Self-Directed IRA Articles & Informational Blog

The Alphabet Soup Of Estate Planning

May 8, 2014

Guest article by Todd C. Ganos, JD, LLM (Taxation), CFP®:

A/B, GST, APT, QTIP, GRAT, IDGT, DING, NING, BDIT, NIMCRUT, . . M . . O . . U . . S . . E. These are just some of the types of trusts that wealthy and high-income families use to help reduce estate and income taxes as well as provide for asset protection.

We all know that the Internal Revenue Code is complex, and state-level tax rules are just as complex. In some cases, though, this complexity has created opportunities for tax reduction, and these trusts are the tools by which that tax reduction might be realized.

Certain types of trusts – such as generation-skipping transfer trusts or simply “GST” trusts – have been around for decades. GST trusts “skip over” the Internal Revenue Service’s ability to estate tax a family’s wealth as it passes down the generations. For families who are exposed to the estate tax, a 40 percent tax at each generation seems punitive. GST trusts can eliminate it. However, trusts follow state property law and most states require a trust to terminate after a certain number of years. As such, in time, the IRS would regain its ability to estate tax the family’s assets. The good news is that a handful of states allow trusts to remain in effect permanently or at least for a substantial period of time. In such cases, a family’s wealth would sidestep the estate tax permanently or at least for many generations. To take advantage of this, a trustee in one of those states must administer the trust.

The potential tax benefits of other types of trusts have come into focus more recently. Periodically, attorneys – on the behalf of clients – will submit a trust strategy to the IRS before implementing it to see whether anticipated tax benefits are valid. Recent rulings by the IRS have affirmed the validity of certain types of trusts that can potentially reduce or defer state-level income tax. For example, consider a family who lives in a high income tax state and who has a large position in a particular stock. The family learns that the company will be bought out with an all-cash offer. The family anticipates a large capital gain on the sale, which they can’t avoid. Knowing that Nevada imposes no income tax on trusts, the family might transfer the stock to a Nevada Incomplete-Gift Non-Grantor (NING) Trust prior to the sale and sidestep state-level income tax. The family would defer income tax payable to their own state until they take a distribution from the NING trust. However, if the family became a resident of a different state – perhaps a lower or no income tax state – and then took a distribution, the family would only pay state-level income tax (if any) to the new state of residency.

Beyond tax savings, there is asset protection. We know that we live in a litigious society. Wealth and high-income families use certain types of trusts to protect themselves from opportunistic plaintiffs. As with tax planning, key to implementing these asset protection strategies is having a trustee in a favorable jurisdiction. Alaska, Delaware, Nevada, South Dakota, and New Hampshire are five states that have enacted laws that are “trust friendly.” They impose no income tax on trusts and they have strong asset protection laws. Delaware and Nevada are the most favored among the five.

So, what might all of this alphabet soup of estate planning mean to your IRA? For individuals with larger IRA accounts, there is the Qualified Terminable-Interest Property (QTIP) Trust. While its name is not sexy, its tax result can be.

Normally, distributions from a retirement plan – whether an IRA, 401k, or another plan – are income taxed at the recipient’s ordinary income rate. For individuals in the highest marginal income tax brackets, the tax imposed seems almost punitive. Might there be a way for a family to reduce the ultimate tax burden on retirement plan assets and maximize the after-tax proceeds it receives? Yes.

Every owner of a retirement plan account designates a beneficiary who will receive the account’s remaining assets should the owner die. For a number of complex tax reasons, one would not normally designate a trust as the beneficiary of one’s retirement plan. In this strategy, there will be an exception. In this strategy, a QTIP trust will be used. It will be a stand-alone trust whose only function is to be the beneficiary of a retirement plan account. With a QTIP trust, the surviving spouse receives income for life and – upon the death of the surviving spouse – the remaining assets pass to children (or whomever).

