Jeff Nabers’ Self Directed IRA & Solo 401(k) Blog

A recent Onion News article has hit dead on what is wanted right now by the masses of the American public. As ridiculous as this article sounds, this type of mentality is exactly what’s been behind many “investment decisions” of the average American in recent past.

Read the article here, and then keep reading my blog if you’d like a more sound approach to investing.

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P.S. Just to be on the safe side, I’ll give you a heads up that The Onion is a satirical, “fake news” organization.

****** A note from Jeff Nabers ******

I asked attorney Dan Marsh to shed a bit of light on entity maintenance and its importance. With a general purpose LLC, failing to properly maintain the entity can result in “piercing the veil” which means subjecting creditors to assets of the LLC owner(s). With a special purpose IRA LLC, “piercing the veil” could mean a prohibited transaction resulting in hefty taxes, penalties, and interest.

Entity maintenance is important and it shouldn’t take too much time or money… yet it could save you a lot of time and money in the long run. I suggested Dan keep this post brief, but instead he did what attorneys are supposed to do: he was thorough. Rather than ask him to dumb it down and shorten it, here’s the article in its entirety…

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LLC stands for limited liability company, and that is the primary purpose for forming such a legal entity. When you enter into a business transaction as an individual (aka sole proprietor), if somebody decides to sue you, all of your personal assets can be subjected to satisfying the law suit. The idea behind an LLC or Corporation is that people are doing business with that entity (the LLC, for example). When a true separation is maintained between the LLC and its members/owners, the LLC can only lose its assets… but not the unrelated assets of its owners.

The cross-liability of one LLC with multiple assets or businesses

Jeremy forms JAH LLC to buy and hold apartment buildings. He buys Apartment Building A as well as Apartment Building B & Apartment Building C.

An accident occurs and somebody gets hurt in the common area of Apartment Building A. This person sues the owner of the buildings, JAH LLC.

Personal assets - Jeremy’s personal assets are protected from exposure to this law suit (except for what he contributed into JAH LLC).

Apartment Building A - All of the assets of JAH LLC can be exposed to satisfying the law suit. This includes bank accounts relating to Apartment Building A and even the real estate itself.

Apartment Building B - All of the assets of JAH LLC can be exposed to satisfying the law suit. This includes bank accounts relating to Apartment Building B and even the real estate itself.

Apartment Building C - All of the assets of JAH LLC can be exposed to satisfying the law suit. This includes bank accounts relating to Apartment Building C and even the real estate itself.

The additional protection of multiple LLCs

Jeremy forms (more…)

If you talk to the average CPA, he’ll tell you that UBIT is the boogeyman and is to be avoided… always. Discussing this topic with an above average CPA (such as Eric Wikstrom of Integrated Wealth Strategies) yields different advice.

The Two Types of UBIT

1. Triggered from a trade or business - if a tax exempt entity (such as an IRA or 401k) owns a trade or business, the income of that business is taxed at trust rates (i.e. very high tax rates). Both IRA & Solo 401k accounts are subject to this type of UBIT.
2. Triggered from ownership of leveraged real estate - if a tax exempt entity (including IRA) owns real estate leveraged with a mortgage loan, the portion of that income attributable to the mortgage loan is taxed at trust rates. This type of UBIT is specifically referred to as UDFI - Unrelated Debt Financed Income. Solo 401k accounts & other qualified plans are exempt from UDFI.

Trust tax rates are very high, so it might make sense to avoid Type 1 UBIT at all costs. On the other hand, a close examination of UDFI tends to revoke its “boogeyman” status.

The reason UDFI isn’t a detrimental cost is that non-recourse mortgage loans (the only type an IRA/401k can legally obtain) are typically only offered at a 65% loan-to-value maximum. So this means that the UDFI tax is only payable on up to 65% of the property’s net income. (That’s right - net income. You do get to deduct depreciation and other expenses before paying UDFI tax).

