Self-Directed IRAs & Real Estate Investing with Kaaren Hall – Part 1 #969
In Part 1 of Joey Romero’s conversation with Kaaren Hall, founder of uDirect IRA Services and owner of OCREIA, they explore how self-directed IRAs allow investors to use retirement funds to invest in real estate and other alternative assets. Kaaren explains how these accounts work, how investors can transfer existing retirement funds into a self-directed IRA, and how non-recourse loans can help finance real estate investments. They also discuss the importance of understanding IRA rules, prohibited transactions, disqualified persons, and the potential tax implications of using retirement funds for alternative investments.
The conversation also looks at how real estate syndications work and what investors should evaluate before committing their retirement funds. Kaaren explains why due diligence, reviewing investment documents, and researching investment partners are essential to making informed decisions. They also explore the responsibilities associated with IRA-owned properties, including covering property expenses, and discuss tax considerations such as UBIT and UDFI, along with Roth conversions and IRA contribution rules.
With more than 20 years of experience in mortgage banking, real estate, and property management, Kaaren shares her passion for educating investors about self-directed IRAs and helping them understand opportunities beyond traditional stock market investments. Through her work at uDirect IRA Services, she has educated tens of thousands of investors and professionals on taking control of their retirement funds. The conversation highlights how self-directed IRAs can open doors to alternative investments while emphasizing the importance of understanding the rules and conducting thorough research before investing.
In this episode:
How self-directed IRAs allow investments in real estate and alternative assets beyond the stock market.
Using retirement funds and non-recourse loans to invest in real estate.
Transferring existing 401(k) funds and IRAs into a self-directed account.
Understanding prohibited transactions, disqualified persons, and potential tax penalties.
How real estate syndications work and what investors should evaluate before committing funds.
Why due diligence, reviewing investment documents, and researching investment partners are essential.
Understanding UBIT, UDFI, Roth conversions, and IRA contribution rules.
Episode:
Narrator
Welcome to the Norris Group real estate podcast, a show committed to bringing you insights from thought leaders shaping the real estate industry. In each episode, we'll dive into conversations with industry experts and local insiders, all aimed at helping you thrive in an ever changing real estate market, continuing the legacy that Bruce Norris created, sharing valuable knowledge and empowering you on your real estate journey. Whether you're a seasoned pro or a newcomer, this is your go to source for insider tips, market trends and success strategies.
Welcome back to the Norris Group real estate podcast. Today we're joined by a returning guest Karin Hall, founder and CEO of UDirect IRA services and the owner of OCRia. Karin has helped thousands of investors understand how to use retirement funds to invest in real estate and other alternative assets.
We're happy to have her back for a conversation about self-directed IRAs and what's going on with OCRia. Let's welcome Karin. Hey, Joey, good to see you again.
How you doing? Well, let's jump right in. There's a lot to talk about. What's the one question that investors are asking you right now that they weren't asking a year ago? Well, what they're asking us is, well, they're asking how to open an account.
Okay, that's what they're asking us. But I mean, what are people actually investing in? Is that what you mean? No, just like what's a general question that people are asking right now? First off, people have no idea they can self-direct. So they're asking us like all kinds of questions.
Because even though self-directed IRAs have been out there 51 years, people don't know about them. So we go into that. But when they're talking about the assets that they could invest in, they want to know about due diligence.
Like, how do I know it's a good investment? You know, how do you do due diligence? Or they'll say how do you invest for retirement? You know, questions like that. So it's more once they understand what self-directed IRAs can do. One of the stats that just right off the bat just blew my mind was that only 4% of United States investors have a self-directed IRA.
I mean, why do you think that's so low? Well, it's so low because the big brokerages houses have so much capital to put toward marketing. And you'll never see a self-directed IRA ad on the Super Bowl, for example. You know, people just hear mutual funds.
You know, we're all busy doing our job, sometimes not thinking about retirement investing, except you and I always are, right? But the average Joe who doesn't do things like this for a living isn't thinking about it. So they don't realize that alternative assets are even a possibility. And I think that's the reason.
So it's not in their scope of information. Do you think it's... Why aren't more CPAs recommending that they do? Or do you think they do and they just don't follow through? It's hard to say. You know, we do work with a number of CPAs who refer business to us.
