locavestor, i.e. "one who invests retirement funds locally whenever possible".

Of course, a locavore's ideal location is amongst agriculture, while the locavestor would have more options in an urban evironment, but even New York City has farmer's markets, and even Idaho has investment opportunities.

Some ideas for locavesting:

1) Loan money locally                                                                           Your IRA can lend money to your church, your kid's soccer coach, your next-door neighbor.  Many people are paying 15-30% or more for credit card debt.  Your IRA could swoop in, earn 10% interest and save someone you know thousands of dollars.  Don't know anyone in need?  You could put an ad in the local paper.  Plus, the money your lender saves will likely be spent locally, further strengthening your town or city.

2) Buy shares in a local private company.                                                            

While this may not be the best time to start a company, many people who were laid off are doing just that.  They need start-up cash, and your IRA could contribute now, and look forward to a bug payout later.   There are likely local established companies which aren't ready to go public, and they may be looking for a cash infusion to help them along until the economy steadies.  Your IRA could buy into the next Microsoft or McDonald's, before they grow gargantuan. 

3) Buy a foreclosed home in your neighborhood.

Your IRA can vastly improve the neighborhood if you buy a foreclosed home and rent it.  Your IRA gets fat with rental income, and the neighborhood's home values improve.  Or if you don't want to deal with renters, your IRA could buy and hold the home, until the local real estate market improves. 

4)Buy the farm.                                                                                       To combine the best of eating and investing locally, you could find a small agricultural operation and your IRA could become a partner.  Not only could your IRA grow like the rutabagas, your retirement investment could contribute to the health of your community, literally.

If you see my new bumper sticker: "Think Globally, Invest Locally", please wave.  I'll wave back. 

401(k)s, developed in 1980 and popularized in the mid 80s, have been a mixed bag.  On the good, 401(k)s encouraged people to invest in their future self by saving money for retirement (and sometimes getting free matching payments from the company).  On the bad, because the 401(k) holder had little or no choice, they also encouraged holders to forget about where their money was going.  In addition, many companies (Enron is the blackest example) highly recommended investment in the company's stock, which is a great idea if you happen to work for Berkshire Hathaway.  

Of course, 401(k)s and how people think about them has changed recently with the death of the stock market.  Now, people know they don't want to invest in the stock market, but they don't know what to invest in.  We're here to help.  We never offer financial advice or take any commission on any investment - you decide what, when, why, where how much.  First step, move your 401(k) into a self-directed IRA.  Next step, decide what to invest in.  No ideas?  Take a look at some of these examples:

1) Real Estate IRA

Investing retirement money in real estate can take many forms - a rental apartment which pays your IRA monthly, a house which is held in an IRA until you decide to sell, even your dream home, which you can live in after you retire.  This real estate can even be in a foreign country, which opens your options greatly.

2)Land

Raw land can be purchased and held until the time is right to sell or build, purchased and leased for farm land or oil or cell towers - the possibilites are limited by your imagination.  As someone famous said, they're not making any more.

3)Gold and other precious metals

Your IRA can purchase gold coins, gold bars, electronic shares of gold.  Buy now, sell when the time is right, and you'll never have to worry about or pay for storage.

4)Loan

Your IRA can provide loans for friends, businesses, or non-profit associations.  If someone you know is paying 20% interest on a credit card, your IRA can loan them the money for 15%!  As long as a person is not a direct lineal decendent(or yourself), your IRA can loan them money. 

5)Private Stock

Find the next Microsoft, Apple or fill in your own successful business, and your IRA can buy some shares in them before they go public.  Nanotechnology, biotechnology, or your next door neighbor's fledgling cookie business, your IRA gets in before the world knows the true value of a start-up company.

Don't limit yourself or your future when you can take the DIY approach and direct your own retirement investment.  Ask a question or open an account. 

Securities brokers and some accountants will be the first to tell you that you don't want leveraged property in either a Traditional or a Roth IRA because you will have to pay taxes in the form of "UBIT". The motivations of the anti-UBIT crowd speak for themselves, but, in nearly all decisions related to leveraging an IRA property or not are about doing the numbers. There is some feeling that UBIT is actually wrong, or a penalty for doing something you shouldn't, in fact, it is part of the tax law that usually pertains to non profit organizations and has been around for a long time.

Non Profits and UBIT

This is how UBIT and non profits are related: A Homeowners' Association "Dairy Glen", a non-profit corporation, has installed a pool and tennis courts for the residents. These facilities are supported by the HOA dues, paid by the residents of that neighborhood. At some point the HOA board decides that they are going to open the recreation facilities to the public and charge admission or offer memberships, all funds going back to the HOA accounts.