However, rather than going the “income for life” route, one year after the retirement plan owner dies, the surviving spouse sells her interest in the QTIP trust – not the IRA, the trust – to a qualified charitable organization at a slight discount. (The discount is done for a specific tax reasons.) Because the surviving spouse is selling her interest in the trust – and not the IRA – it is a sale of a “capital asset” and proceeds of such a sale are income taxed as capital gains and NOT at the surviving spouse’s ordinary income rate. The net result can be as much as 17 percent greater after-tax wealth to the family and a handsome donation to the family’s favorite charity.

Proper use of trusts – even in conjunction with IRAs – can yield very attractive tax results. You can never be too educated in all the possibilities trusts offer. Perhaps it is time to do some more research.

Todd Ganos is a professional trustee and the principal of Integrated Wealth Counsel, LLC, whose divisions provide family office, wealth management, trustee, and trust protector services. He is also a contributor to Forbes magazine online and focuses on the management and preservation of family wealth. Todd can be reached at 866-898-1860.

Funding Your Own Pension Plan

April 29, 2014

For those that closely follow political and financial news, one of the biggest issues to face local and state governments has been underfunded pension liabilities.

Simply stated, the employers made a promise to their employees to provide certain lifetime payments during their retirement years, yet did not adequately fund those obligations year after year. The result is a mad scramble for political cover, and necessary yet painful reductions in pension payments for many retirees.

Evidently, the pain of employer pension funding is not limited to governmental entities. A recent Orlando Sentinel article regarding Walt Disney World union negotiations said that Disney wants the union to give up pensions for new hires, who would instead be enrolled in a 401(k) investment plan. Similar negotiations and changes are becoming commonplace across all industries.

In today’s environment, the obligation to prepare oneself for retirement rests on the individual, rather than their employer. Through 401(k)s, 403(b)s, 457s, Thrift Savings Plans and other such alphabet soup, the heavy lifting of saving and investing is on the individual. Employers often simply provide a small match, if anything at all.

How healthy is your pension plan? You have the ability to rollover most any employer plan into a NuView self-directed IRA and fully self-direct, once you have left the company. Now you have the opportunity to invest in anything the IRS does not prohibit, an extremely short list at that, rather than just a handful of trustee-selected mutual funds.

It’s inspiring when NuView clients feel an 8% return in their self-directed IRA isn’t good enough, and that through their own hard work, they found investments that built their retirement much faster. A second-generation private lender recently shared that she lends out of both her IRA and her friend’s for 12-15%, plus points. Real estate rehabbers are taking advantage of the foreclosures and rising prices to profit their IRAs, while still others take advantage of what they feel are low prices on gold and silver.

Whatever your passion, your retirement may be closer than you think, and your ability to retire isn’t someone else’s responsibility – it’s yours. So fund your retirement plan until it hurts, invest wisely, and stay involved. If you need help, give us a call. Through local investor clubs and the right education and research, you might exceed your goal yet.

Making Sense of Crowdfunding

April 18, 2014

Guest article by Mark Mohler:

You are already accustomed to enduring TV commercials for everything from noisy car salesmen to ambulance-chasing lawyers, but are you ready for a TV advertisement prompting you to invest in a new private startup? Well get ready, because it is only a matter of time before it happens. By now, you have probably heard terms like “crowdfunding,” “peer-to-peer lending” and maybe even “general solicitation.” As more and more rules are implemented allowing different groups to solicit your money in connection with funding their own private business, it is important to understand the changing landscape. “Crowdfunding” is defined by Wikipedia as “the collection of finance to sustain an initiative from a large pool of backers—the “crowd”—usually made online by means of a web platform.” Crowdfunding as a fundraising tool is already everywhere and, through recently enacted changes to US Securities laws, crowdfunding will likely be even bigger in the future.