And so the CPAs do refer their clients, especially when people are looking for a tax break. Like, how can I get a tax break? What can I do? Especially like, you know, like Keystone CPA, how they're heavy in real estate investors. So Keystone will always say, hey, you know, you're already a real estate investor.
Why don't you put some of this in your retirement account? It's already like, it's an asset class you already understand. That's the thing about using a self-directed IRA is you want to invest in assets that you already know. And so if you already get, you know, whatever the asset is, it's like notes, maybe.
If you're already a note person, notes are great for your self-directed IRA. Well, that's one of the things that maybe we're getting a little bit ahead of ourselves. Because we're, you know, we're so used to talking to each other, we just jump in.
I always assume that people know, okay, like all these investment So give us the 60 second, what is an actual self-directed IRA? You know, what's your role in it as you direct and what is the investor responsible for? Sure. I mean, a self-directed IRA is what self-directed means is that you choose the asset. Now, yes.
If you get an IRA, if you have an IRA, and it's with the brokerage house, they're going to offer you stock market correlated assets. And yes, you can choose whatever market correlated assets that you want. So in a sense, it is self-directed there, too.
But the term self-directed, it's jargon. And what it really means, because it's not in the IRS code, the IRS doesn't say self-directed in the tax code, okay? Because when IRAs were created, they say you could invest in anything except life insurance and collectibles. So it's always been there.
But a self-directed IRA, essentially a truly self-directed IRA means jump out of the stock market, jump out of that pool. Now move into alternative assets, private equity, notes, precious metals, crypto, real estate in any of its forms, like, you know, raw land, self-storage, you know, single family homes where your IRA owns a house and a renter moves in and pays your IRA the rent. Now, there was a time when the price of homes was lower, and it was more feasible for an IRA to do that.
It may not be the case today, but people still do that. People will still have their IRA, go invest into a single family home and the renter will pay the IRA their rent. Well, maybe not in California, but there's certainly other parts of the country where this is still feasible, right? And you're able to go ahead and self-direct into other states, into all 50 states with you? Right.
We have account holders in all 50 states. And it used to be, again, lower, I think, like Missouri, where my son lives, you know, that's a low cost state, but even the median price of a home is like $200,000, $300,000, which for the average self-directed IRA is, or the average IRA balance is high. I know that we were able to fund loans through self-directed IRA.
So how does someone borrow alongside with your self directed IRA? You mean as far as like buying a house, but taking on debt? Yes. Okay. So you can do this.
So this is one way an IRA can buy a house. Now, one way is to partner with someone else, okay? Your IRA could partner with a non-disqualified person, which we could get into, but your IRA could take on a partner and the two of you buy a house together. But if you want your IRA to buy a single family home, say, for example, using debt, you could do that.
So say, for example, your IRA comes in with 70% and you take 30% leverage, that's fine. Now understand the source of that leverage. It's really, really important.
The source of that leverage has to be a non-recourse loan. Okay. And so what's a non-recourse loan? I'll tell you what it's not.
It's not a Fannie Freddie FHA VA loan. Okay. It is a special kind of a loan that is really kind of a private loan, privately held in the sense it's not, you know, capitalized by the big markets.
But a non-recourse loan, here's effectively what that means to you. So your IRA goes in, acquires the house with leverage, and after that closes, now here comes rent. So if it's 70-30, 70% IRA, 30% non-recourse loan, when your IRA gets a rent check, then 30% of that rent payment will be subject to a special tax.
So an IRA can buy real estate, an IRA can buy real estate with leverage. But you need to know in advance before you do that, so that you can, you don't want to invest in an asset if you don't know all the parts, if you haven't really penciled out everything. So what will happen then is that you will be subject to a tax, your IRA will be subject to a tax.
And then everyone says, wait, Karin, IRAs are tax-free or tax-deferred, and they are income tax-free, income tax-deferred. But in this case, we're talking about a specialized tax called UDFI, Unrelated Debt Financed Income Tax. Yeah, I'm gonna get into that a little bit.
Yeah. So your IRA can buy a house, and it can be done just the regular way you buy a house with debt. Yes.
There's going to be a lot of folks that are listening. And maybe even folks that are just getting into investing, they're going to have some 401ks from their old jobs that are just sitting around. What can they do with those? Can they transfer them into a self-directed IRA? And what happens? What are the tax ramifications with that? Right.
And you bring up a good point. A lot of people are losing their jobs, I mean, or changing jobs. It happens every day.