Down the road is "Muscle World, Inc." a gym that offers similar facilities to their members. Muscle World pays taxes like any other corporation but has a tough time competing with Dairy Glen because they have to pay taxes. This is where UBIT enters. The government, in order to force fair competition levies UBIT on Dairy Glen because they are now in a business that is unrelated to the original business of maintaining neighborhood facilities. How does this relate to the IRA?

IRAs and UBIT and Leverage in Real Estate

The amount of money you can shelter within an IRA is limited by the annual contribution limits and by how much an employer is allowed to put into your 401k which you may ultimately roll over to an IRA. They really don't want to give you unlimited ability to contribute to a tax-advantaged plan. If you bring additional funds into the IRA in the form of a mortgage, you are increasing the size of your IRA.

The government is willing to give you tax-deferred status on the income generated by whatever you have in the IRA initially but is not willing to shelter the profits of the net income generated by the extra funds brought into the account in the form of a loan. The IRA is treated like a non-profit but the additional funds brought in are not. Thus UBIT enters the picture.

Some Quick Facts

• When calculating UBIT from rental income it is only the NET income generated by the debt leveraged portion, after the deduction of operating expenses, interest and depreciation.
• LLCs will not protect you from UBIT, it still applies
• The IRA pays the tax, not you.
• The IRA has its own tax return and this return affects neither you nor your tax return
• For most leveraged real estate deals an IRA does not pay UBIT until somewhere between years 4 to 8 because of depreciation.
• Losses carry forward so file from inception

UBIT is generated by an IRA in three ways:

1. Net income generated by leveraged portion of an investment @ trust rate
2. Proceeds of a sale taxed based on balance of debt at time of sale @ capital gains rate (if 1 year or more after purchase, short term gains taxed at the trust rate
3. The IRA owns an operating business such as providing goods or services. Tax is on 100% of the net income using the trust rate. This situation is not covered in this article.

UBIT Illustrated

The best way to look at UBIT is not a snapshot but across several years. As mentioned earlier, most leveraged IRA properties don't generate UBIT until between years 4 and 8. This illustration shows year 1, the second looks at year 8.

Summary of key points on calculating UBIT:

• Taxed on Net Operating Income * Debt Financed %
• Taxed on Capital Gains at sale * Debt Financed %
• Debt Financed portion is recalculated each year.
• Tax is only a percentage of Debt Financed net income.
• Calculation of debt-leveraged % is actually the loan balance/depreciated basis of the property

John's Uncle IRA buys an investment property using a non-recourse loan*:

First Full Year of Operation

• Cost of property: $500,000
• IRA investment: $200,000
• Non-recourse Loan: $300,000
• Leverage: 60%
• Mortgage Pmt: $1,600/month
• Taxes & Insurance: $400/month

Other information:

• Rent: $2,500 per month
• Utilities: paid by tenant
• Net Cash Flow: $490/mo = $5,874/yr
• Depreciation: $14,545/yr.
• Principal Payments $4,474
• Interest Expense: $14,720 (4.95%)
• Net Loss Year One ($4,265)
• Annual Appreciation 2.5%

No UBIT is paid.

Year 8

• Rent: $2,951 per month T&I $475
• Utilities: paid by tenant
• Net Cash Flow: $876/mo = $10,512/yr
• Depreciation: $14,545/yr.
• Principal Payments $6,318
• Interest Expense: $12,876
• Net Income Year Eight $2,296

Calculation of UBIT:

Debt Balance/Depreciated Basis:

• 263,835/398,182 = 66.26%
• Net Income * 66.26% = $1,521
• UBI = $1,521- $1,000 = $521
• Tax ~ $104

Year 8

• Sale Price $609,201
• Costs of sale 3% - $18,276
• Net Proceeds = $590,925
• Current year Debt Financed % - 66.26%
• Capital Gain ($590,925-$426,587)=$ 164,338
• (Note $426,587 = depreciated basis)
• UBI portion $108,757

UBIT: $23,655
Gain: $164,338 - 23,655 = $140,683

A good exercise is to take the same size IRA and calculate the gain on a property with zero leverage. It would be difficult to determine the income generated by rental operations but, at the end of year 8, with the same appreciation would be $36,370 after deducting the cost of selling of 3%.

Before someone talks you out of leveraging a property within an IRA, do the numbers and decide for yourself. It may or may not made sense to use a mortgage but at least YOU will understand the decisions you make when investing your IRA money. A self-directed IRA is the only way you can purchase real estate AND have a mortgage on it. The flexibility of the self-directed IRA can provide you a world of choices regardless of which way the numbers go.

Catherine Wynne is a Principal in Entrust New Direction IRA, Inc. a self-directed IRA administrator. She is also a Principal in IRA Tax Services, Inc. A tax service company devoted entirely to IRA tax filings for Unrelated Business Income Tax ( UBIT or UBTI).