Prohibited Transactions: What Investors Can (And Must NOT) Do

What are prohibited transactions?

If you don’t know, and you’re the owner of a self-directed (or “Solo”) 401(k) or self-directed (Solo) Roth IRA, you could end up in serious legal trouble.

In short, a "disqualified" person is anyone who directly benefits from any activity that occurs inside of a self-directed retirement account.

The Self-Directed IRA and Self-Directed 401(k) have become popular instruments for buying real estate over the past decade, because they allow “alternative” investments. With this growing popularity, there is a growing risk that the IRS will increase its enforcement of “prohibited transactions.”

In order to help you avoid accidentally making a prohibited transaction, in this article, we’re going to define some key terms that you need to know in order to get a solid grasp on the concept, outline common prohibited transactions, go over the four different types of prohibited transactions, and give you some tips on how to better protect your assets.

If you want to see our library of articles about these two self-directed retirement plans (note: they are not simply for retirement... they're also great vehicles for tax-free investing), click the links below to get our content hubs:

Terms to Know: Solo 401(k)/IRA, Disqualified Person, Prohibited Transaction

We’ll need to define a few terms first. Prohibited transactions are exactly what they sound like: transactions that aren’t allowed by the IRS. But for our purposes, “prohibited transactions” occur in a very specific context, and to explain that context, we need to go over some common definitions:

Solo 401(k) or Solo Roth IRA: essentially, this is a retirement account that grants you a little bit more freedom. Using a self-directed retirement account, you can invest in alternative assets like real estate, debt, vacant land, gold, silver, cryptocurrencies, and more. If you’re interested in setting up a Solo 401k, click the link to learn more.
Disqualified person: a disqualified person is anyone who benefits from the self-directed account. The IRS doesn’t want investors to use Solo 401(k)s and Solo Roth IRAs to avoid paying taxes. Both of the accounts are heavily tax-advantaged, and it wouldn’t be fair for someone to open a self-directed account to buy a beach-front vacation home tax-free. Unless that vacation home is a rental that isn’t used by any of the disqualified persons, which include the account owner (you, if you opened the self-directed account), the owner’s family members and friends, the custodian/manager of the account, a business entity you own, and more.
Prohibited Transactions: finally, prohibited transactions are any transactions that occur inside of the self-directed IRA that benefits disqualified persons. It’s very important to keep these funds separate from any personal funds. If you used a self-directed account to help you buy your nephew a new car, for example, you just engaged in a prohibited transaction. Sometimes they’re obvious; sometimes they’re not.

You might be thinking: If prohibited transactions include anything that directly benefits the account holder and his/her family, why would you ever open a self-directed account in the first place?

Well, just because you can’t buy assets that directly benefit you doesn’t mean that the assets never benefit you. You can still buy assets that make you a lot of money inside of the account.

It’s the difference between buying shares of a company and buying shares of your own company. Both can be wildly profitable, but only one benefits you directly.

Types of Prohibited Transactions

In general, there are four types of prohibited transactions. In this article, we already provided examples of a couple of them.

Direct Prohibited Transactions: any sort of transaction that directly benefits a disqualified person. If Tom uses his self-directed account to purchase a classic car for his son, that’s a direct prohibited transaction.

Indirect Prohibited Transactions: these are a bit trickier, but the gist of an indirect prohibited transaction is that the IRA or 401(k) owner takes multiple steps to avoid a direct prohibited transaction, while the outcome is largely the same as a direct prohibited transaction. For example, let’s imagine Tom from the above scenario really wants to get his son that classic car, so he loans funds to an acquaintance who ends up buying Tom’s son the car as a “gift.”

Self-Dealing Prohibited Transactions: if you use your funds to buy yourself a vacation home or primary residence, you’re self-dealing.

Conflict of Interest: this often coincides with self-dealing. If you loan money to a business entity that you own, this could be considered a conflict of interest.

What are Some of the Most Common Prohibited Transactions?

With that said, how do most people end up getting in trouble? It’s probably not how you might think.

You can’t be directly involved in the investments you make using a self-directed Roth IRA in any way, and that can lead to some confusing scenarios. Additionally, the money that you use to maintain the investment needs to come from inside the account.

That means the most common prohibited transactions are mistakes—not intentional fraud.

For example, if you buy a rental property with a self-directed account, you can’t go to that property to make repairs. You need to hire outside help to fix anything that may be broken, no matter how tempting it is to make the repairs yourself. And, when you’re paying for that outside help, you can’t use your personal savings. If you do, that’s a prohibited transaction.

Interested in learning more? Check out our related articles:

How Can You Avoid Making a Prohibited Transaction?

In order to avoid making a prohibited transaction and incurring penalties and fines, ask yourself two simple questions:

Outside of my account, do I personally benefit from making this investment?
Do any of my family members, friends, associates, or business entities personally benefit?

If the answer is "yes", you’re likely making a prohibited transaction.

IRS rules are difficult, and it can be nearly impossible to get a grasp on all of them.

If you want to make sure your real estate investing business is protected, start with our investor quiz and we'll help you find ways to protect your assets.

Is an LLC Structure Important for Real Estate Agents?

One of the first decisions you have to make as a small business owner (and yes, a real estate agent is a small business owner!) is how to structure your new venture.

A business structure dictates how you operate, the tax guidelines you have to follow, and what kind of legal protection you have if problems arise; therefore, it is vital that you choose the right type of structure for your business.

When you start your own real estate investment company as a real estate agent, it is doubly important that you protect your assets with the right business structure. Due to the nature of the business, it is essential that you are protected from potential consequences of litigation. Dig deeper into why an LLC structure for real estate agents is important and how Royal Legal Solutions can set you up for success.

What is an LLC?

A Limited Liability Company (LLC) is a type of business structure that protects its owners from losing personal assets if the company is sued. An LLC also offers tax advantages that differ from a Sole Proprietorship or more complex corporations.

As a business structure, LLCs are typically used by small business owners who want to limit their personal liability. This includes Realtors/real estate agents.

Is a Real Estate Agent Considered a Small Business Owner?

Real estate agents who also invest in real estate are considered small business owners. According to the IRS, real estate agents are treated as self-employed and considered a small business owner if they:

are not someone's employee
haven't formed a partnership with anyone
have not incorporated their business

If you work for yourself and file a 1099, you are considered a self-employed independent contractor in the eyes of the IRS.

What is the Best Business Structure for a Real Estate Agent?

The short version? The best business structure for real estate agents who own a real estate investment business is an LLC.

An LLC structure for real estate agents provides several benefits to real estate agent investors over other business structures. Among them:

Benefit #1: It Protects Assets

Protecting your personal assets is one of the biggest benefits of structuring your business as an LLC. If you are sued, your brokerage insurance may not cover the damages. If you operate as a sole proprietor, every single asset you own can be liquidated in a lawsuit.

When you structure as an LLC, however, your personal assets are protected. You would simply liquidate the LLC and start a new company. This is why an LLC is so important for real estate investors.

Benefit #2: It Saves Taxes

As an independent contractor, you are subject to the self-employment tax for independent contractors. The good news is that when you form an LLC and work with a knowledgeable legal real estate firm, you can choose to have your LLC taxed as a different type of entity.

An LLC is a legal designation rather than a tax designation; therefore, you can still be taxed as an S Corporation. S Corporations are not subject to the self-employment tax, which covers medicare and social security, that independent contractors have to pay, which benefits you.

Benefit #3: Self-Directed Retirement Accounts

When you structure as an LLC, you can use your LLC to start a Solo 401(k). With this account, you can buy tax-free investments, become a hard money lender and earn a high-interest rate on the money you loan. You can also loan money back to your LLC if needed.

Benefit #4: Professionalism

An LLC operates as the face of your business. When you're talking with clients about potential investment properties, speaking on behalf of a business organization rather than your personal name goes a long way. This lends a sense of professionalism and trust to those you work with in the real estate investment industry.

Work With a Legal Real Estate Team

As a real estate agent, you might not have considered the need for a corporate structure. But did you know 80% of real estate investors will be sued in their lifetime?

Are you prepared?

Don't let a frivolous lawsuit destroy your future. The correct LLC structure covers you in case your broker's insurance decides to leave you hanging. The right structure might be the difference between losing it all or just losing your LLC.

In the video below, Scott Smith, founder of Royal Legal Solutions, explains the best structure for real estate agents to pay fewer taxes through multiple tax strategies and shield themselves from litigation when deals go south.

When you work with a legal real estate team like Royal Legal Solutions, you set yourself up for success. You’ll learn how to maintain your LLC corporate structure to avoid losing your business. You'll benefit from our team’s expertise on asset protection structures that will protect your personal assets and build a wall of defense if a lawsuit happens.

Additionally, Royal Legal Solutions can help you work around the single-member LLC self-employment tax so your income is considered passive and you retain the financial benefits.

Protect Your Assets With Royal Legal Solutions

If you are a real estate agent who owns your own real estate investing company, ensure that you are protected from personal liability. Work with Royal Legal Solutions to structure your business as an LLC to avoid personal liability and gain the tax benefits of operating as a Limited Liability Company.

Want to make sure your real estate investing business is protected? Start with our investor quiz, and we'll help you find ways to protect your assets.

Realtor photo by Kindel Media from Pexels

Tax-Free Real Estate Investing: How To Get Started

Scott Smith, Royal Legal’s founder, and lead attorney, recently sat down with real estate investor J. Darrin Gross to discuss tax-free investing on Gross’s Commercial Real Estate Pro Network Podcast.

The delightful discussion covered not only the possibilities of tax-free investing in real estate but also how real estate investors can protect their assets. You can click the link above to listen or read on to learn more.

Tax-Free Investing vs. Tax-Deferred Investing

“Tax-free” investing is better thought of as “tax-deferred investing.” Whether you invest in a traditional 401(k) that taxes withdrawals or a Self-Directed Roth IRA, which taxes funds before use, the tax doesn’t just disappear. It’s a question of when the tax is paid.

You can accelerate the growth of your retirement account using either a Solo 401(k) or a Self-Directed IRA. In a nutshell, with tax-deferred real estate investing, you lend yourself money from your own Solo 401(k) that doesn’t have to be repaid until you retire.

How does this work in terms of W2 income?

Anyone with a W2 (employer) income can create their own 401(k) or IRA account. But with non-W2 income, one can take advantage of creating a Solo 401(k) that allows you to defer taxes.

What is a Solo 401(k)?

If you have non-W2 earnings and can demonstrate that you’re an “active” investor, you may qualify for a Solo 401(k). If you structure an entity properly and demonstrate that you are active in its operations, multiple advantages become available. You have to be able to deposit up to $50,000 annually and be in a position to borrow up to 50% of that balance without creating a taxable event. Royal Legal Solutions helps clients set up a Solo 401(k) to run themselves.

What is the advantage of a Solo 401(k)?

The advantage is that you only have to pay it back by the time you retire. So, for example, you can take $50,000 and put it into your 401(k) tax-free and loan yourself $25,000 of that to invest in anything you want.

You still owe that money back to your 401(k), but you don’t need to pay it off until you retire. In the meantime, you’ve got $25,000 in tax-free money in your Solo 401(k) that you can invest immediately.

Does passive real estate qualify?

No, it’s not legal to set up a Solo 401(k) with passive income. But you can open up your own property management company. Doing this turns passive income into active income.

Setting up a property management company for a Solo 401(k)

You can establish an S Corporation to be your property management company. As the sole employee of that S Corporation, you can then set up a Solo 401(k). There are a few inexpensive legal steps to this process, and Royal Legal Solutions can help set up a Solo 401(k) for you.

Do I need to be a real estate professional to have a Solo 401(k)?

No, you just need to be earning active income. The income cannot be classified as passive. But passive income is easily converted into active income by setting up a real estate company, which can then be used to establish your Solo 401(k). The restrictions are light - you just have to be the sole employee of your own company to meet the conditions of a Solo 401(k).

Once you have set up the company, you can channel $50,000 per annum of non-W2 income into the company. That amount pays into the Solo 401(k) up to the $50,000 mark, and all of that is tax-free for now.

The advantage of investing with pre-tax dollars instead of post-tax dollars can typically be a 20-30% bump, and that’s where the actual returns are. You get a pretty significant increase in your investment amount this way, without much risk.

Should I invest with a Self-Directed IRA?

Income from a Self-Directed IRA LLC is also tax-deferred, meaning real estate investments can be made tax-free. The tax is paid later instead of paying tax on the returns of a real estate investment. This allows investors to select the assets they want to invest in, except for “prohibited transactions,” such as collectibles and life insurance.

Tax-Deferred Investing: The Takeaway

Tax-deferred investing is important to real estate investors because it allows them the available funds to buy property from their own Solo 401(k) without paying back a loan to a bank or other financial institution. Essentially, you owe the money you’ve borrowed back to your retirement account, in effect turning yourself into your bank. The difference is that you are an active business, not a passive generator of income.

If you start with tax-deferred investing in your 30s and you don’t have to pay the loan you took from yourself back for another 35 years, your wealth curve will likely have been on an upper trajectory, making it easier to pay the loan back at retirement. Having money available makes a real difference to your ability to invest in real estate today for profit in the future. Unlike using a credit card, the debt here makes more money in the short term, which will pay down later debts more quickly.