In its earliest iterations, crowdfunding in the US was limited to non-investment offerings in order to avoid running afoul of state and federal securities laws. That meant that you could be asked to put up the money for a business or a project, but you could not own an interest in the success of that business or project. Accordingly, the vast amount of crowdfunding to date has been requests for donations or pre-purchases of a product to be created at a later time. Crowdfunding has been very successful and billions have been raised but imagine your chagrin if you were one of the 9,500 crowd backers that provided an aggregate of $250,000 in donations to startup Oculus VR only to see the company sold for $2 billion less than two years later. We can all understand why the providers of this early capital are a bit peeved to be receiving little more than a thank you note in return for funding the meteoric company. As it turns out, some backers now feel used or even scammed by the crowdfunding project. Sensing this unfairness, the JOBS Act enacted in 2012 sought to democratize private equity by allowing companies to use existing technology tools, such as the Internet, to solicit actual investments from everyday Americans. Two years later, the Securities and Exchange Commission has still not fully created the rules for how this can happen but, little by little, you may be noticing the changes.

Some of these changes relate only to Internet-based crowdfunding and apply to all Americans–regardless of net worth. Other changes apply to solicitations through any distribution channel–including Super Bowl commercials or billboard advertisements and are applicable only to investments by certain “accredited investors.” In these cases, everyone can be solicited, but only accredited investors may actually invest. All told, these changes reflect the most dramatic changes to US securities laws since investor protections were first implemented in the early 1930s. The changes are coming to your TV screen, email and direct mail and it is important to understand what you are being asked to do with your money and what to expect in return. If you are using these new rules to find investors for your own business, you need to understand the legal requirements.

For those of us who have been supporting the updating of US securities laws, it is an exciting time but one of frustration as regulatory rules are slow in coming and, at times, overburdensome. The promise is that many ordinary Americans will for the first time have the opportunity to directly invest in private companies in ways that were never before possible. Regular people may be the early investors in the next Facebook, Google or Oculus VR–rather than exclusively institutional investors such as venture capital firms. Even more exciting to some, these laws will permit opportunities for easy and direct “impact investments” such as local investment in small “Main Street” businesses like coffee shops, bookstores and restaurants and behind passionate causes like clean energy, “Made in the USA” manufacturing or natural/organic companies.

The potential bad news is that these changes will bring a whole new category of risk for investors that may not fully appreciate the inherent risks or the illiquidity of early stage investments and may open the doors to the type of fraud that caused lawmakers to heavily regulate the sales of securities in the first place. It probably goes without saying, but “let the crowdfunder beware.”

All told, I see these as positive changes reflective of a modern era where not only wealthy people understand the fundamentals of investing. After all, it should be much harder sell snake oil at a time when you can easily “google” not just technologies but the people who are promoting them. It has also never made sense to me that people of modest means are legally permitted to lose their entire retirement savings at a casino in Las Vegas but cannot invest a small percentage in a private tech company. Which is actually riskier?

Mark Mohler is a business, tax and estate planning lawyer and founding member of Corridor Legal Partners as well as a founder of Sprigster, an online crowdfunding portal for veterans and military spouses. You can contact Mark by phone at 321-473-3337, or you can visit his website at www.corridorlegal.net for more information.

Critical Questions to Ask a Property Management Company

April 2, 2014

Guest article by Eddie Miller:

You probably already understand the amazing benefits of a self-directed IRA, you may even own rental property or are considering the possibility, yet you might not be sold on utilizing a property management company.

Why should you? Well, let’s first look at this from a technical and then a practical perspective.

Technically, the IRS stipulates “when purchasing rental property in a self-directed IRA you may not personally perform any repairs or maintenance of property held within your IRA. Doing so would be considered ‘sweat equity’ and a contribution to your account. Sweat equity cannot be properly measured in value, and the IRS only permits contributions to an IRA to be made in cash. Repairs and maintenance must be paid for at current market rates and must be performed by a third party.”

“Property management can be handled by the IRA owner. However, you must not perform sweat equity or pay for expenses out of your own pocket. You can decide who performs maintenance duties on your own. Or you can hire a third party property manager to perform these duties for you. Again, all income and expenses flow directly in and out of the IRA funds, not your own.”

Now, let’s look at a practical perspective…

When I started investing in real estate my partner and I purchased, rehabbed and sold property, then we also began holding and managing some of our own properties as rentals. As our business grew, we became advisory board members of our local Real Estate Investment Association and, as a result, we met other investors who were challenged with managing their properties.

We found that managing rentals can be a hassle! Yet, because it was a core aspect of our business we figured out how to overcome these challenges to create profitable investments.

