Bruce Norris is joined this week by Kaaren Hall. Kaaren is the owner of uDirect IRA Services, a company that specializes in helping people understand what to do with their self-directed IRAs. Kaaren utilizes her skill of mortgage banking, real estate, and property management to focus on this market and help others even in the midst of the recession that had gone by and collapsed the mortgage market. Through her knowledge, she has educated tens of thousands on building wealth through IRAs and diversifying their investments.
One of the things that is interesting to Bruce is that when Kaaren speaks to his group, she talks about how long IRAs have been in place. It is kind of a shock when you realize they have been around a while. You have been able to self-direct your IRAs for almost 40 years. Gerald Ford signed the ERISA laws into effect in 1974, and they went into effect in 1975. Bruce asked what the total amount of dollars are that are in these types of investments nationally. Kaaren said last she heard the whole overall pool of retirement money is around $23 trillion. Self-directed IRAs make up about 3-4% of this. A lot of people still don’t do this. They make choices to pick somebody to make their choices without realizing how much those companies are taking out of the profits. You put up 100% of the capital, and then the people who are doing the typical IRAs are reaping the benefits of the retirement savings without putting up any capital. This is opposed to a self-directed IRA where you put up 100% of the capital and get 100% of the returns.
It was interesting when Kaaren said they get a percentage of the profits since they actually just get a percentage, whether it is profitable or not. They have a flat fee and are not taking a percentage. Bruce asked how much he can contribute a year to self-directed IRAs. Kaaren said the answer, just like anything related to self-directed IRAs, is that it depends. It depends on your age, the type of account you have, and your income and how much you can contribute. There are different kinds of IRAs, like a traditions, ROTH, SEP, simple, inherited. If you have a traditional IRA, you can contribute $5500 a year if you are under 50. If you are 50 and over, then you can contribute $6500 a year. To keep it simple, this is how it is for a traditional IRA and a ROTH.
Bruce asked if this accelerates at any other age, or if it is 65 and under. She said 50 is where you get the catch-up contribution where you can put in an extra $1000. Life expectancy may increase to such a level that they will come up with a second catch-up contribution. However, at this time it is only that one catch-up contribution. When you make that contribution, it is pre-tax for a traditional IRA. If it is a ROTH then it is after tax. If, for example, you are Bruce Norris or Bill Gates and make a contribution into a traditional IRA, you can do that but your income may be so great that you cannot take a tax reduction. You can still make the contribution, then have those dollars grow tax-deferred. You just don’t get the tax write off if your income exceeds a certain level.
At the Norris Group, they have a different type of plan that lets them contribute 25%, around $51,000, which is called a SEP. This seems to be pretty generous, the 25% compared to $5500. It is great for an employer to offer that and is a calculation your CPA does for you because it is not just 25% of your AGI. You want to talk to your accountant or tax person so they can calculate the correct contribution for you. It is not just to do with what you gross, but rather there are other things that are involved in it. One thing Bruce has learned is it is really important to have a team and that they work together. She had a phone call earlier in the day with people who had a financial advisor on one hand and a CPA on the other. What is so important is that everyone has to be on the phone together so they are all talking about the same thing at the same time. It is always good when the team is all working together.
You cannot be an expert at everything. Bruce said he has definitely sat in front of people who are experts in some things but not in real estate or self-directed money. You can already tell by the advice they are giving that something is not right. When you take an IRA and say you would like to convert it to a ROTH, Bruce wondered if this always makes sense or if there are times when it does not. If you have a regular, traditional IRA and want to convert it to a ROTH, there are a couple things involved. One is that because of a law that was passed and became effective in 2010, you can now convert regardless of your income. There are no income barriers on converting to ROTH, which can be very good news. However, when you convert IRA money into ROTH IRA money, it is a taxable event. The amount you convert is going to be taxable as though it was earned income.
Another phone call Kaaren had was with somebody who had taken a major loss during the recession but decided to say he was going to take the major loss and convert his retirement money to a ROTH. He said this would offset the loss, and this was something with which the CPA helped him. The other thing you want to ask yourself is how hold the person is. If you are going to pay the whole lump of tax all at once, the question is whether it makes sense given your total horizon of what you are looking at. This is where you team comes into play. You may also have a deal that you know will pay off big. You want to buy it with IRA money and convert it to ROTH, invest, and then have your ROTH invest in the deal. It will then pay off big and make sense. This is the kind of conversation to have with your advisor about whether a conversion is the best thing for you.
