The Self-Directed IRA - Real Estate Investments

The self-directed IRA allows individuals to invest retirement funds in real estate focused assets. We’re seeing more investors utilize this unique investment vehicle and we can help you get started with this guide. We’ll go over the benefits of the self-directed IRA, what to watch out for and how to start investing. But first, let’s understand the history of the self-directed IRA.

The Rise of The Self-Directed IRA

The traditional IRA rose in popularity during the 1990s. However, investors were limited to traditional investments. These included stocks, bonds and mutual funds. By the 2000s the self-directed IRA gained popularity. It allowed investing in alternative assets including real estate. Today, the IRA is innovating even more with online platforms for accessing high-yield private investments.    

Four Self-Directed IRA Benefits

1. Diversification- Portfolio diversification is the obvious benefit offered by this product. Some investors find real estate to be a higher yield investment. Plus, some prefer real estate as a tangible asset. Even within the real estate category, investors can diversify with several types of real estate categories.

Here is a breakdown of the main real estate categories allowed by the self-directed IRA:

2. Flexibility - Using a self-directed IRA for investing in some of the assets mentioned above gives investors the freedom to invest in opportunities as they arise. Investors also have the freedom to choose whether to flip or rent out their property. Finally, investors can invest or divest funds in multiple properties as they wish. Plus, self-directed IRA services now exist to make these transactions online-based and even more flexible.

3. Tax Benefits - One of the biggest advantages of using the self-directed IRA for real estate is the tax benefits. Instead of immediately owing taxes on investment gains, the tax is delayed. We’ve seen investors reinvest these funds or allow them to grow for decades. Either way, taxes are only applied at a later date when funds are dispersed. Plus, with a Roth IRA gains aren’t taxed at all.

4. Hedge Against Market Fluctuations - Real estate can provide a hedge against market volatility. When global market insecurities emerge, investors can benefit from having local and familiar investments. Also, real estate of all categories are a tangible asset. This in itself can create more certainty for the investor. All these factors contribute to making real estate a viable option for portfolio diversification.

Pitfalls to Avoid

In order to enjoy the full tax benefits of the self-directed IRA real estate investment, be aware of “self-dealing” rules. In general, these rules prohibit dealings between the IRA owner or his family members/spouse and the IRA account. For instance, an investor can’t buy a property owned under his self-directed IRA. An investor also can’t rent out one of his IRA owned investment properties to a family member. These transactions would result in an unfair double benefit to the IRA owner. Engaging in one of these transactions or any other prohibited “self-dealing” can result in a taxable event.

How to Start a Self-Directed IRA

When setting up a self-directed IRA investors have a few options, each with its own caveats. Below are two options:

What to keep in mind: These custodians have different fee structures and levels of expertise to take into consideration. An approved custodian should be listed by the IRS in their Approved Non-bank Trustees and Custodians listings (1). A custodian will invest self-directed IRA funds based on the owner’s discretion. It is up to the investor to do his own due diligence when making investments. Potential processing delays should also be taken into consideration, since these can be costly when dealing with time sensitive real estate investments. Our online platform can reduce processing delays and administrative cost.  

What to keep in mind: When the IRA owner wants to make an investment she simply accesses the account as she would a normal checking account. No custodian approval is required for dispersing funds. This results in a more efficient investing process. However, LLCs are sometimes subject to filing taxes and paying an annual franchise tax.

Set up your self-directed IRA today

A self-directed IRA for real estate investing provides flexibility and the benefits of portfolio diversification. Unlike traditional investments, a self-directed IRA allows for a tangible asset to hedge against market uncertainties. Perhaps most appealing is the deferred taxes on real estate investment gains. However, these benefits can be undermined through violation of the IRS’s “self-dealing” rules. Structuring a self-directed IRA under the wrong terms can also lead to transaction delays and costly custodial fees.
We specialize in setting up self-directed IRAs to maximize tax benefits, cost savings and control. Whether you require a self-directed IRA for residential or commercial investments, we can provide you with a nuanced solution. Contact Royal Legal Solutions with your questions or to set up a consultation.

The Benefits Of Tax Deferred Growth

Investing in your future may not seem ideal when you have bills to pay now. At Royal Legal Solutions, we understand the ups and downs of daily finances. However, using a tax-deferred investment strategy can help ensure you can enjoy your golden years as you wish. Below, we take a look at the benefits associated with tax-deferred investments and some of the best ways to build your “nest egg”.

Tax Lingo You Should Know

“Tax-deferred” does not necessarily mean you will never pay taxes. Instead, it refers to investment earnings that accumulate free of taxes. These “tax-free” investments and their returns are only taxed once you make withdrawals. Depending on the plan you pick, you have the option of paying taxes before investing instead of later when you withdrawal. But we will talk about that more in a moment.