Let’s examine a simple comparison of the taxes payable on net real estate income with 50% leverage: (more…)

Conventional Tax Strategies for Real Estate

Many real estate investors boast of their tax strategy as involving one or more of the following:

Depreciation - This is a tax concept where the property owner pretends that his property is decreasing in value. For residential real estate, it assumes that the property’s improvements will become worthless over 27.5 years. In commercial real estate, the calculation is for 39 years. During each year of property ownership, the owner can take that year’s pro rata depreciation as if it is a loss against the income of the property… which reduces the taxable income of the property, thus reducing the amount of taxes due. Upon future sale of the property, depreciation normally must be “recaptured” which means that there is no more pretending, and the taxes on the truly realized gains must be paid anyways.

Cash out Refi - This is where the owner of the property will refinance the mortgage. The new loan will have a higher balance than the old one, resulting in “cash out”. Because this is just borrowing, it is not a taxable event. Upon future sale of the property, however, taxes will normally be due on the actual gains anyways.

1031 Exchange - Upon the sale of real property, the gains can be deferred if they are used to purchase property of “like kind” within a certain time period. It goes something like this:

• Sell Property A
• Have a “qualified intermediary” receive the proceeds of the sale
• Replacement property (”Property B“) must be identified in writing within 45 days of the sale of Property A
• Property B must be purchased (closed) within 180 days of the sale of Property A

• Property B must be of equal or greater value to Property A
• Both properties must be “like kind”. For instance if Property A was U.S. real estate, Property B must also be U.S. real estate.

So, savvy real estate investors often (more…)

A question I get all the time is “Can I personally mow the lawn, maintain, and/or repair properties owned by my IRA LLC?” My answer is “No” which usually creates the response “But another company said I could.”

First, let’s summarize that the accountholder/participant of a retirement plan generally can’t have a transaction between themselves and their retirement plan. This includes the furnishing of services, sale of property, lending of money, and extension of credit between a plan and disqualified person (such as the accountholder). Next, let’s establish that active landlording means mowing the lawn, repairing, and fixing up properties, while passive landlording means collecting rent, paying mortgages/taxes/insurance, and contracting out the more active tasks to non-disqualified-persons. So is active landlording allowed? No, and I’ll provide two answers - the technical and the layman’s.

The Technical Answer

The argument for why active landlording for your IRA LLC’s property is not a prohibited transaction goes something like this…

As a general rule, the Internal Revenue Code provides (more…)

Solo 401(k)’s most touted feature is its uniquely large annual contribution limits ($46k - $102k). A lesser known feature may be just as useful for some: participant loans.

What is a participant loan?

A Solo 401(k) participant can borrow up to either $50,000 or 50% of their account value with the following terms:

• To be repaid over an amortization schedule of 5 years or less
• Regular payments no less frequently than quarterly
• At a reasonable rate of interest… generally interpreted as prime rate + 1%

Such a loan may only be made in accordance with the Solo 401(k) plan documents. While most plan documents disallow this type of loan, the Unlimited® 401k offered by my company does allow it.

Under what conditions is this allowed?

Any. As long as the plan documents allow for it & the proper loan documents are prepared and executed, a participant loan can be made for any reason.

When is this useful?

This can be useful when (more…)

Do you have an IRA/401k-owned investment property that has a mortgage and negative cash flow?

Something I’ve been running into lately is Self Directed plan investors who speculatively bought a house or condo in previously hot markets (think Vegas, Florida, Phoenix, etc). Some of these areas have experienced declining values and declining rental income for short term rental properties.

If your plan (IRA or 401k) bought a house & obtained a non-recourse mortgage loan qualified based on short term rental income that has declined, you probably have negative cash flow. How can you avoid foreclosure? Loan money to your IRA/401k.

Loaning money to your IRA or 401k

A little known (more…)

I recently talked to a real estate investor friend online who I have known for about 4 years. He started investing in the height of the housing bubble, and now I think he’s finding it difficult to shed the “bubble mentality”. In our conversation I did my best to cause him to question his perspective and his investing strategy.

I’ve pasted our Instant Message conversation below (with the screen names changed for privacy). I didn’t correct capitalization, punctuation or spelling errors, so you’ve been forewarned.

I thought this would be a useful post because of how tightly this gentleman seemed to grip onto his investment strategy he’d been using since 2004. How tightly are you gripping onto your investment strategy?