And so when you leave an employer, and you have that employer plan sitting there, now, you could leave it in the market, you know, you leave it at risk in the market, or you could move it. I mean, not there's always risk. Or you can move it to like, for example, a self-directed account, and then invest in alternative assets.
So moving custodian to custodian. So when your IRA, again, moves custodian to custodian, it's not a taxable event. So it simply moves and you don't pay tax on that movement.
Now the money goes from one account to the other. And then you can choose what assets that you wish to invest in. Now, can they let's say, okay, let's say I have a 401k.
And I do exactly what you just talked about. Can I say I've got a little bit more money? Can I put more money into it? Or does it is it just has to come across straight? So you can contribute, you can always contribute to an account. And that contribution limit will depend upon your age, your account type, and your income, how much you can contribute, but you can always put your own money in, but there is a cap, a contribution cap.
And those are, and so it's not, it's not like an opportunity, like, hey, I'm transferring in, let's say I'm transferring in 500k, just for an easy number. Yeah, like, I can't say, well, I want to put I want to make this new account five, a million, a million dollars. Yeah, it could only be the the 500k plus the annual limit is what you get that call.
Sometimes friends will say or people will call me and say, hey, I'm inheriting this money, can I put it all in an IRA? Like, well, you can put money but you in an IRA, but it's, you know, up to a cap. So it has to be earned income. Not passive.
Yeah. So you started talking about how an IRA can own the house, let's say, let's say it's all in the IRA. And you're saying the rent goes into it.
But what happens when there's repairs, let's say the water heater breaks and things like that. Oh, no, nothing ever goes wrong with a house. Wait, so what happens there? Like, do I have to come out of pocket or does the can the IRA? Like, how does that work? I do not come out of pocket for that.
That is bad. That is we actually had somebody do that their house needed a new roof. So they got a home equity line of credit on their private house and use that money to fix the roof on their IRA on property.
That's called a prohibited transaction. You don't you're disallowed to your IRA. We'll talk about this now prohibited transactions.
Prohibited transactions break the tax protected bubble of your IRA. Okay. So committing a prohibited transaction is when a disallowed person like yourself provides services to the plan or Ben or, you know, provides benefit.
So you're disallowed to your IRA, if you put your own personal cash, say, for example, you wrote the check to in this case, the roofer, then you would have broken the rules. And that would be a prohibited transaction and the IRS, the IRA could be dispersed to you as a taxable event with taxes and penalties. So don't do that.
Don't use your private dollars for any IRA asset expenses. Now your IRA can pay account fees. And you can personally pay your account fees.
Either way, that's okay. But you don't personally pay the fees to repair an IRA owned asset, or say it's a note and then the borrower doesn't repay. So you need to hire a collection, a collection agency to earn loan service or to come in and grab, you know, get that get that money collected.
You don't pay for that personally either. The IRA does cover that, that expense. Well, okay, so let's say my expenses outside of what I have left in it.
So yeah, it's a $40,000 roofing, and I don't have $40,000 piggy bank and nothing's coming out. What are you gonna do? I mean, if it's something as expensive as a roof, you might not be able to come up with a shortfall, but you could move money from another account into your self directed IRA cover that expense. You could contribute up to your cap.
You could even take on a non recourse loan to cover it, but then you'd have to find a lender that would make that loan and possibly secure the asset and work work that out. But really, there are ways to make up a shortfall. But when it's a big expense, sometimes you just have to liquidate that asset and realize that this asset has expenses that my IRA just can't afford.
Obviously, it's one of those things that you do these types of things, because maybe you don't want to be in the landlord space. You want to just let that take care of itself. Now, what about syndication of funds? How does that work with self directed IRAs? Syndications are our number one asset class for our industry.
Just as long as I've been in the industry, it's been the number one asset class. A syndication, in case someone doesn't know, is really an agreement. It's a contract.
It's approved by the Securities and Exchange Commission, gives an asset sponsor permission to raise capital. That's really what a syndication is. Now, as an investor, and your IRA is an investor, can utilize the structure to be usually an equity partner in someone's deal.
That's a syndication. There's the deal up here in the structure in the contract, but really the underlying asset is also something to underwrite. You want to underwrite the asset sponsor and check them out.
You want to really, really understand what the underlying asset is. If it's a multifamily building, if it's attractive single family homes, whatever it is, what risk are you taking on with that asset? Again, syndications are the way people get into deals, but it really doesn't describe the asset class itself. Typically, syndications are for real estate in some form, though.