Royal Legal Solutions: Helping You Grow Investments Tax-Free

Royal Legal Solutions has tax-saving strategies for everyday real estate investors. Royal Legal Solutions can help you form a legitimate strategy to protect assets. If you are a real estate investor anywhere in the United States and want to learn more about tax-free investing and tax-deferred investments, start with our investor quiz, and we'll help! We are the one-stop shop for tax, legal, and business advice for real estate investors everywhere.

Living Trust or Last Will and Testament: Which is Better for Real Estate Investors?

Estate planning should be on any investor’s “to-do” list, especially the real estate investor. The steps you take now can ensure that your investments will be passed to your family members and chosen heirs according to your wishes—not how the probate court decides.

In this article, we'll examine the living trust and the will, explain their similarities and differences, and offer our recommendations for how you can combine the best of both tools.

How does a living trust work for the real estate investor?

When you form a living trust, you (the grantor) transfer the ownership of your assets (your property) to a special fund called a trust.

You name a responsible person (the trustee) to manage the trust and make sure your wishes are followed after your passing. The trustee can be a relative or a professional from a financial institution. From that point on, the trust owns the property – not you -- a fact that allows for the privacy of both you and your heirs.

A significant advantage of a living trust is that, unlike a will, it allows for the control of your assets to pass to your designated heirs without getting tied up in probate court. Another benefit is that the trust keeps the real estate value out of the taxable portion of your estate.

Other benefits of living trusts are that they are easier to modify and more difficult to challenge than wills.

A disadvantage of a living trust is that it can be complicated and expensive to set up, and it needs competent ongoing management. The cost to set up a living trust depends on the state you live in, the type of trust, and how complex the legal document needs to be.

How does a will fit into REI estate planning?

A will (often called a last will and testament) is a written document in which you name your minor children's guardians and bequeath your belongings and financial assets to individuals or charitable organizations. A will also can stipulate how you want your funeral or memorial service to be held. Whereas a trust becomes active as soon as you create it, a will becomes active upon your death.

All wills must go through probate, a legal process in which the court examines the documents. The probate process can be lengthy, especially if family members contest (object to) the will. As we have explained, trusts are difficult to contest, and they do not go through probate after the grantor's death.

It is wise to name an executor of your will. This trusted individual will know where your will is located and will have access to your personal and financial records after your death. Without an executor, a will is still valid, but without one, it's possible that the document might not be discovered after your death.

If you die intestate (without a will), your estate will be distributed according to your state's regulations. The state will name a personal representative (usually a surviving spouse or the oldest child) to distribute your assets, but the process takes time. Until then, your assets will be frozen.

An advantage of a will is that it can be easy and inexpensive to write -- especially with the many online tools that are available. However, your heirs may pay for your savings later by having to hire a probate lawyer.

Living Trust or Last Will and Testament: Which is Better for Real Estate Investors?

Your final piece of real estate ...

Get the best of both tools with a pour-over will and living trust

Having both a will and a living trust is a powerful way to gain peace of mind for both you and your family.

We recommend that real estate investors have the best of both estate planning tools -- a living trust and a traditional will – by creating a pour-over will along with a living trust.

A pour-over will names your trust as the beneficiary of any property that it does not already hold. Why would this feature be important? Let's say you have neglected to place your new vacation home or other valuable investment property into your trust.

State regulations vary but, without a pour-over will, that real estate might go to an estranged relative rather than to the heir of your choosing.

No one likes to think about their own passing. But the reality is that anyone who is buying and selling property needs to consider an estate plan in a practical, deliberate manner.

We recommend that you evaluate and update your trust documents at least once a year. As long as you remain mentally competent, you can change a revocable living trust at any time. You can fund new property purchases and add the beneficiaries you want to receive any new assets, allowing for a smooth transition.

Rest assured that if you haven't worked out these estate transfer details, your state and the federal government will work them out for you after your death.

You've worked hard to build up your portfolio. We know you want your real estate investments to benefit the people you love. Making an estate plan a priority now can save time, stress, and financial worry later for your loved ones.

Photo by Mike from Pexels

Does Your Real Estate Business Need An Employer Identification Number (EIN)?

Launching a new real estate business is an exciting and rewarding way to build your path to financial freedom.

However, as with any business, you have to pay taxes (womp womp).

And a primary way that state and federal governments keep track of what you owe in taxes is with identification numbers.

One of the first questions you'll encounter when registering your business involves your Employer Identification Number (EIN). In this article, we'll discuss what an EIN is and help you decide if you need to apply for one.

What is an EIN?

An Employer Identification Number—abbreviated on forms as EIN—is a nine-digit number that the IRS assigns and uses to identify businesses and individuals for taxation. An EIN is also known as a Federal Tax Identification Number.

As an individual taxpayer, you identify yourself with your Social Security Number (SSN). However, as the owner of most business entities, you need an EIN to apply for your business license and file your tax returns.

That's right; we said "most" business entities. If your real estate business is a sole proprietorship or single-member LLC, you can use your SSN to file your taxes.

On the other hand, the IRS requires your business to have an EIN if you do any of the following:

hire employees
operate your business as a corporation or a partnership
have a solo 401(k) or Keogh retirement plan
file for bankruptcy
buy or inherit an existing business and plan to operate it as a sole proprietorship
file alcohol, tobacco, and firearms; employment; or excise on your tax returns
withhold taxes on income (other than standard wages) paid to a non-U.S. resident

However, even if the IRS does not require your business to have EIN, many investors apply for one anyway.

Why? As you can see from the above list, having an EIN allows you to make more business moves than you are able to make as a sole proprietor. Some banks will even refuse to allow you to establish a business account or apply for business loans or credit cards without an EIN.

Some investors also feel that using an EIN can make your real estate business look more professional in business dealings. In a competitive real estate environment, an EIN can show that you take your new business seriously.

Also, using an EIN allows you to keep your SSN more secure from identity theft. For example, identity thieves can use stolen SSNs to file fraudulent tax returns. All business EINs are considered public information, but if someone looks for credit information, your EIN will be the only identification number they will find.

Does a general partnership need an EIN?

Although your general partnership may appear to be a simple agreement between two or more business partners, the IRS sees it as a separate business entity. Therefore, all partnerships—including general and limited partnerships—must have a separate tax identification number.

This requirement remains true even if your partnership has no employees. In addition, all partners must report their profits and losses on a Schedule K-1 when they file their personal income taxes.

Does a sole proprietorship need an EIN?

If you have a sole proprietorship with no employees, you may be able to file your business income taxes along with your personal tax return. You will use your SSN as your business taxpayer ID on your tax forms.

However, an EIN for a sole proprietorship is needed when you do any of the following:

change your business to a corporation
form a partnership
form an LLC
revise your LLC to be taxed as a corporation or S corporation
buy or inherit an existing business
begin bankruptcy procedures

How do you obtain an EIN?

Fortunately, unlike many aspects of launching a new real estate business, applying for an EIN is easy, and it's free.

The quickest way to apply online, using the IRS EIN Assistant tool. The process takes less than 10 minutes, and you will receive your new number immediately upon completion.

If you'd rather go the old-school route, you can download Form SS-4 and send it by U.S. mail to the IRS. The processing time for an EIN application received by mail is four to five weeks, according to the IRS website. Please note: The IRS warns business owners to beware of fraudulent online services that offer to apply for an EIN for you.

What if you already have an EIN?

If you already have an EIN and your business goes through some standard changes, you may be able to keep your old EIN. For example, if you change your business name or move to a different address, you can continue to use the same EIN.

However, you'll need to apply for a new number if the ownership or structure of your real estate business changes down the line.

Alternative Investments: The Hidden Path to Huge Tax Savings

For decades, many people have thought they could only invest their retirement accounts on Wall Street.

Most Wall Street IRA custodians only allow you to invest in stocks, bonds, annuities, mutual funds, and CDs. The problem is that these traditional investments only make up a fraction of the profitable assets you can purchase for investment purposes.

But with a Self-Directed IRA, you can move beyond Wall Street and use your IRA funds to make self-directed investments in the “alternative investments” of your choice. Real estate is the most popular alternative investment people make with self-directed IRA funds.

You can use IRA funds to buy commercial and residential real estate, including houses, duplexes, condos, office buildings, shopping centers, mobile home parks, factories, and raw land. This article will explain alternative investments, their different types, and how they can provide you with significant savings at tax time.

What are alternative investments?

An alternative investment is an asset that falls outside the traditional categories of stocks, bonds, and currencies.

Since they are not tied to Wall Street, alternative investments can help diversify your portfolio and enhance your returns. Since many types of these investments are connected with the stock market, they can help investors achieve their long-term financial objectives, even during times of uncertainty in the market.

Alternative investments typically cover a wide range of strategies. However, most of these assets have the following characteristics:

Low correlation to traditional stocks and bonds
Higher return potential than traditional investments
Higher minimum investment requirements
More complex structures
Unique risk profiles
Unregulated by the Securities and Exchange Commission (SEC)

Alternative investments are not for everyone. For instance, they usually offer less liquidity than traditional investments. Many of these non-traditional assets require buyers to lock up their money for five or even 10 years.

What are the types of alternative investments?

Alternative investments can include both public and private assets. Here are some of the categories an investor may consider:

Real estate -- Real estate is the most common type of alternative investment. In addition to office buildings and farmland, however, the real estate category can include intellectual property, including inventions and artwork. The goal for the investor is to understand the long-term value of the asset.

Private equity -- This broad category includes investments in companies not listed on a public exchange. These assets can involve the following:

venture capital
growth capital
buyouts

Private debt -- Private debt involves investments that are not financed by banks or traded on the open market. It’s important to understand that the term “private” in this case refers to the investment instrument itself since both public and private companies can borrow funds via private debt.

Hedge funds – A hedge fund is an investment partnership. Hedge fund managers use a range of techniques – including leverage, short selling, and derivatives -- with the goal of generating a consistent level of return, regardless of what is happening on Wall Street.

Commodities and futures -- These assets include natural resources (such as oil and gas), agricultural products (such as corn and soybeans), and precious and industrial metals (such as gold and silver). The value of these assets follows changes with supply and demand.

Structured products -- Structured products are financial instruments with a value linked to that of an underlying asset, product, or index. Examples include:

market indices
individual or baskets of stocks, bonds, and commodities
currencies
interest rates
combination of the above

Collectibles – Although this type of investing may sound fun, it can be quite risky. Many experts warn that only true experts in the collected item, which can range from wine to action figures, should expect a sizable return on their investment.

What are the Tax Implications for Alternative Investments?

In addition to the diversity they offer your portfolio, alternative investments can also provide tax advantages.

The primary tax benefits of these assets are pass-through depreciation and long-term capital gains treatment. For example, many real estate funds deduct depreciation expenses from your net income, thereby reducing your taxable income.

Also, as longer-term investments, alternative assets may hedge against short-term capital gains taxes.

How to Use Your IRA or 401(k) to Invest in Real Estate

Did you know that you can invest in private alternative investments with qualified retirement funds, such as a 401(k) or IRA?

Most Wall Street IRA custodians allow you to invest only in traditional structures, such as stocks, bonds, mutual funds, annuities, and CDs. However, there are many reasons to form a Self-Directed IRA. Primary among them is that the structure allows you to use your IRA funds to invest in the alternative assets of your choice.

A Self-Directed IRA gives you complete control over your retirement assets. You can use a Self-Directed IRA LLC to make almost any type of investment. For example, the IRS permits using your Self-Directed IRA bank account to buy raw land real estate.

The advantage here is that taxes are deferred on all gains until a distribution takes place. (Before tax 401k distributions are not required until you reach the age of 70 and a half). And, with a Roth Self-Directed IRA, your gains become tax-exempt.

Be aware that the IRS has strict rules on these investments. It’s essential to keep good records of all income and expenses generated by your real estate investments. All income, gains, or losses from the investment needs to be allocated to the IRA.

To get the most out of your investment and avoid any tax issues, you should consider a Self-Directed IRA custodian. An IRA custodian is a financial institution that holds your account and makes sure that it adheres to all IRS and government regulations.

Finally, while most investors access alternative assets through their financial advisor or financial institution, there is a growing number of digital platforms that offer ways to buy them directly. If you are new to investing, we recommend working with a professional who understands the benefits and challenges of these non-traditional purchases.

Keep more of your money with a Royal Tax Review

Find out about the tax savings strategies that you can implement as a real estate investor or entrepreneur by taking our Tax Discovery quiz. We'll use this information to prepare to have a productive conversation. At the end of the quiz, you'll have an opportunity to schedule your consultation. TAKE THE TAX DISCOVERY QUIZ

S Corp Distributions: The Nitty-Gritty

The sad truth is that every year, we have to file and pay our taxes.

While it definitely is a pain in the neck, it can also be an opportunity to evaluate your financial progress for the year. The goal for taxes is almost always to maximize your deductions while minimizing taxes, but often this is easier said than done.

One way savvy real estate investors can reduce their tax bills without running afoul of the IRS is by paying themselves as much as possible through S Corp distributions. If you want to learn more about the nitty and the gritty of S Corp distributions, read on.

Why Real Estate Investors Love S Corps

S Corps are considered a “pass-through” entity for tax purposes. This means that the business is not required to pay corporate income taxes. Rather, the profits and losses for the business are distributed to the owners and reported as their personal income.