[19:00] re_investor: HI Jeff
[19:00] re_investor: How are you buddy?
[19:00] jeff_nabers: Hey there
[19:01] jeff_nabers: I’m doing good. How are you?
[19:01] re_investor: How have you been doing?
[19:01] re_investor: Im alright!
[19:01] jeff_nabers: How’s the RE market up there?
[19:01] re_investor: OH its tight!!
[19:01] re_investor: Its flat and declined over the pervious 6 months
[19:01] re_investor: TOUGH
[19:02] jeff_nabers: what about cash flow?
[19:02] re_investor: Its cashing …
[19:02] re_investor: but, its still tight. I actually was in the process of buying another one
[19:02] re_investor: I stoped canceled the purchase/sale
[19:03] jeff_nabers: how did your previous investments turn out?
[19:03] re_investor: Oh great actually..
[19:03] re_investor: I sold the one in Fairview park
[19:03] re_investor: I got a cash buyer
[19:03] re_investor: The other three are turning out fine
[19:04] re_investor: The one house I have I have 67K in equity right now
[19:04] re_investor: I am currently renting it for 1K
[19:04] re_investor: but, I cant do anything with it until the maket comes back
[19:04] jeff_nabers: Sounds decent
[19:04] jeff_nabers: how’s the cash flow return?
[19:04] re_investor: Its about 300 dollars
[19:04] jeff_nabers: renting it at $1k what do you net per year?
[19:04] jeff_nabers: i see so 6k per year
[19:05] jeff_nabers: how much money did you put into it?
[19:05] re_investor: I was just in the process of refinancing it
[19:05] re_investor: and the mtg company I was using closed up
[19:05] re_investor: so the refi stoped
[19:05] jeff_nabers: how much money did you put in tha tone?
[19:06] re_investor: I was bummed out
[19:06] re_investor: I put in 15K
[19:06] re_investor: to fix it up
[19:06] jeff_nabers: and the down payment was?
[19:06] re_investor: It was alot
[19:06] re_investor: I cant remember…
[19:07] re_investor: I am trying to do something with the equity.. but, I dont know what
[19:07] re_investor: There is not much I can do
[19:07] jeff_nabers: you don’t remember how much you put down?
[19:08] re_investor: why are you wanting to no such details?
[19:08] jeff_nabers: i’m curious what your return is
[19:08] jeff_nabers: cashing out would only decrease your cashflow
[19:08] re_investor: I got into it on no money down
[19:08] re_investor: I had good credit
[19:08] jeff_nabers: well then i would never refi it and never sell it
[19:09] jeff_nabers: you are making a 40% annualized return on the cash you put in
[19:09] re_investor: yeah. Its only worth so much you know
[19:09] jeff_nabers: why would you ever want to take an asset like that off your books?
[19:09] re_investor: To use the equity in the house
[19:09] jeff_nabers: with 10 - 15 of those you’d never have to work again
[19:09] jeff_nabers: to use the equity to do what? continue working real estate like a job?
[19:10] re_investor: right. I just need 9 - 14 more of them
[19:10] jeff_nabers: do your other properties cash flow like this one? (more…)

Did you get your $600 check yet? What will you do with it? Surveys are saying that most Americans will use their “Economic Stimulus” check to deal with gas, food, and catching up on bills. This doesn’t stimulate the economy.

Consumer spending stimulates the economy. In other words, the Department of Treasury sent out checks to us all totaling $150 billion in hopes that we would buy clothes, jewelry, and electronics. Let’s take a step back for a moment and assess how our system works:

Two thirds of our nation’s economic activity is coming from people spending money. When our economy is “going good” it is because people are spending money - often more than they make or have. When our economy is “doing badly” it is because people are saving money or living within their means.

Finances 101

This is America and everyone wants to be rich. How does one become rich?

Make more money than you spend.

Or spend less than you make… in case that hits closer to home for you.

A person following those rules is becoming wealthy, while a person who practices opposite rules is becoming poorer. Here’s where things start to look funny. Our economic system is booming when people are becoming (more…)