Throughout the process we actually uncovered six key points to creating profitability:

Purchase the property that will provide the desired annual rate of return with consideration of the cost of the purchase, repairs, taxes, insurance, vacancy, management, etc.
Hire an efficient, effective and reputable property management company.
Have a sound lease agreement with clear rules and regulations.
Market for qualified tenants.
Conduct a thorough background screening.
Have effective, ongoing communication with tenants.

Quite simply attempting to manage your own property can be a daunting task, and a mistake at any of these points can be costly, which can dramatically lower your desired rate of return.

The core business of a property manager is managing property, which of course is logical, but easily overlooked. By selecting an efficient, effective and reputable management company, you will decrease stress and increase profits.

Below are the top 15 questions to ask property management companies during an interview.

How long have you been managing properties?
How many properties do you manage? Some companies have on-site mangers that manage a lot of doors, but few properties. These companies don’t typically make the decisions that can impact your profitability. Make sure the firm manages enough properties to know what they are doing, but not so many that you become just a number.
Do you have a company website, and can I get the address? Websites are a minimum for management companies. The site should be informative, professional, and showcase properties.
How many people do you have on your team? You don’t want a one-person shop that could be faced with trade-offs between accounting functions and showing functions. In addition, small offices can often lack the resources to immediately address any situation, causing a small problem to become big.
Can I get references from at least 3 owners? Any reputable company that has been in business for a few years should have success stories.
Where’s your office, and what geographic areas do you operate in? Office location is important when considering how frequently your property will be shown or what the travel charge will be for maintenance calls.
How will you market my property? A full service marketing program will use professional signage, online advertising, MLS, etc. Ask how many websites they utilize – the more the better.
What is your tenant screening process? This is a critical question to ask, and their process should be comprehensive. Inquire about the application process. All tenants over 18 years of age should be screened for verification of income, employment, credit, criminal history, eviction history, terrorism list, and sexual predator history. References should also be called.
Can I review your lease agreement as well as your rules and regulations, and have these documents been reviewed by your attorney? A bullet proof lease is your best defense against a tenant that is trying to take advantage of a situation. Not all lease agreements are created equally.
How do you handle maintenance requests? Someone should be available 24/7 to handle maintenance emergencies. After an issue has been reported to the management company, the company should dispatch a qualified technician to first determine whether the repair is general wear and tear or tenant neglect. Tenant negligence should be paid for by the tenant after the repair is complete. If the repair is no fault of the tenant, the owner will be responsible for the cost of the repair.
What training and licensing do you have? Both the property manager and management company must be licensed/registered with the city and state (i.e. Real Estate Broker/Associate). In addition, inquire about other professional property management training and affiliations.
What happens if a tenant does not pay rent? The delinquency process and eviction process should be explained; the company should have a clear, aggressive collection process for tenants who are not paying on time. Progressive companies will track their internal tenant delinquency rate monthly and should be able to share that information with prospective clients. Inquire about the eviction process and costs (this is why a strong screening process is critical to assist in preventing the need for evictions).
What insurance do you carry and what should I carry? Inadequate insurance can leave the owner high and dry if a catastrophe happens. Most management companies are required to carry Errors and Omissions insurance, Workmen’s Compensation insurance (if there is an in-house maintenance team) as well as general liability. Minimum coverage should be $1 M. (For landlords Hazard, Liability and if necessary Flood insurance is suggested for each property.)
How often will you inspect my property? Some type of walk through or inspection should be performed annually. Ideally, there should be a move-in inspection, a 6-month inspection, and an 11-month inspection prior to the tenant renewal or move-out. If a tenant is moving out, then an additional inspection is conducted after the tenant has moved out before the security deposit is returned.
How often does the company send out financial statements and reports? This is the critical factor of your relationship with the management company. It is important to receive and review monthly financial statements and maintenance repair updates.

By utilizing these targeted questions to interview the management company you are considering working with, you will ensure you have selected the right company to represent you, which should help to limit the risk of a low return on your investment.