This is a tremendous advantage over C Corps, which is the default tax status for a corporation. Any income that a C Corp makes is double-taxed: once at the corporate level and again on the individual owner’s income tax return. Designating your business as an S Corps allows your company’s profit to only be taxed once.

You can also use an S Corp to reduce the burden of payroll and self-employment taxes. We’ll get more into this in a little bit. For now, just know that real estate investors often take advantage of these S Corp tax benefits.

However, S Corps will not be suitable for every investor. Due to the costs associated with an S Corp, it usually only makes sense for investors who are earning at least $50,000 annually from their business. If you’re making less than that, the costs of setting up and maintaining an S Corp will probably outweigh your tax savings. Talk to your CPA or a business lawyer to learn whether an S Corp can work for you. Or you can fill out our quick investor quiz and get the help you need.

What Is An S Corp Distribution?

If you’ve never heard of an S Corp distribution before, prepare to meet your new best friend! An S Corp distribution is your proportional share of the S Corps earnings for the year, based on the number of shares you own. It’s the best way to take money out of an S Corp.

If you’re the sole owner of your S Corp, you’ll just get 100% of the income. But if there are multiple shareholders, the earnings will be distributed on a per-share basis. The total earnings will be divided by the number of shares, and each shareholder will receive the same amount per share. So, while the shareholders might not all receive the same total amount, they must each receive an equal per-share payout.

For example, say an S Corp has issued 100 shares as follows:

Ross owns 35 shares
Rachel owns 25 shares
Monica owns 20 shares
Chandler owns 10 shares
Phoebe and Joey own 5 shares each

So, if the business made a profit of $1 million, this is how the dividends would be distributed:

$350,000 to Ross
$250,000 to Rachel
$200,000 to Monica
$100,000 to Chandler
$50,000 each to Phoebe and Joey

Limitations On Distributions

What’s great about distributions is that it’s considered “passive” income, which isn’t subject to payroll taxes. However, the IRS won’t let you skip out on payroll taxes altogether.

Before you can receive any distributions, you’ll have to pay yourself a “reasonable” salary for your contributions to the business. The secret to maximizing your tax savings is to pay yourself the lowest reasonable salary possible and taking the rest of the profits as a distribution.

The IRS doesn’t provide any direct guidelines for how to determine if your salary is reasonable, but some factors to consider include:

Your training, education, and experience
How much work you did
What kind of work you did
How much time and effort you spent
Historical distribution amounts
Market rates for similar work

If you set your salary too low, the IRS might reclassify some of your distributions as salary, which can lead to penalties and additional taxes. The best way to avoid scrutiny is to consult with your CPA or attorney before setting your salary.

Property Transfer Services: How One-Stop Shops Save Investors Money

Real estate investors are always looking for ways to minimize risk while maximizing profit.

One way that they can do this is to transfer title to their property from their personal name to protect themselves.

A property transfer service helps real estate investors move their properties into corporate structures (such as a Series LLC or a Land Trust) to protect assets from lawsuits and other creditors. These legal structures separate your assets and preserve your anonymity, making you look like less of a target for would-be litigants.

What Exactly Do Property Transfer Services Do?

While the process for property transfers is not incredibly elaborate, there are various steps and costs associated with transferring the title to real property. A one-stop-shop property transfer service takes care of everything you need to do to transfer your real estate, saving you time and money.

Bundling these services provides you with the convenience of only needing to find, vet, and transact with one business when securing your assets from unnecessary liability. And perhaps more importantly, these packaged services save investors money. You can always order each of the services “a la carte,” but a property transfer bundle saves money and dramatically simplifies the process.

Transferring Property Into A Series LLC/Land Trust Combo

We recommend using a Series LLC in conjunction with an anonymous Land Trust to secure maximum asset protection. When set up correctly, this combo will hide and protect your assets from potential lawsuit plaintiffs.

To pull this off, you’ll need several different services to be completed:

Drafting a deed
Forming an Anonymous Land Trust
Drafting a Series Document
Drafting a Series Operating Agreement

Drafting A Deed

First, in order to transfer property, you must have a properly drafted deed. A deed is a legal document used to transfer ownership of real property from one person to another. In this case, the deed must transfer title from your name to a Series LLC. For your Series LLC to give you the most protection possible, you must have a properly drafted deed that is correctly transferred into the Series LLC structure.

Creating A Series LLC

To have a properly drafted deed transferred into a Series LLC structure, you will need an accurately drafted and legally binding Series Document and Series Operating Agreements. Then, pairing an Anonymous Land Trust with the Series LLC stops lawsuits before they even start.

Forming an Anonymous Land Trust

An Anonymous Land Trust is a type of trust that allows you to hold title to land and other real-estate-associated assets anonymously, essentially hiding your assets. You can make the Land Trust the owner of your Series LLC, adding another layer of asset protection to your plan. To form an Anonymous Land Trust, you’ll need a properly drafted legal instrument.

Title Insurance Considerations

Title insurance is a specialized kind of insurance that protects you if there are legal issues with the title when transferring real estate. Can title insurance be transferred? The answer is yes, but only in certain situations.

When transferring property to a Series LLC structure, the most reliable method to maintain title insurance is to name a Land Trust as the beneficiary of your insurance policies. Adding your Land Trust as a beneficiary essentially guarantees that you'll get to keep your insurance.

Before transferring any property, it's definitely a good idea to review your insurance policy. Usually, when you transfer property, your hazard and title insurance expire. But if you transfer your properties into a Land Trust, you’ll be able to preserve both your hazard and title insurance.

This method is leaps and bounds better for you than getting a new insurance policy because your new insurance policy premiums would be based on the property’s current value. And thanks to appreciation, the current value will almost certainly be higher than it was when you bought it. While that's good news if you plan to sell it, it's bad news if you need to get a new insurance policy. It means you’d actually end up having to pay more—perhaps a lot more—than before. So you want to hold your policy to the last minute before being forced to renew.

Plus, if your policy isn't already near its expiration date, getting a new policy will unnecessarily cost you extra money, which certainly could be used for much more pleasant things than insurance. This is why it's worth the effort to use the Land Trust method to avoid triggering the expiration clause in the insurance contract.

Can’t I Just Do This Myself?

Every state has its own set of requirements for these documents to be legally valid, and there may even be county-level rules that apply. If a legal document is not drafted correctly, it can render even the most thoroughly planned asset protection plan ineffective. Working with a reputable property transfer service will ensure that everything goes off without a hitch.

Sure, you can find templates for these documents online, but these “free” options are rarely truly “free.” A small investment now could save everything you own later. Unless you happen to be both an experienced CPA and a licensed real estate attorney, it is unlikely that you will know all of the legal, financial, and technical requirements for creating effective and legally binding documents and entities. Don’t take that chance.

Whether you’re brand new to real estate investing or a seasoned investor with the portfolio to match, a competent property transfer service can handle the paperwork and answer your questions.

Why Your Self-Directed IRA Needs A Special Custodian

Individual Retirement Account (IRA) is a term known to all Americans, but even smart real estate investors we work with don't always understand how they work.

It all starts with understanding the role of the Self-Directed IRA custodian.

An IRA must be established by a bank, financial institution, or authorized trust company. Which means only banks such as Bank of America or financial institutions such as Fidelity are authorized to establish and administer IRAs. And not all of these IRA "custodians" allow your IRA to invest in alternative assets, such as real estate.

Not THAT kind of custodian ...

I'm here to say: You do NOT have to invest your IRA funds solely in Wall Street if you don't want to.

You may know that the IRA was designed by Congress to encourage people to save for retirement.
You of course know that you can contribute a certain amount of income each year to an IRA account for investment.

You also need to understand the concept of tax deferral and that retirement funds don't have to be invested only through Wall Street. See our article about Reasons To Form a Self Directed IRA to learn more.

**Traditional Institutions Do Not Always Have Your Financial Best Interests At Heart**

It’s not in the financial interests of the traditional institutional investment companies, such as Bank of America, Vanguard, or Scottrade to encourage you to make alternative investments using retirement funds.

Why? Because they make money when you invest in their financial products and keep your money there for a long time. They make money off of highly profitable trading commissions or by leveraging the power of your savings.

On the other hand, they make no money when you use your money to invest in alternative or nontraditional investments, such as a plot of land or a private business.

They get no commissions and lose access to your money when you don't invest through them. They have no reason to tell you about other forms of investing that wouldn't be in their best interest.

The IRS has permitted non-traditional/alternative investments since 1974. It says so right on the IRS website.

And what's the best way to make those non-traditional investments? Why, with a Self-Directed IRA of course!

So what do you need for a Self-Directed IRA? Money, for one thing. And a custodian who can help you invest it correctly. Which brings us back to the main point...

The Responsibilities Of A Self-Directed IRA Custodian

The majority of all Self-Directed IRA custodians are non-bank trust companies for the reasons outlined above.

The Self-Directed IRA custodian or trust company will typically have a banking relationship with a bank who will hold the IRA funds in a special account called an omnibus account, offering each Self-Directed IRA client FDIC protection of IRA funds up to $250,000 held in the account.

The following are the roles and responsibilities of a Self-Directed IRA custodian:

Record keeping.
Answering questions about your account.
Must be IRS approved.
Permitted to hold and custody IRA and 401k plan assets.
Subject to state regulation.
Review of your Self-Directed IRA assets.
Assisting in opening & funding your IRA account.
Making investments on your behalf (unless you choose to do so.)
Making distributions & paying expenses per your request.
Providing you with quarterly statements.
Reporting information required by the IRS and other governmental agencies.

What are the Differences Between a Self-Directed IRA Custodian and Third-Party Administrator?

All IRA custodians, banks, financial institutions, and approved trust companies are regulated and are authorized by the IRS to act as IRA custodians.

But since actual custodians are directly approved by the IRS, they are the only ones in this group that’s allowed to physically hold retirement assets. IRA custodians are needed in order to make investments with IRA funds.

Whereas, an IRA administrator is not able to hold IRA assets and is not approved or overseen by the IRS or any state banking regulators. IRA administrators essentially act as intermediaries between the IRA owner and a partner custodian.

You Should Work Directly With An IRA Custodian.

IRA administrators are not subject to any IRS or state audit or reviews. Which means they have less "motivation" to do their job perfectly.

An IRA custodian is subject to quarterly state banking division audits and reviews, as well as IRS audits, helping keep your IRA safe from prohibited transactions and fraud.

Using Your IRA to Invest In Crypto (4 Steps)

Crypto is blowing up. And traditional retirement accounts simply aren't equipped to handle the excitement.

Cryptocurrencies (like Bitcoin, Litecoin and Ethereum) are a popular alternative to government-backed currency—especially if you want to conduct transactions quickly and anonymously.

The global crypto market cap has been more than $2 trillion for much of 2021 so far. The market cap of Bitcoin (crypto’s biggest star) hit $1.2 trillion in April.

Looking to get in on the action? The Self-Directed IRA (SDIRA) is the best tool for leveraging your retirement savings to invest in digital currencies.

The SDIRA also offers major tax advantages, leaving you with more capital to invest in cryptocurrencies and other non-traditional assets.

Since Bitcoin and other digital currencies are intangible, they can be difficult for many traditional real estate investors to wrap their heads around.

However, investors who fully grasp how cryptocurrency works and wish to invest in this alternative asset through their retirement plans may do so with accounts that give them "checkbook control."

Steps To Take

Here are the steps you'll follow to invest in crypto using your SDIRA:

Establish and fund an SDIRA (Start with our investor quiz if you need help getting started and we'll take it from there.).
Register an LLC that is 100% owned by the IRA. This gives you the same tax-advantaged status as the IRA. The income and expenses related to the assets will flow through the IRA LLC in accordance with Internal Revenue Service requirements. Note: Cryptocurrency is considered property for federal tax purposes, but because the assets are owned by a retirement account, gains are tax advantaged.
Open a business checking account. You'll do this using funds from the IRA. An IRA LLC is also referred to as a “checkbook IRA.” The checkbook puts the account owner in full control of the transaction (checkbook control). The funds in the IRA LLC’s business checking account are solely for investing in the digital assets (or any other alternative assets allowed with self-directed accounts).
Open an account on a cryptocurrency exchange. You'll do this using the name (and tax number) of the IRA LLC. In addition to being purchased or traded on exchange platforms, digital assets may also be purchased through brokers or by investing in a fund that holds various digital currencies through private placement. In effect, the IRA purchases shares or directly invests as a limited partner.

Family Office Can Keep You Compliant

It's important that you get the right structure in place before you make a move in crypto or any other non-traditional asset. Royal Legal Solutions helps investors use an LLC (limited liability company) to incorporate cryptocurrency into their retirement accounts. If you don't have a LLC and a Self-Directed IRA for real estate investors structure set up already, let's talk about it.

We'll review your real estate investment options and business structures to ensure they are up-to-date, compliant, and bulletproof against whatever the future holds.

Once you're set up, you can become a Family Office member to ensure ongoing compliance with your state and local laws and tax requirements. We meet with our Family Office members every quarter to give them actionable steps to take, making sure their asset protection plans are up-to-date.

Why The Self-Directed IRA LLC Means You Don't Have To Pay IRA Custodian Fees

A Self-Directed IRA LLC is an IRS-approved tax structure that allows you to personally manage your retirement account without having to pay a custodian. It also offers several other benefits, such as ease of access and tax-free profits.