The Benefits of Tax Deferred Investments

There are two primary benefits when it comes to tax-deferred investments, both of which primarily revolve around saving you money and reducing taxes.

Invest Now, Pay Later

First, by paying taxes later, your investment returns are allowed unrestricted growth. This means that the money that would be taken by taxes, stays in your account. The more money in your account, the more you can invest. With more investments comes a higher potential return.

Potentially Lower Taxes

Second, most investments are initially made prior to retiring. In general, the taxes collected from your employment wages are much higher than those that are levied against your retirement earnings. By default, most Americans earn less during their retirement years than they did while working. Whether working part-time, holding easier jobs, or relying on their “nest egg” – retirees are not typically working high-dollar 9-to-5’s. By waiting to pay taxes on your investment gains, you can potentially owe less than you would if you were taxed upfront.

Types of Tax-Deferred Vehicles

So how can you jump onboard the tax-deferred train and start increasing your retirement fund? Most people jump on the bandwagon in one of three ways:

Let’s take a closer look at the differences between these vehicles.

401(K)

A 401(K) makes for a great long-term investment strategy. Often offered by employers, contributions are made on a pre-tax basis. This means, not only are you investing in your future, but you are also reducing your taxable income. Many employers will match your contribution as well, increasing your investment capital. (Check with your employer. Some may require a certain number of service years from you before they fully match your contributions. Others may have a cap for dollar-to-dollar matching.) There is a catch with 401(k)s. Withdrawals made before retirement will be subjected to higher taxes than they would be if made later as well as an IRS penalty tax. In addition, most 401(K) companies will treat your withdrawal as a loan; you will need to repay the funds should you take a withdrawal before retiring.

IRAs

There are several kinds of IRAs available. Traditional IRAs tend to be a favorite of those grossing $200,000 or more annually. In fact, 64% of those with higher incomes have at least one traditional IRA. Contributions made to a traditional IRA are tax deductible in most cases. However, an early (or pre-retirement) distribution will subject you not only to higher taxes, but also to an additional penalty. Roth IRA contributions are made after taxes have been taken from your wages. As with traditional IRAs, your investments can grow tax-free. While post-retirement withdrawals are tax-free, the IRS makes a clear distinction when it comes to early disbursements. Your original contributions can be withdrawn at any time from a Roth IRA; distributions of earnings, however, are subject to income taxes and a 10% penalty tax. For those who elect to open a Self-Directed IRA (SDIRA), which can be either traditional or Roth, investments are also tax-deferred. Because you must have a custodian for a SDIRA even though you make your own investment decisions, make sure you hire a reputable investment professional who won’t take advantage of these specialized nature of these accounts. (Our investment professionals have years of experience.)

Deferred Annuity Contracts

An annuity contract is a deal between you, as the investor, and a life insurance company. In a deferred annuity contract, income payments from your investment are paid at an agreed upon future date, as either installments or a lump sum. There are two phases to a deferred annuity contract – the investment savings phase and an income phase. Deferred annuity contracts can have fixed or variable rates associated with them. Withdrawals from annuity contracts are a bit more complex than those of 401(K)s and IRAs. Annuity contracts are typically subject to a “surrender period”. Depending on the contract, investors may be required to wait many years before withdrawing money from their account. Should they pull money prior to the end of that period, they will have to pay a “surrender charge”. As with the 401(K)s and traditional IRAs, a 10% penalty is charged by the IRS if money is withdrawn before retirement and withdrawals are subjected to income tax rates.

Tax-Deferment and You

Tax-deferred investments are great for planning your retirement. Pre-tax deductions lower your taxable wages, giving you a bit of a savings upfront. By not paying taxes immediately on your investment returns, you are able to invest even more. This creates a potentially larger return as you approach retirement age. When you do make withdrawals during retirement, the taxes paid on them are lower as well. Whether helping you arrange annuity contracts or providing financial advice and investment support on your IRA, we are here to help.

A Series Of Landmark Prohibited Transaction Cases: Peek & Fleck Vs The IRS

This article is part 2 of a series with the goal of educating you, the Self-Directed IRA LLC investor, on how to successfully invest & avoid triggering prohibited transactions.

At this point in your life you know two things in life are certain, those things being death & taxes. It almost feels like a no-win situation, doesn't it? Funny enough, according to Greek mythology, you even have to pay to book passage on the boat that takes you to the afterlife.

Why You Should Understand Prohibited Transactions

Try to think of prohibited transactions as the sharks circling you and your state of the art Self-Directed IRA LLC investment boat.
The prohibited transaction rules are extensive, and the penalties even more so. Penalties for triggering a prohibited transaction range from excise taxes to instant dismantlement of your IRA plus fines.  (Can you say "ouch" ?)