We have a couple folks in the DBL Capital Fund that are using their self-directed IRA. That's something that they could do too. Can you talk about that a little bit? Sure.
It's very easy to do. Again, once you've done your due diligence, you've chosen your asset. You fill out an application on our website.
It takes 10 minutes. You complete a digital app. Then you provide the information on where your funds are now.
Is it in an IRA? If it is, we can do an IRA to IRA transfer for you. It's very quick. If it's in a previous employer plan, that has a couple extra steps.
That process could take maybe two weeks before your money is in your account and ready to execute out into a deal. You open it, you fund it, and then you invest. You give us the investment documents.
We review them just to make sure, for example, that they're titled correctly. We're looking to see that the IRA is actually receiving an asset in exchange for the funds disbursed, that kind of thing. We're not saying if it's a good or bad deal or approving that deal, but we're reviewing it in this way.
With your written permission, we'll disburse money. Now your IRA is invested. Now you've self-directed and your IRA owns that asset.
Again, all expenses of the asset have to be paid by the IRA. That's very important to know. Now you talked about a little bit.
Your IRA can partner with people and entities? Yes. Yes, it can. It's very simple.
It is self-directed, so it's less formal, but you come up with an agreement between parties that, hey, we're going to do this. I'm not talking necessarily about a joint venture. I'll just say a joint venture isn't an asset.
You can't invest in a joint venture. You come up with the terms between the parties privately, and then you've got those terms agreed to. Now you're going to partner.
You can do that. But it can't be me? It's not yourself. It's not you.
Wow, I had this conversation the other day with somebody. Some self-directed IRA companies will say you can partner with yourself. Some people really say that.
I think, huh, okay, I've been audited. I don't know about you. But when I was audited, if I sat in front of that auditor and I had to prove that I had no personal benefit from my IRA owned asset, and I partnered in my own deal, I would have a tough time proving that because I did have personal benefit.
Now, there is a revenue ruling, I think it's 2000-10, that says there are certain circumstances in which it's allowed. So there is a small loophole where you could invest with yourself using 2000-10. Okay, well, then let's talk about who your IRA can do business with.
What counts as a disqualified person? Right. Think of it this way, simply that if you passed away, who would inherit your estate? If you passed away, no will, who would get your estate? It would be your spouse. Children and grandchildren, parents and grandparents, and that sort of thing.
So those people are disallowed. But also, it would also be, for example, a fiduciary to the deal. Or it would also be a 50-50 business partner would be also considered disallowed people.
So your IRA does not benefit disallowed people. And that's who they are. Again, you and your spouse, children and grandchildren.
But nieces and nephews, brothers and sisters, they're okay. Just so you know. Okay.
What are the biggest mistakes that real estate investors make when they're first starting to direct what they're self-directed? They don't do their due diligence. They don't read the docs. I mean, now, this isn't how it was when we started, Joey.
Now you can put that deal into chat GPT and say, Hey, you tell me about this. And you can also use, is it AI or is it SI? Superintelligence? You tell me. Well, I think that's super sometimes.
I'll give you that. I'll tell you that. Well, whatever it is, you can say, Hey, does this person have any black marks on their criminal record? Do they have a criminal record? But you also want to do things that you can't do on your computer.
And that's talk to people who have already done business with that person. Did they pay as agreed? That isn't always a firm foundation for like, total, you know, a total clear to close thing where you know, you're not going to have any problems. Because people will be people.
Due diligence is a big deal. But make sure you understand the deal, understand the terms, understand what to expect as far as a return of capital. And really, really do your homework first.
Because if that money is valuable to you, it's then your time should be equally as valuable the time that you take or you should invest that time to do your due diligence and make sure you really know the deal, know the asset sponsor, know the underlying asset. Well, that probably goes doubly for partnering with people, right? Oh, my gosh, doesn't it? Yeah, no partners never had a problem ever. Ever, ever.
All right, let me throw let me throw a curveball at you. All right. What if my self directed IRA owns a vacation rental? Can I stay and pay the rent? No, because you're disallowed to your IRA.
You're a disallowed person. So that's pretty easy. All right.
So what is the craziest thing that somebody has tried to do with their self directed IRA? Oh, man, you know, I did a podcast and I told the story. And he clipped it into some reels, right? It got 9 million views. Well, now I need to hear this.