Self-Directed IRA LLCs vs. Traditional IRAs

A Self-Directed IRA LLC allows you to take control of your retirement by giving you the ability to invest in anything you want. Except for collectibles, such as art. The best part is, you won't have to ask a custodian for consent or pay any custodian fees.

With a traditional IRA, you must go through a custodian when you wish to make investments using your retirement funds, which often triggers high custodian fees and transaction delays.

With a Self-Directed IRA LLC, a special purpose limited liability company (“LLC”) is established that is owned by the IRA and managed by you or any third party. As manager of the IRA LLC, you will have total control over the IRA assets to make the investments you want and understand – not just investments forced upon you by Wall Street.

Not THAT kind of custodian ...

A Self-Directed IRA LLC Gives You Control of Your Retirement

With a Self-Directed IRA LLC, you will have total control to make any approved investment, including a real estate purchase. You can even pay for improvements and then sell the property without ever talking to the IRA LLC custodian.
Since all your IRA funds will be held at a local bank in the name of the Self-Directed IRA LLC, all you would need to do to engage in a real estate transaction or other investment is write a check straight from the IRA LLC account or simply wire the funds from the IRA LLC bank account.

No longer will you need to ask an IRA custodian for permission or have the IRA custodian sign the real estate transaction documents. You will be able to make investments by simply writing a check.

With a Self-Directed IRA LLC, you will never have to seek the consent of a custodian to make an investment or be subject to excessive custodian account fees based on account value and per transaction.

Self-Directed IRA LLC Benefits

#1 Invest in real estate & much more tax-free

With a Self-Directed IRA LLC, you will be able to invest in almost any type of investment opportunity, including real estate, tax-free.

#2 Virtually no IRA custodian fees

With a Self-Directed IRA LLC, you no longer have to pay excessive custodian fees based on account value and transaction fees. Instead, with a Self-Directed IRA LLC, you keep your money with a passive Self-Directed IRA custodian, often a bank.

Think of the passive custodian as a piggy bank for your Self-Directed IRA LLC. Whenever you need money for an investment, you just go to the piggy bank. You can write a check. You don't actually have to go or speak to your passive custodian.

#3 Tax deferral

With the Self-Directed IRA LLC structure, all income and gains from IRA investments will flow back to your Self-Directed IRA LLC tax-free.

An LLC is treated as a pass-through entity for federal income tax purposes and your IRA, as the member of the LLC, is a tax-exempt party. Which means all income and gains of the LLC will be tax-free.

A Self-Directed IRA LLC allows you to enjoy many more advantages, including the following:

Better protect your retirement assets from a falling stock market or against inflation.
Make a real estate or other investment by simply writing a check( Truly it is that easy.)
Generate profits tax-free when you use the same Self-Directed IRA LLC to purchase domestic and foreign real estate, private mortgages, gold and stocks, bonds, and mutual funds inside the same plan.
Buy your future retirement home or vacation property now at today’s prices, rent it out, and then move in at the age of 59 and 1/2!
Diversify your retirement portfolio and invest in almost any type of investment tax-free.
Take control of your retirement funds and hold them at a local bank or credit union.
Protect your IRA from creditors or bankruptcy.
Purchase real estate foreclosures and tax liens on the spot, or make personal loans by simply writing a check and generating profits tax-free.

To learn more Royal Legal Solutions' IRA LLC custodian services, take our investor quiz and you'll get the opportunity to book a free consultation.

Business Trusts: Your Key to Greater Control Over Your Investment Accounts

Business trusts can allow you to safely and inexpensively manage your Self-Directed IRA (SDIRA).

With typical IRAs, you’re at the mercy of the "custodian" (the financial institution that manages your investment). With a Self-Directed IRA business trust or LLC, you get access to different types of alternative investments (including real estate), that you otherwise wouldn’t be able to purchase with those funds.

So the SDIRA grants you the "checkbook control" you need, which means more direct authority and oversight over the investment and management decisions regarding the funds held in your retirement account.

With a business trust, there are even more benefits, as we'll see ...

Why You Should Use a Trust Instead of an LLC

If a legal entity allows you to manage your Self-Directed IRA more effectively, should you open a business trust or LLC? You could theoretically become the trustee of either entity, so why would you choose a business trust?

One key reason: the trust saves you money.

Business Trusts Don’t Have Annual Fees

LLC filing fees vary by state, but most states charge anywhere between $50-800 for annual filing fees and reports, creating an additional and unnecessary expense.

The states with the highest annual LLC filing fees are:

California ($800)
Massachusetts ($500)
Nevada ($350)
Delaware ($300)
Maryland ($300)
Tennessee ($300)
Washington DC ($300)

That’s not to mention the initial filing fee cost, which averages anywhere from $100-200. If you ignore or forget to pay your fees, your LLC gets shut down. If you’re managing a lot of money in that LLC, this could cause even bigger issues.

For Self-Directed IRA investors, business trusts offer the same checkbook control with fewer annual fees. That means a lower cost and generally less upkeep. A California business trust, for example, would save you $800 a year right off the bat (and an additional $70 if you count the initial filing fee). Instead, you could pay nothing annually.

But that isn’t the only benefit trusts afford you...

LLCs Can’t Offer the Same Level of Anonymity

Additionally, business trusts go beyond the protections afforded to you by an LLC. They don’t require that you file publicly. When you form an LLC, the Articles of Organization, along with your name and address as the trustee of that LLC, must be filed with your Secretary of State.

Business trusts don’t have that same requirement, giving you an additional layer of anonymity and asset protection in the event of a lawsuit. If the litigators can’t find who owns the trust, they can’t sue that person.

Tax Efficiency

Finally, business trusts can be more tax-efficient than LLCs. A business trust is considered a “disregarded entity” separate from its owner. That’s also true for LLCs—but there’s a key distinction: even if you file taxes as a partnership, most states require LLCs to file income taxes. If you choose to use an LLC, that’s an additional headache.

This also ties in with the anonymity. Business trusts don’t have to be filed publicly, they don’t have to be updated annually with any reports, and they don’t have to report income taxes. If you use them to shield your Self-Directed IRA, you’re protecting against legal trouble to the greatest possible extent while minimizing costs.

What Can You Hold in a Self Directed IRA Business Trust?

To give you an idea of the types of assets that you could invest in with your retirement funds using a business trust, here’s a short list:

Real Estate
Vacant land
Silver and Gold
Tax lien certificates
Cryptocurrency

However, just because you have access to more investments doesn’t mean there aren’t rules to what you’re allowed to do and what you aren’t allowed to do. We actually have a specific list of prohibited transactions.

For one, you aren’t allowed to self-deal in any way. If you want to buy a vacation home using your Self-Directed IRA, that’s prohibited. The investment can’t serve you, and you aren’t allowed to work on it yourself. If you choose to purchase a fixer-upper, you also need to hire contractors for that fixer-upper. DIY is expressly prohibited.

Your Key to Greater Control Over Your Investment Accounts

Here are some of the biggest takeaways from this article:

Both LLCs and business trusts give you an additional layer of asset protection.
Business trusts can save you money by cutting back on annual fees. Unlike a Traditional LLC, there is no registered agent, no franchise taxes, and no yearly fees.
They offer the same checkbook control as self-directed IRA LLCs with even more protection. They’re relatively simple to set up and there’s no legal requirement for you to publicly file your business trust, offering you additional anonymity.
You can use either a business trust or LLC to separate your personal assets from the holdings in either entity, protecting them in the event that you get sued.

What are the Benefits of Creating an LLC for Each Rental Property I Own?

Should you hold all of your properties in your own name, put all of your properties under a single LLC, or create separate LLCs for each rental property?

Are there any other ways to set up your company structure?

When it comes to asset protection, there’s really no question: there are benefits of creating an LLC for each rental property you own. If you ever face issues with litigation, your entire portfolio is no longer at stake.

If you’re found liable for some property issue and all of your holdings are under your name, your life savings are potentially on the line. There’s no reason to stay up at night worrying about your kid’s college fund because you’re not sure about one of the basement stairs in your rental. Asset protection insurance doesn’t cover everything, but if you’re smart about the way you set up your structure, you can mitigate the chances of potential lawsuits.

If you’re interested in protecting your rental properties from litigation (and if you have a significant investment in those properties, or even just a positive net worth, you should be), the question isn’t whether or not you should create an LLC, but how many LLCs you should create.

In this article, we’ll go over the benefits of creating an LLC for your rentals, how many rental properties an LLC can legally have, and—of course—whether or not you should create multiple LLCs for each rental property.

The Benefits of Creating an LLC for Rental Property

In short, it’s all about asset protection.

The benefits of creating an LLC for your properties are essentially the opposite of the drawbacks of keeping it all in your name. Disasters happen, and insurance policies don’t always cover the full scope of those disasters. If a tenant makes a claim that your insurance doesn’t cover and you’re found liable for any damages, you could lose your life savings.

If you create an LLC for your rental, the only thing at stake is your equity in that rental—which, if you’re using a significant amount of leverage—might not even be that much money. On the flip side, if you’re personally sued, your LLCs are separate. They won’t be affected by the lawsuit.

Furthermore, LLCs allow you to preserve your anonymity. This is especially important if you’re investing in out-of-state properties and hiring a professional management company. You don’t want to be contacted in the event that things go south. When the transaction appears on the auditor card, instead of your full legal name showing up, you could use a fictitious name or copy the property address and add an “LLC” at the end.

Here are some of the benefits of creating LLCs, in a condensed format:

Your personal assets are protected.
You preserve anonymity to a greater degree.
The only thing at stake during litigation is your equity in the property.

The only reason you wouldn’t create an LLC for rental properties is if you either 1) want to save a small amount of money now at the risk of losing your entire portfolio later; or if you 2) don’t understand the process. At Royal Legal Solutions, we specialize in asset protection, and we can help you find the best solution for your needs, particularly if you’re looking to protect your single-family home investments.

When Should You Have Multiple LLCs vs Just One?

If one LLC is good, why not have multiple?

If you have only one rental, you can set up a secondary LLC in addition to your primary in what’s called a “two-company structure.” This allows for even more protection. The secondary LLC will carry out the day-to-day operations of managing the rental, much like a property management company, while the primary will act as a holding company. That way, the operating (secondary) LLC holds most of the responsibility. If you get sued, it’s likely that the secondary LLC will be the one at stake—and it doesn’t have any of the equity.

Furthermore, if you own more than one rental, you can either keep repeating the above process, incorporating each rental property separately, or set up a series LLC. One of the issues with multiple LLCs is the annual costs of maintenance. A series LLC essentially just adds separate secondary LLCs for each rental property.

Are There Other Options for Asset Protection?

Another option for asset protection could be individual trusts. These operate in a similar fashion to LLCs, but there are different benefits and drawbacks. For more information, check out our article, “Should Rental Property Be in an LLC or Trust?”

A trust might offer just as much protection as an LLC, and it can even help you cut back on estate taxes, but it might require more time and resources than setting up separate LLCs. Feel free to contact us to see if it’s an appropriate solution for your asset protection needs.

Conclusion: What are the Benefits of Creating an LLC for Each Rental Property I Own?

When it comes to creating LLCs for rental property, the objective is clear: asset protection.

If all of your rental properties are in your name and you’re found liable for damages, all of those rentals, as well as your personal assets, are on the line. Asset protection insurance doesn’t cover everything (and there’s a limit to how much each policy covers). Instead, setting up multiple LLCs offers an alternative effective insurance policy against litigation.

You can do this by creating multiple LLCs or by creating a Series LLC. Additionally, if you find it appropriate to your situation, you could put each rental property in its own trust.

There are lots of ways to bulletproof your rental property investments and protect your anonymity, and we’re here to help.

Self-Directed IRA Bitcoin Investing

Bitcoin is constantly making headlines. We're getting a little sick of hearing about it, to be totally honest.

As Bitcoin becomes mainstream, we hear stories of the crypto-savvy investor buying Bitcoin in its early years and becoming a millionaire. Which leaves more investors asking, “Why not me?”

In 2021, IRA investors are increasingly diversifying with Bitcoin and other cryptocurrencies. Self-Directed Bitcoin IRA investing can deliver high yields along with the tax benefits of non-digital investment.

Here’s a brief primer on Bitcoin and three steps investors can take to start making their own Bitcoin investments using a Self-Directed IRA-owned Business Trust.

Bitcoin Basics

With cryptocurrencies, encryption is used to make new currency units and perform transactions. All this is done in a decentralized system and records are kept in a blockchain, which is a type of digital ledger.

Bitcoin, released in 2009 by Satoshi Nakamoto, is one of thousands of cryptocurrencies but is easily the most popular. Bitcoin must be stored using an online digital wallet or in a personal computer. Due to hacking concerns, some owners use a hardware wallet (a USB-like device protected with a PIN code).

Bitcoin Gets Attention From Investors

Bitcoin turned heads in the investment world by going from a price of under $1 in 2011 to $40,111 on January 14, 2021. The highs and lows have attracted headlines, as in December of 2017, when prices doubled in a matter of weeks. As I write this, its current U.S. value is $33,626.60.

Bitcoin’s wider adoption and impressive gains led to the “Bitcoin IRA," bringing the flashy new investment into the stodgy world of traditional retirement accounts.

Bitcoin Meets the IRA

A traditional IRA (individual retirement account) doesn't permit alternative investments such as Bitcoin and other cryptocurrencies. They're not really known for trying new things.