As you can see, anyone investing with a Self-Directed IRA LLC should be careful to avoid engaging in prohibited transactions, for to do so is doom. Not to mention, the IRS will always have an eye on you from then on out. (But then again, they already did, didn't they?)

Peek & Fleck Vs The IRS

In 2001, two taxpayers, Mr. Lawrence Peek and Darrel Fleck decided to use Self-Directed IRA's to acquire a business. They established Self-Directed IRAs using 401k rollovers, created a new company named FP Company, and then directed the IRAs to purchase the stock of FP Company with the cash in their IRA's.

To finalize their purchase, in addition to the cash and other credit lines, FP Company provided a promissory note to the sellers. This promissory note was backed by the personal guarantee of Peek & Fleck, and the guarantees were then backed by the deeds to the Peek & Fleck's homes.

In 2003 and 2004, Peek & Fleck converted their traditional IRAs to Roth IRAs. In 2006 and 2007, the IRAs sold FP Companies stock, which had increased in value, for a gain. Peek & Fleck used their Roth IRAs to ensure there would be no tax on the gain from the sale of the stock.

The IRS, believing a prohibited transaction had occurred, audited the income tax return for both Peek & Fleck for the tax years of 2006 and 2007.
After reviewing the individuals’ tax returns, the IRS adjusted their tax returns to include the capital gains income from the sale of the stock as well as imposed excise tax for excess IRA contributions.

Both Peek and Fleck contested the IRS’s adjustment and went to the Tax Court with a petition.

Why Was This A Prohibited Transaction Case?

The IRS argued that Mr. Fleck’s and Mr. Peek’s personal guarantee of a promissory note from FP Company to the sellers of the business in 2001 as part of FP Company’s purchase of the business assets were prohibited transactions.
Unfortunately for Peek & Fleck, The Tax Court agreed with the IRS. The Tax Court found that Peek & Fleck had committed prohibited transactions, that their IRA's had ceased to be IRA's as of the beginning of 2001, and that their capital gain from the sale of FP Company by the IRA's should've been taxed.

The Tax Court pointed to Internal Revenue Code Section 4975, which prohibits direct and indirect lending of money or extensions of credit between an IRA and its owner.

The Tax Court found that it did not matter if the loan guaranteed by Peek & Fleck was to FP Company and not the IRAs directly. Why? Because IRC Code 4975 clearly prohibits the lending of money or extension of credit between a retirement plan and a disqualified person.
Then Peek & Fleck countered this, claiming that the IRS’s notices issued in 2006 and 2007 were too late because the loan was made in 2001. The IRS disagreed and so did the Tax Court.

The court cited that since the non-recourse loan was ongoing, the prohibited transaction continued and on January 1, 2006 it remained true that both Mr. Peek and Mr. Fleck personally guaranteed the company loan.

Case Outcomes & Summary

The Tax Court found that Mr. Peek, his attorney, and his business colleague's  (Mr. Fleck) personal guarantees of a loan/note from their newly-formed corporation stock of which was owned by Peek & Fleck's Self-Directed IRA's, to third party incident to asset purchase transaction, was an IRC Section 4975 prohibited transaction.

The Court set a precedent, finding that whether or not their IRA's were involved directly was irrelevant since IRC Section 4975 was broadly worded to include both direct and indirect loans and guaranties to IRAs.

What Happened to Peek & Fleck?

The Tax Court found Peek and Fleck liable for a 20% tax penalty because their underpayments of tax were a “substantial understatement of income tax”. But unfortunately for them, that wasn't the worst part.

Most prohibited transactions are resolved with the owner paying a tax, such as UBTI or UBIT. But in this case, because a prohibited transaction occurred between an IRA and its owner, which results in the tax disqualification of the IRA, Peek & Flecks IRAs were disqualified and totally distributed.

What You Can Learn From This Prohibited Transaction Case

The Peek case affirmed that, in the eyes of the Tax Court and the IRS, an IRA holder can legally use retirement funds to invest in a wholly owned entity that is controlled by him or her without triggering the IRA prohibited transaction rules. That entity could be an LLC, to give a clear example.

What was not mentioned above is that Peek & Fleck relied on the advice of a certain CPA, who was also advocating for the transaction, no doubt for personal gain. (Conflict of interest, anyone?)

When it comes to investing with a Self-Directed IRA, you should always seek the help of a professional who knows the ins and outs of the IRS rules so you don't find yourself in a situation like Peek & Fleck.

If you want to learn more about investing with a Self-Directed IRA LLC and how to avoid triggering prohibited transactions, take our Tax Discovery Quiz.