Eddie Miller is the CEO of Pristine Property Management and Miami 4 Investors, co-director of the Miami Landlord Association, and two-time best-selling author of “Living Inside-Out: The Go-To Guide for the Overwhelmed, Overworked and Overcommitted” and “The New Masters of Real Estate: Getting Deals Done in the New Economy.”

Planning for a Longer Retirement

March 19, 2014

As far as the average lifespan goes, men have always been at a huge disadvantage. If you were born in 1967, males were to live until age 67, and females to more than 74, at least 8 additional unfair years. However, 40 years later, males have closed the gap with an expected life span of 76 years, as females live to 80.5 years old, on average according to a Lancet article. But those nine extra years come at a huge cost: We now have to pay for eight more years of retirement, with women adding six years to their needs.

While Social Security continues to be underfunded, there are signs that the aging population has realized the fact that, as far as retirement is concerned, they will not be able to rely on the government. More than 38% of US households now have IRAs, according to the Investment Company Institute. Combined with employer plans, more than 80% of households have accumulated some retirement funds.

The $5.7 trillion in IRAs today represent about $124,000 per household that has an IRA. Yet, IRAs tend to be more heavily used by older people (45% of those aged 55-64) and also, not surprisingly, used by the wealthier households (62% for those earning more than $100,000 per year).

Self-directed IRAs represent only a small portion of the $5.7 trillion, as little as 2% or $100 billion, according to the North American Securities Administrator Institute. If it’s such a great idea, why don’t more people use self-direction? The answer is simple: Self-directed IRAs are not meant for the majority of investors. If you listen to conventional financial advisors, many would caution against making your own investments in anything other than publicly offered securities. Most advisors would make the following points:

They are dangerous – you have to take the time to understand the investment and properly weigh the risk and the reward
It takes too much time – not just in studying the investments, but by staying involved throughout the lifecycle of the investment once it’s made
Investments may not be sufficiently diversified – true, if you invest in only one asset, but self-direction may also significantly expand your options
Too many choices – the drawback of choice is that it breeds complexity, and some investors are paralyzed by the myriad options
You may not be able to understand your investments – unless you understand your investments, with or without a financial adviser, you are just gambling
You have to stay involved – higher net worth individuals often get phone calls from their brokers when events happen that may be critical to their holdings, but self-directed IRA investors must stay aware of those issues on their own
You advisor is also thinking, but not saying, “My brokerage won’t benefit” – in many cases, self-directed investors receive all the benefits without the management fees and commissions that traditional investors pay through conventional brokerage houses

If conventional wisdom doesn’t dissuade you from self-directing your IRA, you are in the minority. You want to be involved, you want to understand your investments, and, most importantly, you want to incur the risk and reward afforded by alternative investments, such as real estate, notes, private mortgages, private placements, tax-liens, and precious metals.

So now that the population is living longer, the responsibility of providing a solid future throughout retirement falls fully on the individual. Break away from the herd, and be part of a group that wants to seize control of their retirement plan. The tax benefits secured by IRAs reduces the sting of income tax on investment growth. Take a look around our site to learn more about how a self-directed IRA can be used to expand your investment choices and reduce the drag of Wall Street on your earnings. After all, you have plenty of years ahead to reap the benefits.

How Do You Find Alternative Investments?

March 6, 2014

Finding and evaluating private placements, equity and bond hedge funds, and commodity based hedge funds and managed futures programs has always been a very ad hoc and inefficient process. The founding partners of FNEX faced the same challenges as every other investor in that they only saw a small number of deals from their brokers, investment advisors, and private bankers. Financial advisors from the large RIA and Broker Dealers can only recommend the offerings that have been through their internal research departments which limit them to a handful of the very largest funds. These are the same names that everyone recognizes because their CEOs are regular guests on CNBC.

It isn’t practical for an investment firm with thousands of advisors to review and approve private securities and hedge funds from mid-size and “emerging managers” because the size of the fund and the support staff managing the strategy aren’t large enough to handle the traffic those referrals would generate.