But what about the Self-Directed IRA (SDIRA), with its more flexible structure? The IRS doesn’t list Bitcoin as a forbidden investment (only list life insurance and collectibles are specified as non-permissible IRA investments). Check out our article, Our 3 Most Popular Self-Directed IRA Investments, to see what else is (and is not) permitted.

How to Invest in Bitcoin Using a Self-Directed IRA

#1 Do Your Research

The information I’ve provided about Bitcoin is a good primer, but is by no means a substitute for doing your own due diligence. Be prepared for the uncertainty that surrounds Bitcoin as a new investment.

Also, since Bitcoin isn’t under a regulated system don’t expect the same type of publicly available financials you’d find with traditional stocks or mutual funds.

You can educate yourself on how the IRS deals with Bitcoin investments; a good cryptocurrency resource is Investopedia.

#2 Choose the Right IRA Custodian

The "custodian" is the financial services company that manages your retirement account for you. To learn more, check out our article, Why Your Self-Directed IRA Needs A Special Custodian.

Traditional IRA custodians won't even think about it, but if you're in the market for the self-directed version, you'll need to make sure your IRA custodian is IRS-approved and allows Bitcoin investments. Still, you probably won’t enjoy true checkbook control over your account.

Your SDIRA is self-directed (as the name says), but it isn’t “self-managed.” This means you can’t write a check out yourself for a Bitcoin transaction without a custodian approving the transaction. The processing time can hurt you when you're trying to buy or sell quickly. Also, the fees can add up when choosing this route.

This doesn’t mean you should give up on Bitcoin investing with a Self-Directed IRA. Royal Legal Solutions may be able to help you eliminate the custodial overhead. Many of our clients are Bitcoin investors who enjoy direct control over their IRA investments. Start with our investor quiz to see if you can take advantage of our custodial services.

#3 Choose a Good Cryptocurrency Exchange

Once your Self-Directed IRA is setup and you have direct access to your funds, you’re ready to purchase Bitcoin. Choose a reputable exchange and understand its fee structures. More importantly, be aware of any security flaws and hacking issues. Currently, Coinbase and Kraken are some of the most reputable exchanges.

#4 Choose a Good Cryptocurrency Wallet

For those new to cryptocurrency, this step may seem like the hardest to understand. A cryptocurrency wallet isn’t a physical wallet, although it can take physical form as a hardware digital wallet. Wallets are accessed via a private key, which is a hexadecimal code that you should guard just as you would a security box key. Like a bank account, the wallet holds your balance and a reference to all transactions. It’s also where you can send and receive currency. Think about security when choosing a wallet. Online wallets are convenient and usually offer a mobile version. However, they are susceptible to hackers. Hardware wallets are more secure because they hold the private key in an offline, unhackable device.

#5 Keep Your BTC Investments in Compliance

The “self-dealing” rules that apply to other alternative assets also apply to Bitcoin. For instance, an investor can’t sell Bitcoin to his own IRA nor can any of his family members. This can disburse the IRA or lead to a taxable event. Also, be mindful of annual reporting requirements which require market valuations similar to real estate properties.

#6 Enjoy Tax-Deferred Earnings

With a Self-Directed IRA you can apply the tax-deferral benefits enjoyed by other alternative investments towards Bitcoin. Bitcoin investments can grow unhindered as taxes aren’t applied till funds are disbursed, which can mean decades of growth.

#7 Explore Other Cryptocurrency Investments

Bitcoin is the most widely-known cryptocurrency. However, once you’ve gotten your feet wet in Bitcoin investing, you can expand towards others currencies such as Ethereum and Litecoin. Like Bitcoin, Litecoin has enjoyed tremendous growth. It’s second to Bitcoin in market capitalization, followed by Ethereum and Ripple.

When expanding your Self-Directed IRA, consider what advantages rival currencies have as an alternative to Bitcoin. For instance, Litecoin enjoys faster transaction times and a larger coin supply limit of 84 million compared to Bitcoin’s 21 million.

Start Investing Today

Like any other investment, investors should complete their due diligence, choose the right custodian and be aware of custodial fees. Check out our Using Your IRA to Invest In Crypto (4 Steps) article while you're at it.

Lastly, keep Bitcoin investments in compliance with IRS regulations. The unique steps Bitcoin investors need to make may be overwhelming at first. They include choosing a cryptocurrency exchange and digital wallet. However, once investors get their feet wet, they’ll be a step ahead in expanding their Self-Directed IRA towards other cryptocurrencies. For now, investors could start off with Bitcoin and other private investments using a Self-Directed IRA.

Articles of Incorporation Vs. Operating Agreement: What's The Difference?

When you're starting a business, you have to think about the boring stuff.

There are legal decisions to make. There are forms to complete. Although the paperwork can seem overwhelming, these documents are essential to keeping your operation running smoothly.

One of the common questions new small business owners have concerns articles of information vs. operating agreements. What’s the difference?

Articles of incorporation and operating agreements both outline the structure of a business and define its ownership. But each of these documents serves a unique purpose, and small business owners and real estate investors often mix them up or think they are the same thing.

To help you understand which document you need for your business—or if you need both—we'll examine the characteristics of each one, including their similarities and their differences. Don't be bored ... Getting this right on the first try will increase your chance of success down the road.

articles of incorporation vs operating agreement cat

Bored? Don't be. A profitable business is exciting!

What are articles of incorporation?

Articles of incorporation (also called a corporate charter or a certificate of incorporation) is a set of legal documents that establishes a corporation in the eyes of the state. These documents, which are typically filed with the secretary of state, give the business owner asset protection by separating personal assets from the business assets.

The information included in your articles of incorporation can vary according to the nature of your business and your state's requirements. However, these documents generally include the following elements:

Legal name and address of the business
Date business was established
Business purpose
Business bylaws
Names of the business owners
Name and address of the registered agent
What share of ownership can be held by investors
What restrictions are placed on business activities

If you are filing for incorporation as an LLC, you are not legally required to have articles of incorporation. However, if your business is an S or C corporation, you must file these documents with your state.

What is an operating agreement?

An operating agreement is a legal document that establishes internal operating procedures and defines the business relationship between the members (owners) of a limited liability company (LLC). All LLCs with two or more members should have an operating agreement to protect the business' LLC status, clarify verbal agreements in writing, and legally protect the agreement in the eyes of your state.

An LLC operating agreement should include the following elements:

Description of the business operations
The succession plan if an owner exits or an unexpected issue occurs with an owner
How managers are appointed, their responsibilities, and obligations
How members vote on important issues
How the transfer of ownership occurs
How profits, losses, and distributions are handled
How records are maintained
Other information members feel is necessary

Although not all states require Series LLC operating agreements, legal experts recommend having a written agreement (or bylaws) that outlines your business operations. In addition to helping your business run more smoothly, some financial institutions will require corporate bylaws before you can open an account or get a loan.

How do articles of incorporation and operating agreements differ?

One way to look at the difference between these two legal documents is that articles of incorporation define a business as a corporation with the state, while an operating agreement defines how the business owners relate to each other. Therefore, the first one is a public document, while the second is more for internal use.

Another difference is operating agreements are often less formal than articles of incorporation and therefore are usually easier to update and adjust as the organization changes and grows.

How are articles of incorporation and operating agreements similar?

Articles of incorporation and operating agreements both outline your business structure and share some similar features. Both documents contain basic business information, such as its name, purpose, management structure, and how it will operate.

Another thing the documents have in common is that they both can contribute to the successful operation of a small business.

How do you write articles of incorporation or an operating agreement?

Both articles of incorporation and operating agreements require wording that is specific to your business, your state's requirements, and your type of operation. Vague or general verbiage can create problems down the road.

For example, here are some problems to guard against in your legal documents:

Not defining decision-making powers. Be sure to specify what decisions need to be unanimous among the members and which ones can be made by a majority. Also, clarify what constitutes a majority.
Not being specific on manager selection. Use precise language on how managers are elected or removed. If voting occurs, spell out who is eligible to vote on managers.
Not keeping the manager's powers in check. Spell out the exact duties of the manager to prevent possible abuse of power. Clearly state how and when company assets may be sold, including when a vote is needed on these decisions.

An experienced legal professional can answer questions and provide help with operating agreements or articles of incorporation. The bottom line is that while these documents can be a headache to prepare when you are launching your new business, you will be glad later that you took the time to do them right.

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Image by Sandy Müller from Pixabay

The Revocable Living Trust: Your Estate Planning Secret Weapon

Having a sound financial plan makes sense for your future and your family's future.

You may be young. You may be new to real estate investing. But estate plans aren’t just for the wealthy; nor are they for those who are close to retirement.

Estate planning is for anyone who wants to lead a secure life in their retirement years and pass on their hard-earned assets to loved ones.

This article will examine a valuable estate planning tool: the revocable living trust. We'll see what this tool offers, how to create one, and delve into its advantages and potential disadvantages as part of your estate.

What is a revocable living trust?

A revocable living trust (also called a revocable trust) is a written legal document that specifies how you want your assets to be handled when you die.

Since it is a living trust, you create this document during your lifetime. And since it is a revocable trust, you can make changes to it at any time. The main advantage of a revocable living trust over a will is that your heirs will be able to avoid probate, and the details of your estate will remain private.

How do you set up a revocable living trust?

As the creator of the trust, you (the grantor) must name a trusted individual to manage and administer your trust after your death. If you prefer, you also could name a financial institution or legal office as your trustee.

Once you have established the trust, you can transfer assets, including bank accounts, investments, and real estate into the trust. Going forward, you can amend or change the trust whenever you choose to do so (keep that beautiful word "revocable” in mind). Any income generated by the trust's assets goes to you and is subject to taxation.

For some assets, you will need to have to notify insurance companies, banks, and transfer agents about the trust. You may need to update beneficiaries, get new investment certificates, retitle vehicles, and sign new deeds accordingly.

You should also consider establishing a pour-over will, a financial tool that allows unallocated or unfunded assets to "pour over" into your trust.

Irrevocable vs. Revocable Living Trusts

With a revocable living trust, you can change or even void a trust at any time during your lifetime. If you want to remove a specific beneficiary, you do that as well. No one needs to sign off on the changes; it is up to you as the grantor.

On the other hand, with an irrevocable living trust, the grantor gives away all ownership rights to the assets. Why would someone want to set up an irrevocable trust? The answer has to do with taxes.

Does a trust need to file a tax return? The IRS views a revocable trust as a grantor's trust and not a separate entity. The income from a revocable trust must be reported on the grantor's personal tax return. However, since the assets in an irrevocable trust are no longer yours, the trust itself pays all the taxes.

After the granter of a revocable trust dies, a revocable trust becomes irrevocable. No further changes can be made to the trust, and it works the same as an irrevocable trust.

What are the benefits of a revocable trust?

We've already stressed the main advantage of a revocable living trust: its flexibility. You’ll appreciate this benefit if you are doing your estate planning early in your career.

Here are some of the other benefits of this financial tool:

A revocable trust can cover your assets if you become incapacitated. If you are unable to manage your own affairs, your trustee will step in and manage the trust. This changeover can happen automatically without any court involvement or other delays.
Revocable living trusts can include your wishes for guardianship and spending habits for minor children.
Revocable trusts do not go through probate. Your beneficiaries will not have to wait or pay for court proceedings.
A revocable trust may cost more money to set up than a regular trust, but it can save money and hassles later since it holds up better to court challenges.
Unlike a will, a revocable living trust is not part of the public record. The identity of your beneficiaries and the distribution of your assets can remain private.
The Federal Deposit Insurance Corporation (FDIC) offers insurance of up to $250,000 for each beneficiary of a revocable living trust—up to a maximum of $1,250,000.

What are the disadvantages of a revocable living trust?

The initial process of creating a revocable living trust can be expensive and time-consuming if you aren’t getting help from an asset protection attorney near you. For example, you may need to get new titles for some of your real estate assets.

After you have created the trust, you need to update it every time you purchase a new asset or open a financial account. Any assets you do not place into the trust will become part of the probate process after your death.

Also, if your marital status or parental status changes, you will need to update the trust. These changes in life circumstances will not automatically be part of the trust.

What are the main differences between a revocable living trust and a living will?

Understanding living trusts is a bit of a learning process. You may be wondering if you need a living trust, a will, or both. The answer is both in many cases.

Both a living trust and a living will allow you to plan the distribution of your assets and name your beneficiaries. You also can revise each document as you wish during your lifetime.

However, a living will go into effect only after your death. A living trust covers your assets in three areas – while you're alive and well, if you're incapacitated, and after you pass away.

Another key difference is that a will must go through probate and become part of the public record. On the other hand, living trusts remain private and avoid probate.

If you have minor children, a will allows you to name their guardians. A revocable trust does not include this information. It only allows you to determine when your children can receive their inheritance and to name will administer the trust for your children until they reach age 18.

Whether a revocable living trust is right for your estate plan depends on your individual circumstances. You'll also want to consider the rules regarding trusts in your location since they can vary state by state. You may want to consider a land trust vs. a living trust. Unlike a living trust, which can hold any type of asset, a land trust holds only real estate or property-related assets such as notes, mortgages, and air rights.

As we've seen, revocable trusts do take some time and planning to create, but they have many long-term advantages for you and your beneficiaries. You can find some revocable living trust templates online, but we recommend that you consult your attorney to find out what best meets your needs and financial goals.

