This week Bruce is joined once again by Hugh Bromma. Hugh is the CEO for Entrust Group. The Entrust Group was founded in 1981. Hugh is recognized as an industry spokesperson in the self-directed market. Entrust provides tax enhanced services such as self directed IRAs, and qualified plans to tax payers. Entrust manages over $4 billion worth in assets.
Bruce begins by asking if any big changes are coming up in 2010 that will affect what people may do with their IRA. Anyone who wants to convert a traditional IRA to a Roth IRA may do so without any income caps. These converters may pay taxes over 3 years for the amount that they convert from their traditional IRA. Before, the income cap was $100,000, even if the traditional IRA was for a couple. Now a person with a very large IRA may convert to a Roth.
When you use a Roth, you do not pay any taxes. With a traditional IRA, you pay taxes as soon as you get distributions.
The government chose to formulate the Roth program because it allows them to be paid in advance. This program has made the traditional IRA fundamentally obsolete for people who want to pay taxes upfront on an asset that they know will depreciate dramatically.
To make the conversion from the traditional IRA to a Roth, you must pay taxes on both a federal and state level. Some states may have higher taxes than others. There are times when making a conversion is a bad decision. Anybody who contemplates a conversion should speak to a tax professional, because everyone’s tax situation is going to be different. One must determine whether it is advantageous to pay taxes up front or over time. If you have an asset in your IRA with a very low market value, but will appreciate tremendously, then it is probably a good idea to convert that asset.
If you are unsure of the value of your assets, then you should have it appraised, or you should hire a broker who will provide you values on comps.
Leverages are permitted when transferring from an IRA to a Roth. The debt is going to be a true non-recourse to the individual. The title and the debt of the properties in the IRA will be paid for, and signed by, the retirement account. There is an unrelated debt financed income tax, which may be paid on that debt portion. You must pay tax on the money that you borrow from your IRA, but the amount will be relatively insignificant.
The Roth IRA was established in 1998. Hugh Bromma has an expertise that Bruce does not think most people understand. Bruce has never been asked, “What are you doing with your Roth?” This surprised Hugh.
If you have an established Roth IRA, you cannot make a direct contribution to your Roth if your income exceeds $100,000. In 2010, if you drag a maximum contribution to your traditional IRA, then you will be able to pay the tax and make that direct contribution. This change in 2010 will be permanent.
Bruce did research on the highest tax rates in the U.S. since 1913. He was shocked to discover that 80 percent of the time, the top tax rate was over 60 percent. This scares Bruce and Hugh, and they fear that some high tax changes will take place in 2011.
At 59 and a half, if you have an established 5-year Roth IRA, then you can start taking distributions without penalties. If you start taking distributions prior to 59 and a half, or from an unestablished Roth, there is a 10 percent penalty for premature withdrawal. If you die, then your Roth IRA will still be subject to an estate tax.
With a Roth IRA, you cannot get a second home for personal use. Secondary homes may only be used for investment purposes. You cannot live in it, use it, personally repair it, or do property management on it. Cousins and in-laws are allowed to use a secondary home, but not your son, daughter or wife. You are also prohibited from hiring a son-in-law from rehabbing the home. The rules state that you are not allowed to receive a current benefit from your Roth assets. This rule includes yourself and someone that is related to you. Also, if you have ownership in an IRA or Roth then you may not use funds outside of that account for rehabbing or loan payments. If you do make a mortgage payment using money outside of your IRA, it is considered an excess contribution and it is reportable to the IRS. You will be forced to withdraw that mortgage payment by the next year, or you will be penalized for 6 percent of the amount of the infraction.
It is also against the rules to put money from your Roth account into a company that you are a manager of. If you own 10 percent or more of such a company then you are subject to penalization.
If people try to find a way around the rules, they are almost guaranteed to get caught. Some people who try to commit illegal transactions lose the entire value of their IRA. However, it is not considered a criminal act to commit an illegal transaction. Illegal transactions are punished through extreme taxes. Illegal transactions are a great benefit to the IRS, so there is no need for the IRS to prosecute.
Bruce thought of a creative transaction that might occur between two people: There are two investors who know each other, but are not partners in any business. They both buy properties at trustee sales. Buyer A buys a house using his own money, and then gives Buyer B the option to buy it for a dollar more than he paid. Buyer B fixes it, sells it, and the proceeds over the cost go to the Roth IRA of the other guy, and then the buyer receiving the benefit returns the favor. Bruce asks Hugh if this is an okay transaction. Hugh says that they must consider whether or not their transaction could be seen as a sham from the IRS. This transaction could be considered a sham, because its intent is to avoid paying taxes. It gets down to intent and Bruce decides to scrath that plan.
Bruce brings up leveraging with Options. Bruce talks about optioning land in the coming years and how that would be structured. Bruce knows someone who made $30 million on that plan, but it wasn’t in a Roth. If he had made that transaction in his Roth then the transaction would be legal. Options are one of the best uses for Roths. Options is one of the best plays that savvy Roth IRA investors use to increase their accounts.
Bruce’s Roth could have enough money to do a real estate transaction every month. He could fix properties and resell them 12 times every year. This may or may not be a problem with the IRA. If you are doing this kind of work professionally, and you are perceived as a dealer, then it is not illegal to do it within a retirement account. However, there may be dealer issues outside of the IRA. This is typically not a problem. One of the obligations you have for your individual retirement account is to make a lot of money. If you are using that money to make 10 option plays every year, then you will probably not have any issues. If someone uses their IRA to hire sales people for their property sales, then they will be labeled as a dealer. Richard Lipton has written a few articles on this subject.
If someone has a buy-sell operation with employees, but also has a Roth that does the same activity on a smaller scale, then that would probably be okay. Hugh is not completely certain about this, depends on their mood, but he considers the IRS to be reasonable in the tax courts.
Spec building is allowed with Roths, as well as land ownership and trust deed investment. Entrust needs a complete package before it cuts loose with an investor’s funds. The package is up to the IRA owner, but Entrust needs to make sure that you have an asset that can be titled in the name of the trust for an individual retirement account. Unfortunately, sometimes people will try to buy or sell a note, but they then discover that their note is actually a private placement or some other sort of asset. Buying an existing note and investing in a trust deed that is currently initiating involves the same fundamental process.
Bruce asks Hugh to describe the term “checkbook access”. A checkbook IRA is an LLC that is usually sold to someone from a lawyer. It is a single member LLC that is allowed to be owned by an individual retirement account. That LLC is run by the IRA owner. Hugh has discovered that many people use this system to make prohibited transactions. Entrust has developed a Real Checkbook IRA in which a person receives a debit card and a checkbook, which becomes an asset of their IRA. They may then buy their investments using that methodology.
Hugh Bromma’s website is www.theentrustgroup.com. Bruce and Hugh will be teaching together at an investment seminar on January 2nd.
The Entrust website can be found at www.theentrustgroup.com. January 22nd, Hugh and Bruce will be teaching together.
We’d like to thank Hugh Bromma and Entrust for sponsoring I Survived Real Estate 2009. Thank you!