Bruce asked when you have an IRA and ROTH IRA existing at the same time and you make contributions, does it always go through the filter of the IRA first and then to the ROTH or is this step unnecessary? Kaaren said it does not. If you are under 50 and have $5500 you can contribute, that is $5500 to your traditional and ROTH combined. It is not $5500 to the traditional and $5500 to the ROTH. Rather, it is $5500 to both combined, but you get to choose whether to put it in the ROTH or traditional. Whether or not you can contribute to a ROTH depends on your income. They have it on their website at udirectira.com about where those breakdowns are. This way if you are going to contribute to a ROTH IRA and are married and make a certain amount or are single, there is a cutoff where you can make too much to contribute to a ROTH. There is still an income barrier in that sense. You can convert regardless of income, but with contributing there is a max.
In 2014, if you are a single person make $114,000, then that is the cutoff. If you are married and filing jointly, the cutoff is at $181,000. You can contribute $5500 to your IRA and convert it, regardless of income. You still need two stages if you make enough. Bruce asked if the conversion from an IRA to a ROTH is limited or if you can do as much as you want. For example, if you had $1 million could you convert it and put it in the ROTH all at one time. Kaaren said you can, and she has had a client who has done this very thing.
Bruce asked if the tax can be paid out of the IRA. Kaaren said not in this case since it is taxable as income. You cannot pay the tax out of your IRA, you have to pay it outside of it. It is really a fine line. When Bruce was thinking about the questions for the interview, he was thinking what might be tax questions.
Generally investors, especially those who think they can take care of their own things, get more aggressive than they are allowed. Bruce asked what a self-directed IRA cannot invest in usually. Kaaren said one thing it cannot do is if somebody wants the IRA to be the down payment on a purchase of real estate. You think this seems to be logical, but you cannot personally guarantee loan to your IRA. Your IRA will not borrow a Fannie/Freddie conventional conforming FHA VA kind of a loan. An IRA can borrow money if it is a non-recourse loan, and then it can be a down payment. However, it is not a down payment on a regular loan. This is one thing where investors get the idea and want to get creative.
Bruce also asked about silver and gold. Kaaren said lots of their account holders take their IRA and buy the actual metal. This is then stored at a facility in a Delaware depository. Going another step further, Bruce wondered about collectible coins. Kaaren said the IRS only has two things in which you cannot invest IRA dollars. One of these things is collectibles. If it is a U.S. minted coin, it is okay. Bruce talked to somebody who was doing something pretty innocent and who had a son in the business. They had him sell them a house in their IRA and get paid. They would then have their other relative do the maintenance on it. None of this flies because there are rules called the prohibitive transactions, and they are genius in their simplicity. The depth is not immediately apparent. You can read about all the prohibitive transactions under Internal Revenue Code 4975.
Certain people are allowed and others disallowed to the IRA. People who are disallowed are lineal ascendants and descendants. This means your parents, your grandparents, and their spouses. You and your spouse, your children and grandchildren, and their spouses are disallowed to the IRA and anybody offering services to the plan are disallowed. People who are okay are those who are off to the sides on your family tree such as your aunts and uncles, cousins, and brothers and sisters. Your IRA can buy a house, and your uncle can live there. It can buy the same house, but your father cannot live there because he is disallowed by the IRA that your uncle is not. Bruce asked if he was a handy man who mowed his own grass and didn’t charge his IRA. Kaaren said then how it would work is you would not be allowed to do that because you are disallowed to your IRA since it is a different kind of prohibitive transaction since you are providing services to the plan. It’s not like the IRS will drive by and interrogate you about mowing your lawn, but you are not allowed to do it due to it being an over contribution of sweat equity.
Bruce asked about the penalties and if she has seen people do things that were innocent to them for which they were penalized. Kaaren said it has nothing to do with how learned these people are. There was an attorney who opened a self-directed IRA, purchase a house that had renters, and he decided to have the renters send everything to him. He put it into his own bank account, but he did not know he was doing wrong. He went forward to claim all the rental income on his income tax as though he had earned it, but it was his IRA that earned it and all the money should have gone back into the IRA. This was unfortunate; and when they found out about it they dispersed his account to him.