Is My Roth IRA Protected in a Bankruptcy?

Although relief available through the Paycheck Protection Program (PPP) and the CARES Act may have kept them afloat for a while, many businesses and individual investors continue to experience the economic fallout caused by the pandemic.

Chapter 11 filings were up about 20 percent in February 2021 over the same month in 2020, and because bankruptcy filings lag behind other signs of economic distress, experts predict the worst may be yet to come.

If you’re considering filing for bankruptcy, it’s natural to be concerned about your retirement accounts. In particular, you may be wondering about your Roth IRA bankruptcy protection.

Before 2005, certain retirement assets—including traditional and Roth IRAs—had some protections at the state level, but these protections varied from state to state. However, after President George W. Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005, the federal government now protects the IRA assets of all U.S. citizens.

Under BAPCPA, the following retirement savings accounts are generally excluded from bankruptcy:

Employer-sponsored retirement plans (401(k) and 403b plans) – no dollar limit
Employer-sponsored SEP and SIMPLE IRA plans – no dollar limit
Traditional and Roth IRAs – up to $1,362,800
Rollover IRAs (assets “rolled over” from an employer-sponsored plan) – no dollar limit

As you can see, only IRA assets have a dollar limit for their bankruptcy protection. This amount, which applies to traditional and Roth IRAs, was set in April 2019 and will be adjusted for inflation in 2022 and beyond.

Do Roth IRAs Have Additional Bankruptcy Protections?

Both types of IRAs (traditional and Roth) offer tax advantages. The key difference between a Roth IRA and a traditional IRA is the timing of when you claim those advantages. With a traditional IRA, you take out contributions now and then pay taxes later. With a Roth IRA, you pay taxes on contributions now and then take out tax-free withdrawals later.

If you have rollover assets combined with your IRA contributory assets, and your IRA account balances are approaching the $1,362,800 limit, you may need to provide documentation showing how much of your IRA balances come from employer retirement plan savings.

Each state can still create additional laws regarding the types of property that may be protected from creditors, such as a home or a vehicle. And, in some states, people filing for bankruptcy have the option to choose between following the federal laws or the state laws regarding exclusions of personal property, depending on which one is more favorable.

To read more, check out our other resources:

What if your account is over the limit?

While BAPCPA does not offer creditor protection for Roth and traditional IRAs accounts above the current $1,362,800 limit, a bankruptcy judge has the authority to extend the protection if they believe your situation warrants it.

How to protect rollover IRAs

Under the terms of BAPCPA, a rollover IRA is either a Roth IRA or a traditional IRA that was funded initially by a qualified retirement plan. These “qualified” plans, including traditional pension plans, standard 401(k) plans, and some employee profit-sharing plans, are shielded from creditors in a bankruptcy.

To make sure that a rollover IRA from an employer-sponsored retirement plan has full protection, it’s a wise idea to create a separate account just for those assets. With separate accounts, the origin of the assets is easy to document in a bankruptcy proceeding.

What About Inherited Roth IRA Assets?

In a 2014 decision -- Clark v. Rameker -- the Supreme Court unanimously ruled that inherited IRAs should not have the same level of creditor protection as retirement plans under federal bankruptcy law.

The Supreme Court’s decision seems to be limited to IRAs inherited by someone other than a spouse. There are special tax code rules for spousal beneficiaries, including the ability for a surviving spouse to roll over the inherited IRA into their own IRA.

However, Clark v Rameker applies to Self-Directed IRAs (both the Roth and traditional varieties). A Self-Directed IRA is an account that does not have a “custodian,” meaning account holders are able to invest in “non-traditional” assets, such as real estate, precious metals, and renewable energy.

The court gave the following as reasons for the ruling:

Unlike other retirement plans, inherited IRAs do not permit additional contributions.
Account holders can liquidate inherited IRAs at any time for any reason without penalty. (Other IRAs are subject to penalty for early withdrawal.)
IRA owners must either begin taking minimum distributions every year or withdraw all the IRA funds within five years of inheriting them, no matter how far they are away from retirement.

It’s important to note that after an IRA is inherited by a beneficiary other than a spouse, the law sees the account in the same way as all other assets when it comes to creditor protection. That means that a creditor may be able to may obtain a judgment and a court order to seize a Self-Directed Inherited IRA.

However, as we noted earlier, some states give debtors a choice between handling their bankruptcies under federal or state guidelines. It’s worth finding out how your state stands on the issue since some states offer exemptions that are more favorable for Self-Directed Inherited IRAs and account holders with IRA balances over the dollar limit.

Parents of adult children who are spendthrifts or who are facing legal issues may want to set up a trust rather than passing their IRAs directly on to their children where, depending on their state, they may be seized by creditors.

To Wrap It Up ...

No one wants to think about bankruptcy, but this past year has thrown us some challenging circumstances. While many employer-sponsored retirement accounts are protected from creditors, it will put your mind at each to know for sure.

If you still have questions, speak with your plan administrator or your financial advisor.

Photo by Jason Dent on Unsplash

How To Create A California LLC (And Why You May Want To Reconsider)

It doesn't matter if you're just starting out or have been investing in real estate for a while; protecting your assets is vital. If you live in California, you might be considering creating an LLC in California to protect your investments. However, not only can the process of forming a California LLC be cumbersome and confusing, but other business structures may actually provide you with better asset protection in California than an LLC.

Creating A California LLC: A Play-By-Play

Before we have a chat about your other options, let’s walk through the steps for forming an LLC in California, in case you decide it’s the right choice for you.

Step One: Register With The Secretary Of State

To create your LLC, you’ll need to register with the California Secretary of State. First, you’ll need to choose a unique name for your business and submit a Name Reservation Request Form to the Secretary of State. This submission will reserve your name of choice for 60 days.

Under California law, the LLC name must include one of the following LLC identifiers:

LLC
L.L.C.
Limited Liability Company
Limited Liability Co.
Ltd. Liability Company
Ltd Liability Co.

Before the 60 days is up, you’ll need to file Articles of Organization (Form LLC-1) with the Secretary of State to formally register your business.

Your Articles of Organization must include the following information:

Your LLC’s name
Your business address(es)
The name and address of an agent to receive service of process for the business
If the LLC will be managed by one manager, more than one manager, or all LLC members

Step Two: File A Statement of Information

Within 90 days of filing your Articles of Incorporation, you’ll also need to file a Statement of Information (Form LLC-12) with the California Secretary of State. You’ll also need to file an updated Statement of Information every two years to keep your business active.

Your Statement of Information must include the following information:

Your LLC’s name and Secretary of State entity number
Your business address(es)
The name(s) and address(es) of the LLC’s manager(s), or, if no manager has been appointed or elected, the name(s) and address(es) of each member
The name and address of an agent to receive service of process for the business
A description of the LLC’s type of business or services
The name and address of the LLC’s chief executive officer, if one has been elected or appointed

Step Three: Register With The Franchise Tax Board

On top of the taxes you’ll have to pay to Uncle Sam, you’ll also need to pay state taxes to California. To pay your California taxes, you’ll have to register with the Franchise Tax Board. To register to pay your taxes online, call the Franchise Tax Board at 1-800-353-9032 (or 1-916-845-2829 if you’re outside the U.S.) to begin the online registration process. If you prefer, you can also file your taxes by mail with Form 568.

Step Four: Register With The EDD and Request An EIN

If your LLC will have employees, you’ll need to register with the California Employment Development Department (EDD) and request an Employer Identification Number (EIN), also known as a federal tax ID, from the IRS.

To hire legally in California, you need to register for a payroll tax account number on EDD’s website. You’ll also need to request an EIN from the IRS using Form SS-4, which you can submit online, to set up payroll and pay federal payroll taxes. Even if you don’t intend to hire employees, you may want to apply for an EIN anyway, as it can make it easier for your business to open a bank account and apply for business permits.

Step Five: Apply For A Seller’s Permit

Finally, if you intend to sell or lease any goods, products, or tangible property subject to sales tax through your LLC, you’ll need to register online for a free seller’s permit from the California Department of Tax and Fee Administration. Under California law, you need to obtain a seller’s permit and pay sales tax on items that you sell.

Other Important Steps

California law requires your LLC to have an Operating Agreement that outlines:

How your LLC will be managed
LLC ownership
How capital will be raised
The distribution of profits and losses among members
How membership changes can occur
How the LLC can be dissolved

While California allows you to have either a verbal or written Operating Agreement, it’s strongly advised that you create a formal written Operating Agreement for your LLC to help preserve its limited liability status. Operating Agreements are internal business documents, so while you do need to have one, you don’t have to file it anywhere.

Similarly, opening a separate bank account for your business is not required, but it is an essential step for separating your business assets from your personal assets. If you commingle your assets, you may risk losing your limited liability status if your business is ever sued.

Disadvantages Of A California LLC

The LLC has been around for a long time and is one of the most popular forms of business entity in the United States. And it's easy to see why. But there are some disadvantages to this form of ownership, too, particularly in the state of California.

A significant disadvantage of a California LLC is the high costs of starting and operating an LLC in the state. In fact, LLCs in California must pay an annual $800 tax to the Franchise Tax Board, plus additional fees if the LLC’s total income is more than $250K.

California has also been particularly reluctant to accommodate LLCs from other states and Series LLC. If you want to start a California Series LLC, be prepared to pay $800 each year for each series.

Alternatives To A California LLC

Other business structures can provide Golden State real estate investors with better protection than a California LLC and save your hard-earned cash at the same time.

Delaware Statutory Trusts

If you’re wondering how to avoid California’s franchise tax, the Delaware Statutory Trust (DST) may be your best option. As a trust structure created in Delaware, assets held in a DST are not subject to the $800 annual franchise tax in California. You can even use a series structure with a DST to enjoy the benefits of a series LLC without the exorbitant taxes.

Land Trusts

Up until recently, the answer to “does California recognize land trusts?” was no. Recently, however, California began to recognize land trusts, allowing real estate investors to protect their investment properties without having to pay oppressive franchise taxes. A California land trust can also be used to hide property ownership, avoid probate, and create additional protections against California’s community property laws for married investors. You may also want to consider a title-holding land trust, commonly referred to as an Illinois Land Trust.

California Business Trusts

IRA business trusts are an excellent alternative to a California self-directed IRA LLC, as business trusts aren’t subject to franchise taxes. As with an LLC, you maintain complete control over your assets and investments without having to pay costly custodian fees. However, it’s important to note that a California business trust doesn’t offer the asset protection you would get from an LLC.

What Is the Roth IRA 5-Year Rule?

The Roth IRA 5-year rule sounds like it is far from the sexiest topic in the world.

However, if you invest in a Roth IRA, it’s crucial that you understand it unless you’re cool with paying extra taxes. You’re not? We didn’t think so.

Following the 5-year rule when taking funds out of your Roth IRA can help you avoid taxes and substantial penalties.

This article seems a little sexier now, doesn’t it?

Keep on reading if you want to learn more about how understanding the 5-year rule can save you serious cash.

What Is the Roth IRA 5-Year Rule? sexy man and woman

Self-Directed IRAs: The Sexiest of All Retirement Accounts?

What Is An IRA?

An IRA (short for Individual Retirement Account) is a retirement savings account you can open and manage without going through an employer. Traditional IRAs are “tax-deferred,” which means that you can invest pre-tax funds in the account. With a traditional IRA, you can contribute up to $6K of pre-tax income each year. Once you hit 50, that annual limit jumps to $7K.

While you can invest in a traditional IRA with pre-tax money, you know Uncle Sam isn’t going to let you avoid taxes forever. Once you turn 72, or 70½ if you hit 70½ before January 1, 2020, the IRS is done waiting for its tax money. You’ll have to start taking required minimum distributions (RMDs) each year, and, unsurprisingly, you have to pay income taxes on them.

What Is A Roth IRA?

While you use pre-tax income to invest in a traditional IRA, Roth IRAs are the exact opposite. With a Roth IRA, you are only allowed to invest post-tax income. However, for many people, Roth IRAs actually offer more significant tax benefits and more flexibility.

First, since you already paid taxes on the money you invest, the IRS won’t make you take RMDs from a Roth IRA. You can keep your money invested and keep earning more and more income. And the kicker is, you don’t have to pay taxes on your earnings. Unlike traditional IRAs, you pay income tax on the amount you invest, not the amount you take out, so any money you make with your Roth IRA investments is almost always tax-free!

Income and Contribution Limits

Of course, the feds have to put SOME restrictions on the awesomeness of Roth IRAs. As with Traditional IRAs, you can only contribute $6K each year ($7K for our 50+ friends). There are also income requirements for who is allowed to use a Roth account. As of 2021, phase-out amounts for married couples who file jointly are $198,000 to $208,000 and $125,000 to $140,000 for single people and heads of households.

What Is The Roth IRA 5-Year Rule?

Now that we’ve given you way more information about Roth IRAs than you probably needed let’s move on to what we’re actually supposed to be talking about: The 5-year rule. While you can always withdraw contributions you have made to your Roth IRA without taxes or penalties, the Roth IRA 5-year rule refers to the five-year waiting period imposed on some withdrawals from a Roth IRA account. There are three circumstances where the 5-year rule applies: earnings withdrawals, conversions from a traditional IRA to a Roth IRA, and inherited Roth IRAs.