FNEX created a Private Securities Marketplace that is open to any accredited and institutional investor. On the FNEX platform, investors will find private placements being offered by a range of different sized investment banks. These are direct placements into companies raising growth capital in a wide variety of industries such as biotechnology, real estate, and clean energy, just to name a few. Fund managers with a broad array of different investment strategies in equities, bonds, forex, precious metals, stock indexes, agricultural, and energy commodities are also on the platform.

To assist in the evaluation of each offering, FNEX offers a variety of different diligence, valuation, and research partners that investors can engage on an as-needed basis. The FNEX Education Center is full of current research, white papers, and links to industry resources to help investors learn as much as possible prior to investing.

The FNEX Deal Room feature allows investors to view and download offering documents and subscription agreements as well as communicate directly with the investment banker or fund manager. As always, every self-directed investor should review the available materials with a trusted advisor or legal counselor prior to investing.

After an investor locates a deal and requests IRA funds from an administrator like NuView, the investor can upload all of the paperwork for processing and copies can be provided to the IRA administrator to make sure the documents are in good order before closing. Investors will also be able to complete a Buy Direct letter from the IRA administrator so the funds can be dispersed directly from a custodial account to the Bank or Fund Manager. It is important to note that FNEX is not a custodian and will never be in possession of funds at any part of the investment process.

Membership to FNEX is free and the registration process is very simple. Because the offerings on the site are only available to accredited investors, investors must complete a brief investor questionnaire to ensure that the current SEC guidelines for investing in private offerings are met. After investors complete the survey step, access to the site is granted. FNEX offers profiles to save personal investment criteria such as minimum investment amount, strategies, and risk profile.

FNEX offers a way to expand the alternative investment choices available to investors. If you would like more information, please visit FNEX at www.FNEX.com.

Please note, NuView IRA is also not a fiduciary and only provides services to self-directed accounts that are nondiscretionary and/or administrative in nature. The Account-holder or his/her authorized representative must direct all investment transactions and choose the investment(s) for the account. NuView IRA has no responsibility or involvement in selecting or evaluating any investment. Nothing contained herein or on FNEX shall be construed as investment, legal, tax or financial advice or as a guarantee, endorsement, or certification of any investments or of FNEX itself.

Pitbull Conference to Spur IRA Private Money Lending

February 26, 2014

Investing in real estate through a self-directed IRA might not be for everyone. For many, being a landlord is daunting – hassling with tenants, upkeep on maintenance, and all the other elements of owning rental property. Although IRA holders have the ability to hire third-party property managers, some do not prefer all the moving parts associated with owning investment real estate.

However, there are other investments that take advantage of the reemerging real estate market that don’t require the day-to-day involvement of property management. Last week in Ft. Lauderdale, we had the opportunity to address a packed room of eighty private money lenders at the Pitbull Conference, and from all reports, that business is booming.

The need for private money is significant, so much so that real estate-backed lending is one of the fastest growing self-directed choices in IRAs. The lenders, representing funds from $1-60 million, were eager to learn how IRAs could be put to use for financing buying, fixing up and flipping, and renting investment property. It just so happens that the time for their business couldn’t be better.

According to BankRate, current 5-year CD rates garner approximately 2%. At that rate, it would take about 36 years for an investment to double in value. It’s no wonder that people are looking for alternative ways to make their retirement funds work at a more efficient rate. Is the stock market better? It certainly has done well over the past two years, but how much higher can it go? And what type of gains can you make while you still hold the investment, or must you sell out to earn your gains?

When lending private money out of your IRA, the rate you charge is based on the outcome of your negotiation with the borrower. It can be a conventional 30-year mortgage, or a six-month loan to a rehabber. At NuView, IRA lending has had anywhere from 5 – 18% interest, depending on the client’s loan terms and collateral.

To seriously misquote Shakespeare’s Hamlet, “Either borrower or lender be.” An IRA can do both. Look through our site or give us a call to learn more. We will help you unlock your IRA and let you make all the decisions.