You need to hear this. That is that we had someone well, this was, you know, this is pre you direct, you know, back in those days, okay, where someone, a young guy took his Roth IRA and invested in Super Bowl tickets. All right, now let's think about that.
Huh? What's that? So the IRS says that your IRA can invest in anything except life insurance contracts and collectibles. Okay, so that's one barrier to get across. The other one is, were these tickets collectibles? No, they were not.
They're just blank, you know, plain tickets. Anyone who bought a ticket could have would have bought the same similar sort of ticket was an embossed or whatever, or especially. And was this Roth account holder? Was he in the business or trade of selling tickets? No, he was not.
So with all those barriers cleared, this young man invested in these Super Bowl tickets with his Roth IRA, sold them at a profit, that profit went back into his Roth IRA, and assuming he gets to 59 and a half, and then the money will come out tax free. Wow, boom, that's crazy. And when I this it taught me do not read the comments when you when you get not because people don't know self directed IRAs to begin with.
And oh, this lady is crazy. She doesn't know what she's talking about. And it's like, huh, I kind of do, you know, I kind of, you know, let's just it's just a shameless plug wrote a book, you know.
So it doesn't make me perfect. I find that I'm I fall short of perfection. But it does mean I did write a book for bigger pockets called the self directed IRA guidebook.
So yeah, well, we'll link it in the in the in the show notes for sure. I'm having fun with you, Joey. This is fun.
Yes. So you touched on the UDFI. What's the other the other acronym that we always talk about when we talk about self directed UBIT? So can you explain that a little bit? Yeah, they're kind of twin taxes for the rulebook people who are listening and you know, you have they just they're ready to make a note here.
So jot this down. It's the it's the IRS website irs.gov and look up publication 598 just type pub pub 598 and it will tell you about UBIT and UDFI. They're both tied to the trust rate.
It's like what is the rate on the tax? It varies. So this is a good thing to discuss with your tax professional. UBIT is unrelated business income tax UDFI is unrelated debt financed income tax.
So for example, if your IRA were to invest in an active business that could throw off this unrelated business income tax to your IRA. And so you would file your IRA would file a form called a 990 t like you when you and I do our taxes, we file a 1040, right? But when an IRA files its taxes, it's a 990 t because it's a tax exempt entity. So the IRA would file a 990 t and then pay whatever, you know, UDFI taxes were owed out of the pro yet of that, you know, the money already in the account.
But it's it's when your IRA invests and their proceeds due to active income of the business. Okay. Well, let's talk about Roth versus traditional for real estate investors.
Where does it make sense to convert and pay the tax now? Right. So when you're converting from a pre tax to a Roth account, obviously, tax free money is the brass ring, isn't it in retirement, you want to retire and not worry about it. So a couple of things, you want to take a look at your tax return and did you if you have a down year, that's not tax advice.
It's just a fact. But if you if you have a year when you're not when you're not going to be in a super high tax bracket, that might be a good time to do a Roth conversion at a lower tax rate. That's, you know, maybe you take a hit on one side, but hey, hey, it's here's the good news, the shining, you know, the shining silver lining.
Thank you. Silver lining. Yeah.
The silver lining is that I could do Roth conversion. Hey, let's look on the bright side. And you won't be taxed at the same rate.
So yeah. What are the contribution limits this year? Yeah, I mean, if you for example, like a traditional IRA, it's $7,500 if you are under 50, okay, 49 and younger. But if you are older, if you're 50 plus, it used to be $1,000 catch up contribution.
Now it's $1,100. So they changed that to that increased. So if you're 50 plus it is now $8,600 that you can contribute to a traditional or Roth.
Now say you have a traditional and a Roth that say $7,500 is for both combined. It's not 7575. It's it's it's a combined contribution.
You could split it, but the total can't equal more than $7,500 between your Roth and your trad. That wraps up the first half of our conversation with Karin Hall. We'll be back next week for part two.
Thanks for listening to the Norris Group Real Estate. For more information on hard money loans, trusteed investing and upcoming events with the Norris Group, check out thenorrisgroup.com. For more information on passive investing through the DBL Capital Real Estate Investment Fund, please visit dblcapital.com. The Norris Group originates and services loans in California and Florida under the California DRE license 01219911 Florida mortgage lender license 1577 and NMLS license 1623669. For more information on hard money lending, go to the