Withdrawing Earnings

The most commonly encountered situation involving the Roth IRA five-year rule is when attempting to withdraw money that you earned from account interest rather than money that you contributed to the account.

For earnings withdrawals to be tax-free, you must withdraw the earnings at least five tax years after the date you made your first contribution to any Roth IRA you own. You must also be at least 59½ years old. This means that even if you are over the age limit, you have to wait until it has been five years since your first contribution to take out your earnings without taxes or penalties.

Converting A Traditional IRA To A Roth IRA

The second way the five-year rule applies to Roth IRA withdrawals is when you convert a traditional IRA or a traditional 401(k) to a Roth IRA. Since traditional IRAs and 401(k)s are funded with pre-tax money, you have to pay taxes on any funds you convert from a traditional account to a Roth IRA.

Once you convert to a Roth IRA, you’ll have to wait five years to withdrawal any converted funds. This can get confusing because each conversion has its own five-year waiting period before you can withdraw the funds tax- and penalty-free.

However, IRS rules state that when you take money out of a Roth IRA, the oldest conversions are considered to be withdrawn first. When the IRS decides whether your distribution should be subject to early-withdraw penalties, the order of withdrawals are contributions first, followed by conversions, and then earnings.

Say, for example, that you have $100K in a Roth IRA - $75K in contributions; $20K in conversions; and $5K in earnings. If you were to withdraw $80K from the account, the IRS would consider you to have depleted your contributions before moving to converted funds, so only $5K of your balance of conversions would need to comply with the 5-year rule.

Inheriting A Roth IRA

The rules surrounding inherited IRAs can be incredibly confusing, but fortunately, applying the 5-year rule to inherited Roth IRAs is relatively straightforward. When the owner of a Roth IRA passes away, a beneficiary who inherits the account can withdraw contributions or earnings without penalty as long as the Roth IRA has been open for five years. If not, you’ll need to wait until you hit the five-year mark before withdrawing any earnings if you want to avoid a penalty. However, you can still take out all of the contributed funds regardless of the age of the account.

Never Hurts To Double-Check

We’ve covered the basic principles about the 5-year rule in this article, but many other factors must be considered before withdrawing funds from a Roth IRA. We recommend consulting with your lawyer or CPA before taking an unscheduled distribution from your Roth IRA to ensure you won’t suffer penalties or have to pay taxes.

Especially when it comes to your money, a second opinion is very sexy indeed!

Taxes For An LLC: How the IRS Sees Your Limited Liability Company

If you're a real estate investor, you should be aware of how the tax code and the way you structure your business will affect how much money Uncle Sam takes from your bank account.

For example, the IRS has a lot to say about your Limited Liability Company (LLC) and how taxes for an LLC are handled.

If you don't already have one, it's time to create an LLC. Not only does owning your properties and other investments through an LLC protect you from liability, but it can also save you some serious tax dollars if you make the right elections for your business.

Buckle up! It’s time to learn the basics of how the IRS sees your LLC and what the tax benefits of an LLC are.

What Is An LLC?

An LLC is a business structure that offers its owners limited liability from the business’s debts. That means if you are the owner of an LLC, your personal assets are protected from any debts or obligations incurred by the company. You and your LLC are considered to be separate legal entities.

This type of legal structure is helpful for real estate investors because it's cheaper and easier to create than other entities like a corporation but still offers the all-so-crucial protection from personal liability.

The people or entities that own an LLC are called its “members.” There is no maximum number of members an LLC can have, and most states will allow single-member LLCs, which have only one member, to be formed.

LLC Tax Classifications

For the purposes of taxes, LLCs are considered “pass-through” entities. This means that LLCs do not pay taxes. Instead, the LLC’s profits are reported on its members’ income taxes. However, depending on the number of members in the LLC and the tax elections chosen for the business, the IRS will treat an LLC as a corporation, partnership, or a disregarded entity.

Disregarded Entities

If you own a single-member LLC, the default tax status for your business is called a “disregarded entity,” which means that the IRS ignores your LLC entirely and just considers its profits to be your personal income. This is the same way that the IRS taxes sole proprietorships. When you file your federal income tax return, you will also need to submit a Schedule C form, which details the profit or loss from a sole proprietorship.

Many states also allow LLCs to be treated as a disregarded entity when the LLC is solely owned by a married couple. However, if you form a married-couple LLC in a community property state, it will be taxed like a multi-member LLC, so it’s crucial that you do your homework before making any decisions.

Partnerships

The IRS will automatically tax multi-member LLCs like a partnership, which means that each member will receive a Schedule K-1 and include their portion of the LLC’s profits as taxable income on their personal income taxes. When LLCs are taxed as partnerships, each member must also include a completed Form 1065 for partnership taxation with their tax returns.

Corporations

Although the default tax classification for an LLC is either a disregarded entity or a partnership, members of an LLC may choose to be taxed as a corporation by submitting Form 8832 (Entity Classification Election) to the IRS. For tax purposes, there are two varieties of corporations- S-Corporations and C-Corporations.

Like LLCs, S-Corps are pass-through entities, where corporate income, losses, deductions, and credits are passed through to the business’s shareholders for federal tax purposes. With C-Corps, on the other hand, the business itself is taxed, and then each shareholder is taxed again on their earnings when they pay personal income taxes.

C-Corps are generally not the best choice for an individual real estate investor, but, in some situations, an S-Corp can save you a significant amount of moolah on single-member LLC self-employment tax.

While you must pay yourself a reasonable salary from the LLC’s profits, you can receive any income your business makes on top of your salary as a shareholder distribution instead of in a paycheck. Because the IRS considers distributions to be “passive” income, you don’t have to pay self-employment/ payroll taxes on the money you receive as a shareholder distribution.

However, this move only pays off if your LLC makes enough income to support a reasonable salary for yourself on top of shareholder distributions. Generally, this threshold is around $75K annually for a single-member LLC, but this can vary depending on your particular circumstances.

What Is The Best Tax Classification For My Business?

Unfortunately, this is not a question that any blog or article can answer for you. Not even the all-mighty Google can give you advice on this issue. Because everyone’s circumstances are different, we strongly recommend that you meet with a business attorney or tax professional to discuss the tax classification that will save you the most money.

Keep more of your money with a Royal Tax Review

How Does A Reverse Mortgage Work?

Actor Tom Selleck (Magnum, P.I.) is the latest celebrity shilling for them on television.

Maybe you have an older family member or neighbor who has gotten a phone call from a financial institution offering them.

But what are reverse mortgages and how do they work?

If you are a senior homeowner with most of your net worth tied up in your home, these loans can sound pretty appealing. If you're a real estate investor, you may be wondering if you can use a reverse mortgage to your advantage.

In this article, we'll explain what a reverse mortgage is, the pros and cons this cashflow option can offer to some older Americans, and how you can decide if it's right for your financial strategy now or in the future.

WHAT IS A REVERSE MORTGAGE?

A reverse mortgage is a type of federally insured loan available to Americans age 62 and over. It gets its name because it works in the opposite way as a standard home loan.

With a regular mortgage, the bank gives you a lump sum that you pay back with interest over a set period of time.

With a reverse mortgage, the lender makes payments to YOU based on the equity you have built in your home. You have the option of receiving monthly payments, a lump sum, a line of credit, or a combination of the different options.

Over time, the amount you owe in interest and fees on the loan grows while your home equity declines. You retain the title to your home, and the balance isn't due until you or your heirs sell your home.

WHO QUALIFIES FOR A REVERSE MORTGAGE?

Reverse mortgages are only available to a specific set of homeowners. In order to qualify for a reverse mortgage, you must:

be at least 62 years old
own the home outright or have built up a considerable amount of equity in the home
live in the home as your principal residence
not be delinquent on any federal debt
be current on property taxes, insurance, and any homeowners' association fees
pass a credit check
complete counseling session about reverse mortgages from an approved counselor

Reverse mortgage loan values may be influenced by the home's value, how much equity is in the house, and other factors. And older borrowers are eligible for greater total loan amounts because age directly correlates with limits.

WHAT ARE THE ADVANTAGES OF A REVERSE MORTGAGE?

With life expectancy in the U.S. growing closer to 80 years, many Americans are outliving their personal retirement savings. As a result, they may be unprepared for the rising cost of living and the mounting medical expenses that often accompany aging.

Reverse mortgages are ideal for older homeowners who may not have much in the way of savings or investments but who have built up wealth in their homes. In other words, this type of loan allows you to turn an otherwise illiquid asset into a liquid asset without having to move out of your home.

Whether they're living with the results of an investment gone awry or the difficulties of a fixed income, any senior with cash flow issues may want to consider a reverse mortgage.

Here are some of the other attractive features of these home loans.

FLEXIBLE LENDING OPTIONS

This type of loan offers flexible disbursement options, meaning you can borrow only the amount you need. Investors may choose to accept the loan as a single lump sum, in monthly installments, or even as a line of credit. This amount of control the borrower has in this regard is greater than most loans.

If your need is more about your long-term budget, try to put a number on what you need for, say, one year. This amount will help you and anyone helping with your financial planning determine what a conservative loan amount for you might be.

MORE CASH ON HAND

For some cash-strapped retirees, a reverse mortgage allows them to remain in their long-time homes without having to downsize. Some borrowers even use the proceeds of a reverse mortgage to pay off their existing home loan.

You can use the money from your reverse mortgage for any purpose, including:

Paying off other debts
Investing in mortgage notes
Taking a bucket list trip
Investing in assisted living facilities
Acquiring investment property
Starting a charitable trust

We'll discuss below why you'll need to account for reverse mortgages in your estate plan. However, if you just want to live out your golden years comfortably, you can do so and even plan to pay off your mortgage at the same time.

Lock In the Value Of Your Home

If we've learned anything about the economy in recent years, it's that anything can happen. If for whatever reason, the value of your home ends up being less than the amount owed on the reverse mortgage, you are protected. In practical terms, that means, if home prices fall in your area, you or your heirs won't have to worry about paying the balance.

INTEREST LIMITS

The reverse mortgage has an interesting set of rules regarding interest. On the plus side, you're not charged interest while you continue to live in the reverse-mortgaged home as your primary residence. Interest is also capped on the first $100,000 worth of debt.

NO TAX LIABILITY

The IRS considers the funds you receive from a reverse mortgage as a loan advance rather than income. That distinction means the money is not taxed, unlike other retirement income from distributions from a 401(k) or an IRA.

WHAT ARE THE DISADVANTAGES OF REVERSE MORTGAGES?

A reverse mortgage isn't for everyone. There are some risks to this type of loan that you should carefully consider.

Here are some of the potential downsides of taking out a reverse mortgage.

DECEPTIVE OR INFLEXIBLE TERMS

Although we have come a long way since the unscrupulous practices by some lenders in the 1990s and early 2000s, not all reverse mortgage providers are ethical. Some will assume you won't do your due diligence and will take advantage of you.

Carefully vet a financial company before considering a loan, and have someone you trust to read the fine print. This person could be a CPA, financial planner, family member working in the industry, or even another investor you know who's successfully used a reverse mortgage and knows what to look for in a loan agreement.

You're examining the documents for any terms that the sales reps haven't disclosed. Any added terms should serve as red flags that you need to shop around with other lenders.

Also, be on the lookout for inflexibilities. For instance, reverse mortgages are often challenging to refinance. Ask your salesperson about your refinancing options, and then be sure to see how these claims compare with the written agreement. Any time a salesperson's word vastly differs from a written offer, it may be time to walk away.

Here are some tips for avoiding reverse mortgage scams from the FBI and the U.S. Department of Housing and Urban Development (HUD):

Do not respond to unsolicited ads for reverse mortgages.
Be wary of anyone claiming that you can own a home with no down payment.
Do not sign any agreement that includes terms that you do not understand.
Do not accept any payment for a house you do not own.
Get advice from a reverse mortgage counselor of your own choosing.

REVERSE MORTGAGES ARE NOT FREE

Some of the unscrupulous ads of the past have promoted reverse mortgages as a means to get free access to your own money. These loans do have the following costs associated with them:

Counseling fee. Before getting the loan, you must participate in a counseling session with a nonprofit housing counseling agency. The typical counseling fee is around $125.
Lender fee. You'll pay an origination fee of either 2% of the first $200,000 of your home's value or $2,500 or (whichever amount is higher) plus 1% of your home's value above $200,000. (There's a cap of $6,000).
Closing costs. You'll need to pay for a home appraisal, home inspection, and title search. In some cases, you may also have charges for a credit check, escrow services, land survey, flood certification, and pest inspection.
Insurance premiums. The Federal Housing Administration (FHA) charges an upfront mortgage insurance premium equal to 2% of your home's value. These loans also have annual mortgage insurance premiums equal to 0.5% of the outstanding loan amount.

You may have the option of rolling some or all of these fees into your loan balance, but, of course, if you choose to do that, you'll receive less money.

YOUR LOAN MAY BECOME YOUR FAMILY'S DEBT

If you fail to make an estate plan or somehow account for a way to pay your debt after your death, your reverse mortgage may be subject to probate. Probate can take time and cost money, and in the meantime, your heirs do not have access to your estate.

If you die with debt, the debt gets passed on, just like your assets and earnings do. You can offset this downside of a reverse mortgage in two ways:

By minimizing your loan to what you're confident you can pay directly from your estate
By updating your estate plan to account for the reverse mortgage

Our suggestion is to take care of this critical detail immediately after seeking the loan. You may pay it off during your lifetime or pre-arrange for your estate to make payments. However, interest is likely to increase if you delay, and your beneficiaries must pay off the debt.

