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 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.
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.
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.
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.
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.
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. Note: If you borrow money from the S corporation (via a loan), you’re never going to have capital gains.
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.
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 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 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.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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