Great Returns on Secured Real Estate Loan Transactions

February 20, 2014

Guest article by Mark Fixler:

You have probably asked yourself, how can I take advantage of the real estate market? Before I answer you, let me share a little history: Lenders owned nearly 660,000 foreclosed homes in April 2008, up from 493,000 in January 2008 and 231,000 in January 2007, according to First American CoreLogic, a real estate research firm based in Santa Ana, California. This surge in defaults has increased the inventory of bank-owned homes, known in the business as REO, or real estate-owned, properties. For investors in distressed properties, never in American history has there been such an attractive buyer’s market.

And now, with a self-directed IRA, you can seize the opportunity to generate an 11% annual return secured by a private real estate transaction at a 60% LTV, or loan to value. Whether you participate in a real estate loan transaction with Jag Enterprises or another company, it affords you the interesting option to receive a monthly income stream of higher interest than what is currently available in CD’s, etc. This type of transaction allows your self-directed IRA to receive a great return without the need for you to do the work in the real estate market. These types of transactions are truly passive in nature, suggesting a rare win-win scenario.

Ask yourselves: Do I want my IRA to just invest in the stock or commodities markets with potential volatility, or is there room in my portfolio to self-direct my IRA for a great income stream secured by a private real estate transaction?

Mark Fixler is the owner of Jag Enterprises LLC. Through his company, Mark has participated in more than 400 real estate transactions since 2008. He has been in business for 15 years, living and working in the Cleveland area. Mark can be reached at 440- 951-2170.

New Case Answers Important Questions About IRA LLCs

February 13, 2014

Guest article by Mat Sorensen:

Can my IRA own substantially all of the ownership of an LLC? Can my IRA/LLC pay a salary to me for serving as the manager of the IRA/LLC? The U.S. Tax Court issued an opinion in the case of Ellis v. Commissioner, T.C. Memo 2013-245 and answered both of these questions.

In Ellis, the Tax Court resolved two questions posed by the IRS. First, did Mr. Ellis engage in a prohibited transaction when his IRA acquired 98% of the membership interest in CST, LLC? And second, did Mr. Ellis engage in a prohibited transaction when CST, LLC (owned 98% by his IRA) paid him compensation for serving as the manager?

As to the first question, the Tax Court held that Mr. Ellis’ IRA did NOT engage in a prohibited transaction when it acquired 98% of the ownership of a newly established LLC. The other 2% was owned by an unrelated person who was not part of the case and whose ownership did not have an impact on the decision. The IRS contended that a prohibited transaction occurred when the IRA bought ownership of CST, LLC. The Court disagreed, however, and held that the IRA’s purchase of the initial membership interest of the LLC was NOT a prohibited transaction. The Court stated that the IRA’s purchase of membership interest in a new LLC is analogous to prior holdings of the Court whereby the Court held that an IRA does not engage in a prohibited transaction when it acquires the initial shares of a new corporation. Similarly, the court held that a new LLC is not a disqualified person to an IRA under the prohibited transaction rules and as a result an IRA may invest and own the ownership of the LLC. IRC § 4975(e)(2)(G), Swanson V. Commissioner, 106 T.C. 76, 88 (1996). Consequently, the Court’s ruling means that it is NOT a prohibited transaction for an IRA to acquire substantially all or all of the ownership of a new LLC.

As to the second question, the Tax Court held that it was a prohibited transaction for the LLC owned substantially by Mr. Ellis’ IRA to pay compensation to Mr. Ellis personally. The court reasoned that, “In causing CST [the IRA/LLC] to pay him [IRA owner] compensation, Mr. Ellis engaged in the transfer of plan income or assets for his own benefit in violation of section 4975 (c)(1)(d).” This type of prohibited transaction is often times referred to as a self dealing prohibited transaction and occurs when the IRA owner personally benefits from his IRA’s investments. The Court looked to the operating agreement of the LLC which authorized payment to Mr. Ellis for serving as the general manager and also the actual records of the LLC which showed the payments to Mr. Ellis. When using an IRA/LLC, one of the many important clauses in the operating agreement is one which restricts compensation to the IRA owner or any other disqualified person (e.g. IRA owner’s spouse or kids). Also, the actual payment and transaction records of the IRA/LLC will be analyzed so it is important that both the LLC documents and the actual payment records do not allow for or result in payment from the IRA/LLC to disqualified person (e.g. IRA owner).