ASSETS ENCUMBERED BY DEBT CAN'T PASS TO HEIRS

Let's say you take out a substantial loan against your home's equity. If you pass away before making payment or fail to update your estate plan, your heirs may be unable to inherit the home until the loan is paid off in full. If you lack the funds in your estate, that could mean one less asset for your heirs.

Also, it's important to remember that a reverse mortgage diminishes the equity you have in your home. By the time the loan needs to be paid off, there may much equity left for your heirs to inherit.

Difficulty SECURING OTHER LOANS

A reverse mortgage is relatively easy to obtain if you meet the qualifications, but it doesn't necessarily "look good" to traditional hard lenders. Some seniors who take out reverse mortgages may find it difficult to secure additional lending elsewhere. This factor can be problematic for investors who rely on good terms to make their deals profitable.

This type of loan also could limit your ability to qualify for other need-based government programs such as Medicaid or Supplemental Security Income (SSI).

SHOULD YOU GET A REVERSE MORTGAGE?

If, after weighing the pros and cons of a reverse mortgage, you're still unsure if it is right for you, here are some factors to consider. A reverse mortgage could be a good option for you if:

Your home is increasing in value. In this case, you may be able to take out a reverse mortgage and still have money left over for your estate.
You plan to live in your home for a long time. The longer you live there, the more the upfront costs associated with the loan are worth it.
You can cover the current cash expenses – including property tax, insurance, and maintenance -- of living in your home.

As with taking on any form of debt, you should take your time deciding on a reverse mortgage. Although it is a relatively easy way to boost your cash flow in the short term, it could put your finances at risk down the road.

Make sure you fully understand the pros and cons of reverse mortgages and enlist the help of professionals to help you make the judgment call. Even a close network of fellow homeowners and savvy borrowers with experience in reverse mortgages can be a valuable source of information.

Learn everything you can about these financial tools, shop smart for a lender, read the written loan terms carefully, and be sure to ask plenty of questions. If a reverse mortgage doesn't feel like it's for you, you can always explore other financial options.

Why Do Independent Contractors Love the S Corps? Short Answer: Lower Taxes!

Independent contractors and real estate investors love S corporations (S corps). That's because an S corp provides significant advantages over sole proprietorships or traditional corporations—both in terms of limited liability and reduced taxation.

Introduction to S Corporations

An S corp is not a separate type of business entity. Rather, it is a designated tax status for businesses that meet these criteria:

The business is incorporated within the United States.
There is only one class of stock.
The business has 100 or fewer shareholders.
The shareholders are U.S. citizens or legal residents.

An S corp otherwise follows all the other requirements of a traditional corporation. It has a board of directors, drafts corporate bylaws, has shareholder meetings, and keeps meeting minutes of company meetings.

Advantages of S Corporations For Independent Contractors

Compared to sole proprietorships and traditional corporations, S corps have several benefits, including lower taxes and reduced legal liability.

To receive these benefits, the corporation must register as an S corp. You'll do this by filing IRS Form 2553. This form essentially states that the corporation meets the requirements listed above and that all shareholders consent to the registration.

Reduced Legal Liability

If you operate as a sole proprietorship and get sued, all of your personal assets are at risk. For example, assume you do business as a sole proprietorship and own $200,000 worth of real estate at 100 North Street. You also have $6.2 million in other personal assets.

If you get sued as a sole proprietor, all of your assets ($200,000 + $6.2 million = $6.4 million) could be subjected to liability. However, assuming your S corp is in good standing and complies with all legal requirements, if someone sues you for an issue related to the property at 100 North Street, your liability could be limited to $200,000.

Taxation Benefits

S corps have huge taxation advantages because business income passes directly to the shareholders. There’s no separate corporate tax—only the shareholders are taxed. This is known as the “pass-through” concept and is a distinct advantage over sole proprietorships and traditional corporations.

For the independent contractor or self-employed real estate investor, this means that you are the owner and employee of the company. As an employee, you pay yourself a reasonable salary and are taxed on that - while the S corp itself pays no taxes.

Before discussing the advantages of an S corp over a sole proprietorship or traditional corporation, you need to understand what constitutes a reasonable salary.

How The Self-Employed Determine 'Reasonable Salary'

An S corps’ shareholder-employee must be paid a reasonable salary as compensation. It is treated as employee wages for tax purposes. The IRS requires the salary to be reasonable because it pays the self-employment tax (i.e., it funds Social Security and Medicare). Check out our article, Using Your S Corp: Payroll Taxes for the skinny.

It is critical to get the reasonable salary right because the IRS will be taking a close look—trust us on this. Fortunately, the IRS has published factors to consider when determining the appropriateness of a salary. IRS Form FS-2008-25 provides these factors, listed verbatim here:

Training and experience
Duties and responsibilities
Time and effort devoted to the business
Dividend history
Compensation agreements
The use of a formula to determine compensation.

There are other factors as well, but they only become relevant when the S corp has multiple employees. For the individually-owned S corp, which is typical of many independent contractors and real estate investors, these do not apply.

There are many rules of thumb for estimating reasonable compensation. Presented in terms of salary per total business profits, they range from 33:67 to 50:50 to 60:40. However, instead of relying on generic guesses, we recommend hiring a certified public accountant or lawyer to estimate the percentage of business profits devoted to salary.

Here’s are examples of how S corp taxation works compared to sole proprietorships and traditional corporations.

S Corporations Vs. Sole Proprietorships

Let’s assume you are an independent contractor or a real estate investor with a sole proprietorship. Last year, you made $100,000 in profits. As a sole proprietor, you pay a 15.3 percent self-employment tax, or $15,300, in taxes.

Now let’s assume that you have an S corp, and you’ve worked with your accountant or lawyer to arrive at a reasonable salary of $60,000. In this case, because the S corp profits themselves are not taxable, you would only pay the self-employment tax on your salary. That would be $60,000 x 15.3 percent = $9,180. So, being structured as a corporation with S corp registration, instead of a sole proprietorship, would save you $15,300 - $9,180 = $6,120 in federal taxes.

S Corporations Vs. Traditional Corporations

A traditional C corporation not registered as an S corp would pay federal taxes on both the corporation’s profits and the employees’ salaries. This likely would be significantly more than the amount paid solely by an S corp employee.

To learn more, check out our article Series LLCs and S Corporations: Which Is Best For Your Business?

Conclusion

If you are an independent contractor or real estate investor, consider structuring your business as a corporation registered with the IRS as an S corp. Our legal experts at Royal Legal Solutions can discuss your options, including the calculation of a reasonable salary under an S corp ... So don't hesitate to reach out if you have any questions about this strategy!

5 Ways The Self-Employed Can Invest for Retirement

When it comes to being self-employed, it can feel like the deck is stacked against you.

Gig workers and independent contractors don’t have the benefit of an employer-sponsored 401k plan or retirement contribution matching program. It can be tough to set aside 15-20% of your income to pay your own payroll and Social Security taxes, take out a little bit more for your healthcare program, and then worry about retirement savings on top of that.

Still, here are 5 ways the self-employed can invest for retirement.

Why Worry About Retirement At All?

The outlook for retirement in the United States is bleak, to say the least. If you aren’t worried about it, you should be.

Here are the facts:

In the United States, 15% of adults aged 25+ have nothing saved for retirement at all, according to Northwestern Mutual’s Planning and Progress Study.

For those that do have retirement savings, the median 401k account balance is only $25.8k (roughly $64.5k for adults at retirement age), according to Vanguard’s 2020 Analysis, “How America Saves.”

But there’s always Social Security, right? Unfortunately, if that’s what you’re relying upon, you’ll only be slightly above the poverty line during your Golden Years. The average Social Security benefit is about $18k per year, according to the Social Security Administration.

Meanwhile, a retiree’s average expenditures are $49,279, according to the Bureau of Labor Statistics.

That means, of the 85% who do have retirement savings, only a very small fraction of them can actually afford to retire.

Luckily, if you clicked on this article, we’ll get you set on the right path. And, if you’re young, your money has time to compound, which means even a little bit of money goes a long way.

Self-Employed Retirement Investing Strategies

Roth IRA

The Roth IRA is the gold standard for most self-employed people, for both its effectiveness and ease of use. Why? First off, when you open a Roth IRA, you contribute after-tax money. Normally, with a 401k or traditional IRA, your money grows tax-deferred, so it lowers your tax bill for the year by reducing the amount of taxable income that you have, and then you pay normal income taxes on distributions that you take in retirement.

With a Roth IRA, you’re paying those taxes up-front and, in return, receiving tax-free distributions in retirement. According to the Congressional Budget Office, taxes are near historic all-time lows. We can’t predict the future and we aren’t trying to, but there’s a solid chance that taxes won’t remain as low as they currently are. It’s certainly possible that they remain at the same rate, or possibly even decrease -- but, looking at historic trends, it seems unlikely.

If you expect a similar income in retirement as you have now -- or if, after your ~$18k per year Social Security benefit, you expect to make more, or if you expect taxes to increase -- then the Roth is your go-to.

Furthermore, a Roth IRA is simply easier than a 401k. In order to open a 401k, you need an EIN at the very least, but if you want to open a Roth IRA, you just have to contact an investment firm and request one. You could do it online in fifteen minutes.

Finally, you can withdraw your contributions penalty-free at any time. You don’t have to wait until you’re 59 ½, like you do with a lot of other accounts (although you will be taxed on gains that you withdrew). So, if you put in $5k last year, and that $5k grew to $8k, you can still withdraw up to $5k with no penalties, because you already paid the taxes on it.

What’s the catch?

If you’re under the age of 50, you can only contribute $6,000 to a Roth IRA per year. If you’re above the age of 50, that number increases to $7,000.
For the tax year of 2021, the income limit for Roth IRA contributions was $140,000 for single filers and $208,000 for a married couple filing jointly. If your maximum adjusted gross income was more than that, you can’t contribute to a Roth IRA.

Solo 401k (Roth or Traditional)

The Roth 401k takes the second spot on our list, tied with the traditional (although we’ll explain why we prefer the Roth).

A 401k is a bit more difficult to open than an IRA. In order to open a solo 401k, you must be a business owner with no employees, and you must have an employer identification number (which you can quickly get by applying for one with the IRS).

The benefits of the Roth 401k are similar to the benefits associated with a Roth IRA, except the contribution limits are much higher. You can contribute up to $57,000 to a Solo 401k, so chances are you’ll never truly max out your retirement savings -- although major props to you if you do.

If you invest in a Roth 401k, you have access to your contributions at any time, which gives you quite a bit more freedom regarding when you use your money.

But, with that said, the traditional Solo 401k is also a great option. Plus, if you combine it with the Roth 401k, you’ll have more options in retirement for controlling your taxable income to make sure you stay below a certain tax bracket.

Traditional IRA

The traditional IRA is similar to the Roth except it works the other way: you pay taxes in retirement rather than now.

A traditional IRA is your best option if you expect your income in retirement to be lower than it is right now, if you earn too much to contribute to a Roth, or if you expect tax rates to decrease.

This might seem confusing. You might be thinking to yourself, “Now I have to gamble on whether or not taxes are going to go up? I don’t know anything about that. This is all too much. I don’t want to think about it right now.” Rest assured that the difference between a Traditional IRA and a Roth IRA is not a deal-breaker. The deal-breaker is inaction, doing nothing at all, continuing not to contribute to your retirement. Very few people look back and say “I wish I had saved less for retirement,” but at our current rate, about 90% of people are going to wish they had saved more -- chances are, you’re one of those people.

Here are some things to know about the Traditional IRA.

The contribution limits are the same as the Roth IRA, listed above.
As for the income limits, the traditional IRA doesn’t have any. However, for single-filers, deductions begin to phase out at $66,000 and phases out entirely at $76,000,

Simple IRA

The Simple IRA is a good option if you’re looking to hire employees in the future (or if you currently have employees). Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, any business that sets up an automatic contribution plan for retirement gets a $500 tax credit.

The Simple IRA contribution limits are $13,500. You’ll have two options for your employees: automatically contribute 2% of their paycheck or match 3% of their contributions dollar-for-dollar. The option you choose depends on how much they currently earn and how much you’re willing to contribute.

SEP IRA

The maximum contributions for a SEP IRA are 25% of your earnings up to $57,000.

SEP IRAs offer fewer benefits than the Roth IRA or Solo 401k, and you can’t make catch-up contributions past the age of 50. Still, SEP IRAs are easy to set up and typically have low administrative costs. They were designed for businesses that wouldn’t have otherwise developed a retirement plan.

The exact limitations are a bit more confusing, and they depend on how many employees you have -- that’s why it earns the bottom spot on our list.

Conclusion

Gig workers and independent contractors have a lot to juggle. You have to pay close attention to your taxes, making sure you’re setting aside at least 15-20% for payroll and Social Security taxes. After that, you have to consider how you’re going to pay for healthcare. Then, finally, you get to worry about your normal tax bill.

Amidst all that, while you’re just trying to get a business off the ground or do some gig work on the side, it can feel like it’s impossible to plan for retirement.

With these 5 ways the self-employed can invest for retirement, though, we’ll get you set on the right path to a well-funded retirement.

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WHAT IS A REVERSE MORTGAGE?