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

Owning Coins With Your Self-Directed IRA LLC

Are you a current or aspiring coin collector? Of course this can be a satisfying hobby in its own right, but what if you want your coins to be protected as an investment? You may already be familiar with, or even already investing with a Self-Directed IRA LLC. But many investors don't know that sometimes you can hold certain types of coins within a Self-Directed IRA LLC. Of course, holding your coins with this type of account is not without heavy restriction from the taxman. Ensuring with your compliance with the law can be a complex matter, but we're here to break it down as simply as possible.

When it comes to investing and holding coins or metals with your Self-Directed IRA, Internal Revenue Code Section 408 outlines what your friends at the IRS say you can and can’t do.  Items classified as "collectibles" can't be held within your Self-Directed IRA LLC. These include, but aren't limited to, the following:

But wait, there are some exceptions.

Exceptions for Coins in a Self-Directed IRA


The IRS makes specific allowances fors specific types of  gold or silver coins, as well as any coins minted or issued within the U.S. This will be a recurring theme in the life of a coin-collecting investor.  All of the coins allowed in a Self-Directed IRA have to originate and have been crafted by either the federal or a state government.

So what defines these exceptions? Here are  the rules, which you can read for yourself (scroll down to section "m" for the exceptions). And yes, this will involve some serious reading. As you read, remember that collectibles are NOT fair game. This should help you determine what items in your collection meet the specifics. Don't worry, we'll go over all of this in more detail below.
Here's a quick summary of everything above you just read. Or, more likely, skipped right on over. And I don't blame you, at least I get paid to read this stuff. This portion of the tax code is basically saying any metals must be in the "physical possession" of an American institution, such as a bank.  This, however, doesn't apply to specific coins, such as you might have in your own collection. More details about the physical possession requirement can be found below.
31 U.S.C. 5112 gives a comprehensive list and definition of the types of coins that the IRS allows. Refer to it in the link above if you're unsure whether your coins are permitted in your Self-Directed IRA LLC.

How Do Investors Hold IRS-Approved Coins With A Self-Directed IRA?

Hopefully you now have at least some understanding about how the IRS views Self-Directed IRA’s holding coins. If you don’t, I can’t blame you. There’s a reason people pay me money to interpret these IRS rules for them!
Did you know that a coin can be treated as bullion? This means that, it's essentially going to be treated similarly to precious metals (such as raw platinum, etc.). That "physical possession" requirement  we discussed above will apply if this is the case.

What’s the Key Difference Between Bullion and Money?

Think of bullion as raw material. Gold, as we all know, can be made into lots of stuff: jewelry, coins, nuggets, bars, even a lovely commode if you're ultra-wealthy and eccentric. Bullion is distinguished from money based on the fact that it is appraised, bought, and sold at a given price based on mass and purity.  The smart-alecks reading this are likely already aware that the value of these kinds of items can fluctuate substantially.
Money, however, only has a face value. Most of the time, what you see is what you get.  Whether we're talking a $20 bill or a quarter, you know exactly what it's worth and can exchange it for items of equivalent value basically anywhere in the U.S.

Physical Possession

It appears those requirements regarding where IRA-held coins are stored apply both to bullion and coins. This includes the IRS-approved coins, such as the American Eagle gold coins collectors know and love. The rationale behind this is the fact that many of these coins are worth far more than their face value, based on the fact that their materials are worth more than however much they were stamped to be worth when they were minted.

Which means, legally speaking, you should put all IRS approved coins in a bank or other trust.

Putting IRS-Approved Coins in a Bank


Banks are a smart place to hold your coins.  They're also often the only legal place to do so, at least if you want the coins in your Self-Directed IRA LLC. There's some debate over whether safe deposit boxes are compliant with the Taxman's requirements.
Many people believe a safe deposit box held within your Self-Directed IRA LLC (complete with its name on it, not yours) will be okay with Uncle Sam.  IRS-approved precious metals should not be stored at home or in the personal possession of an individual the IRS wouldn't consider a trustee. So if you own the coins, don’t keep them at home or at your friend's house.
Here’s my personal take on this issue. So before I give you my perspective from a legal standpoint, just remember, it’s my job to help you avoid costly fees and penalties. Also keep in mind that unless you've paid a retainer and have  a signed contract with both of our names on it, I'm not your lawyer.
Your best option when it comes to IRS-approved precious metals or coins which are owned by your retirement account is to keep them in a depository approved by the IRS. This will eliminate any doubt that you're keeping in line with the physical possession requirements.  
If you would like answers to any questions you have about owning coins, collectables, or anything else  with your Self-Directed IRA LLC, call Royal Legal Solutions at (512) 757–3994 to schedule your consultation.