In gold, when you take your first shot it will sometimes go into the woods and you have a mulligan. Bruce asked if this ever happens in real life where the IRS looks at the party’s intent and sees that they did not mean anything. Kaaren said you can have it halo, and intent is not really the point. There is a get out of jail free card, which is like a mulligan. This is called an opinion letter. You go to the Department of Labor, and you can get a letter from them that costs about $10 grand. If the IRS says you committed a prohibitive transaction, you can request a special exception known as a private letter ruling. It does not set a precedent, so it is not like when you get a private letter ruling it is okay for everybody else. It is a private letter ruling just for that one situation, but if you have a $1 million IRA and you commit a prohibitive transaction, $10,000 may not be that much money to get a private letter ruling.
Bruce also asked about if he had a lot of money in his IRA and would really like a second home five years from now. Would you be able to buy it in your IRA and use it as a rental 4-5 years? This is a yes and no question. The IRS says you cannot buy assets for present or future use. But, if your IRA buys a house and the intent is to have it as an investment property, and you hold it as one and both rent it out and keep a log of what you are doing, then five years later the only thing really to do is take the house out of your IRA since you already own it. It would make the most sense to move in here. You get an appraisal to determine the value, then you withdraw that house from your self-directed IRA. The value of the property then becomes a taxable thing for which you are sent a 1099. Bruce wondered if at this point with the IRA they would be glad to sell you the house but would carry the paper. Kaaren said this would not be possible because you can’t buy the property from yourself, but rather take it as a withdrawal.
This is really the way we think. One decision is made, and all of a sudden there is a whole new root system of things you never thought about that you really cannot do. The IRS tries to keep it simple, and when it comes to IRAs they are for retirement purposes only. This means no personal present direct benefit today that is all for retirement benefit. The other thing is that it is for investment purposes only. It cannot be a vacation property or primary residence, but rather it has to be an investment home if you are investing in real estate. It has to be with the intent of keeping that asset as an investment.
Bruce said a lot of people they deal with have rental portfolios and IRAs. The best place to flip a property would be in non-taxable balloon. Bruce wondered if there is a number of properties that can be flipped safely within an IRA. This is another situation where it really depends. Kaaren belongs to a group called RITA (Retirement Industry Trust Association), whose head is named Mary. They were in a taxi cab together driving one mile in Washington D.C. Kaaren asked her how many properties you can flip in a year, and she gave an interesting case. There was a young woman whose IRA flipped 25 properties in a year. The IRS took a look at it and said she was running a business in her IRA. It’s not that you cannot do it, but rather it was unrelated business income tax. In this particular case, the IRS ruled that 17 of the properties could go tax free and only 8 were taxed. This was just with the finding the IRS made at the time. There was not necessarily a rhyme or reason you could look from the outside and say it makes sense. To go to that point, if you are a professional flipper and this is your business. Your IRA flips one property, and this could be seen as running a business in your IRA and could be taxable. It is allowed and possibly taxable.
Bruce asked about taking money out of an IRA and a Roth and what age is mandatory. Kaaren said with a traditional IRA, when you turn 70 ½ you have to start looking at required minimum distributions. When you approach this age, you need to be having these conversations with your financial advisors. You will need to take a certain amount of money out of your pre-tax account to satisfy the IRS since they want to get their tax money on it. You therefore have to take required minimum distributions. This is based on your life expectancy, so there is a table and a couple other different ways to look at it. This is why you want tax advice on this.
When it comes to a ROTH IRA, the proceeds are tax-free for life, so there are no required distributions. You can continue to contribute to a ROTH IRA as long as you have earned income and you do not exceed a certain limit. Bruce asked if your ROTH is making $10,000 a month and you would like to get this every month, would it not be taxable, either state or federal. In a ROTH IRA, you take the distribution, request a withdrawal, and disperse the money. You take the interest and let the investment stay where it is.
Bruce asked if there are any future changes to the retirement plans. Kaaren said one change has to do with the way IRAs are reported. There is a document called a 5498 that reports value, a 1099 that reports distributions, and they are looking to add something to these forms that tells the IRS what kind of asset the account holds. This is something that is on the horizon. Bruce asked if this will make appraisals more common as far as what the assets are. Kaaren said they probably will, and the IRS would know if you have precious metals in your IRA that you did not have before. The IRS will now know you have an LLC and a house in your account, so who knows where this will lead.
For more information, you can visit uDirect IRA on their website at www.udirectira.com or email@example.com. Phone number is 714-460-5505.
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