It is also important to note that the Tax Court rejected Mr. Ellis’ argument that the payments were exempt from the prohibited transaction rules under section 4975 (d)(10). Section (d)(10) provides an exemption to the prohibited transaction rules for payments from an IRA to a disqualified person [e.g. IRA owner] for services rendered to manage the IRA. The Tax Court rejected this argument stating that the payments from the IRA/LLC were not for management of the IRA but for management of the IRA/LLC and its business activities. In this case, the IRA owner was actively involved as the general manager of the IRA/LLC which LLC bought and sold cars. As a result, the Court held that the payments were not exempt and constituted a prohibited transaction.

I was happy to read this case and find the Court’s conclusions because it matches the same opinion and advice we have been giving clients regarding IRA/LLCs for nearly ten years: that a newly established LLC owned by an IRA does not constitute a prohibited transaction but the IRA/LLC cannot pay the IRA owner (or any other disqualified person) compensation for managing the IRA/LLC.

Mat Sorensen is a lawyer and the author of The Self Directed IRA Handbook: An Authoritative Guide for Self Directed IRA Investors and Their Advisors. He is a partner with KKOS Lawyers in its Phoenix office and assists clients nationwide on self directed IRA matters. He can be reached at mat@kkoslawyers.com or by phone at 602-761-9798. His website is www.sdirahandbook.com

Tips for Title Insurance

February 3, 2014

Guest article by Deborah Farnell:

When evaluating an investment in real property, whether for purchase or to hold a note on, one of the most important aspects in your risk assessment is making sure the property has a clear title. Typically, there are no IRS or custodial/administrator requirements to obtain title insurance on IRA-owned real estate. As the primary fiduciary of your self-directed IRA, the decision to insure the title to the investment property is entirely yours.

If you chose to simply have a title search of the property performed without actually purchasing the title insurance policy, you may gather useful information, but there is no coverage to protect you as the homeowner or lender. Quite often investors will rely on a pencil search or ownership and encumbrance report to inform them of any issues with the property and then forego the actual purchase of a title insurance policy to save money. These title search products provide no protection and are often performed as preliminary searches without the formality of a title search that is required to issue a policy of title insurance. In the current market of abundant foreclosures, short sales, bankruptcies, and fraudulent activity it is more important than ever to protect your investment. Title insurance is a one-time premium that protects your investment for the entire time you own the property.

Here are some helpful hints to consider when obtaining title insurance for your transaction:

Work with a title company that is familiar with complex transactions and is considered investor friendly. Quite often when you are shopping for title insurance and do not have an established relationship with a title insurance professional, you will get objections and claims that the transaction you are proposing is illegal when all that is needed is a better understanding of the structure of the deal.
Be proactive in getting the information on the transaction to your IRA administrator and title company as soon as possible. My title company does not charge a cancellation fee for transactions that do not close, and we ask our clients to get us the contract as soon as it is accepted so that we can begin our title work immediately and get any objections or problems solved before deadlines come due. Since there are often a number of parties involved in these transactions that need to review, question, and revise documents as the deal concludes the more proactive you can be to allow the parties time to perform their necessary due diligence, the smoother the transaction will be.
Review the title commitment carefully. Make sure you understand the requirements and exceptions listed on the commitment and that all items are satisfied as needed. Quite often when purchasing from national banks or servicing agents, a national title company may be used that is not familiar with state or local rules and customs. Perfect examples of this in Florida are the issues with unrecorded utility liens and code violations, which vary by city or county.
If you are purchasing property to be held in your IRA, you can typically get the seller to pay for the owner’s title insurance policy. If you are lending money and holding the note, you can require your borrower to purchase a lender’s or mortgage title insurance policy that covers your interest in the property.

Deborah has been in the title industry for more than 18 years and is the owner of Southeast Professional Title, LLC, in Maitland Florida. You can reach her at Deb@seprotitle.com or 407-539-0781.