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…)

5500-EZ for Solo 401(k) plans

If your Solo 401(k) plan assets exceeded $250,000 in value in 2007, a 5500-EZ must be filed by July 30, 2008. This is an informational return used to report plan value to the IRS and does not require any tax payment.

990-T for IRAs with mortgage financed real estate

If your IRA owns mortgage leveraged real estate, a form 990-T should have been filed with UBIT payment by April 15, 2008. Unrelated Business Income Tax is one an IRA must pay on the portion of income or gains attributable to the mortgage leverage used. For example, if your IRA owned a property with a 50% debt to basis ratio, then 50% of its income would be taxable at trust rates. While many investors balk at the idea of paying taxes on IRA profits, a tax analysis in most scenarios typically favors paying UBIT over making the same investment with non-retirement funds.

While I generally avoid mutual funds like the plague, I don’t avoid the stock market altogether. I’ll split what I do in the stock market into two categories: long and short. Either way, I’m honest with myself in admitting that no matter what I do in the stock market, it will be speculative and risky.

Long

“Going long” means buying a stock and expecting its price or income to rise so I can sell later for a profit. There are millions of people who have access to the same information as you, and that is generally reflected in the price of that stock. If you know something non-public about the company, trading it may be illegal for you. I’ve bought individual stocks before; I just treat the situation honestly; it is speculative in nature, and I only make such trades with very small portions of my portfolio.

I don’t go long on mutual funds because I don’t know what I’m going long on. It is virtually impossible to know what I’m actually investing in when I buy shares of a fund.

Short

Selling Short… A short position is the opposite of a long one. Instead of buying low and selling high, selling short is a matter of selling high and then buying low. For me to do this, I borrow shares of a stock and simultaneously sell them at the market price in expectation of a price decrease. To close this position later, I just have to buy back shares of the same stock at the then market price and pay back the borrowed stock. If during my position the stock price declined, I profit; if the stock price increased, I have a loss.

Ex: ABC Company seems to be doomed. It’s currently trading at $50, but I think it will go much lower over the next couple months. I sell 100 shares short. This means I borrow 100 shares and simultaneously sell them for $5,000. A few months later I see the stock price has declined to $35. To close my position, I buy 100 shares back for $3,500. I pay back the borrowed shares and retain the $1,500 profit, less fees and commissions.

I like short selling more than going long. I often notice (more…)

Luck… Doing very well in publicly traded securities is sometimes a streak of good luck. I’ve had a terrific run on the craps table in Vegas many times. Eventually, I run out of good luck. Many people experience the same thing with trading.

Insider Trading… This is when a person has non-public information on which he bases a trade in a public securities market. It is illegal. Insider trading in public securities can lead to imprisonment. Insider trading in real estate and private investments can lead to extraordinary profits.

Arbitrage… This is the act of profiting from the mispricing of assets. When an ounce of gold costs $900 in New York and $895 in Japan, “arb” traders will buy lots of gold in Japan and immediately sell it in New York… theoretically risk free. When dealing with transaction costs, arb trading typically requires (more…)

Has your saving really been a loss? Has your investing really been saving? Let’s find out. To start, here are my definitions…

Investing - the placing of assets to build wealth in a way where overall return can be maximized and risk minimized confidently, competently, and consistently.

Saving - the act of reducing spending in an effort to accumulate wealth.

Surrendering - the placing of money into a situation where you have little to no understanding of where your money actually went… and thus little or no control of what happens to it.

Building on that, my philosophy of wealth building contains 4 simple truths:

1. Investing primarily in the stock market is only possible on a large scale (like Warren Buffett) or with nonpublic information. The latter is illegal and can result in imprisonment.
2. In the current inflationary environment, saving US dollars results in a loss of wealth… even in a CD or money market fund.
3. The average person’s investable assets are inside retirement accounts, such as IRAs or 401(k) plans.
4. The average person cannot invest until they restructure their retirement accounts to have unrestricted investment options.

What you’ve called investing may have actually been saving and surrendering under my definitions.

Investing into a stock may be (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…)