Self-Directed IRA Secrets Revealed: How to Build Your Wealth Tax-Free

By H. Quincy Long

Build Wealth Tax-Free!

Did you know that your knowledge of Self-Directed IRAs can benefit you today, not just when you retire?

If you aren't putting your Self-Directed IRA to work for you as a wealth-buildin

• Language: English
• Publisher: Ira N. Richer Publishing, LLC
• Release date: Sep 22, 2022
• ISBN: 9798986858418

H. Quincy Long

H. Quincy Long is the founder and CEO of Quest Trust Company. He has been a licensed Texas attorney specializing in real estate for more than thirty years and is an active real estate investor. Mr. Long began offering Self-Directed IRA services as a Third-Party Administrator (TPA) in 2002. He is a nationally recognized expert on Self-Directed IRAs and has written and lectured widely on the topic as well as on other real estate-related issues.

Book preview

INTRODUCTION

The information contained in these pages about the powerful concept of Self-Directed Individual Retirement Accounts (IRAs) can change your life. Reading this book will help you to understand the nuances of Self-Directed IRA investing and educate you on issues you need to consider when making your investment decisions. This book is a culmination of almost twenty years of effort and experience in providing Self-Directed IRA services. My goal is to help you to imagine the almost unlimited investment possibilities with Self-Directed IRAs. A Self-Directed IRA not only helps you build your retirement wealth but also can provide current income for you today, regardless of your age.

Acting as a Self-Directed IRA provider has given me a bird’s-eye view of the various ways people invest in their Self-Directed IRAs. Some people are amazingly successful investors, while others make poor decisions and lose all their precious retirement dollars. This book chronicles the experiences, both positive and negative, that I have seen and personally experienced over the years. Many of the concepts and investment techniques covered in this book are equally applicable outside of IRAs.

Chapter One describes what a self-directed IRA is, including its benefits, advantages, disadvantages, and risks. You will learn how a Self-Directed IRA can help you save on taxes and how you can use Other People’s IRAs (OPI) to provide income for yourself today.

Chapter Two covers factors affecting wealth accumulation, including illustrations of what it takes to accumulate sufficient funds for your retirement goals, how much taxes hurt your wealth accumulation, the importance of yield and compounding, and how a Self-Directed IRA can help mitigate the negative effects of taxes.

Chapters Three through Nine explore the many ways that people invest in their Self-Directed IRAs. Chapter Three covers the ins and outs of buying real estate in an IRA. Chapter Four describes the various investment strategies you can use to build up even small balance IRAs. Chapter Five gives you detailed descriptions of issues to consider when lending money from your IRA and how to attract private capital to fund your current real estate investing as a borrower of private money. Chapter Six introduces the world of buying, selling, and creating notes. Chapter Seven describes the creative use of options, which is one of the most underutilized investment techniques in real estate investing. Chapter Eight explores the circumstances when income from an IRA’s investments might be taxable to the IRA, and how making investments in your IRA which incur taxes may still be a great way to build your tax-free wealth. Chapter Nine discusses the issues surrounding the use of entities when investing through your Self-Directed IRA.

Collectively, these chapters will give you an excellent overview of the many ways you can invest your Self-Directed IRA into alternative assets, such as real estate, promissory notes, LLCs, limited partnerships, privately owned corporate stock, trusts, and more, free from the restrictions of more traditional brokerage IRAs.

Chapter Ten provides a brief synopsis of my journey from my start as a real estate investor to owning a Self-Directed IRA custodian.

A Self-Directed IRA is a very powerful tool for your wealth accumulation, but there are rules you need to understand and comply with to avoid making mistakes that can destroy your IRA. Included in Appendix A is a thorough explanation of disqualified persons rules. A disqualified person is one who cannot directly or indirectly enter into or benefit from any transaction in your Self-Directed IRA. Not only must you understand who is on the list of disqualified persons to your IRA, but also who is not a disqualified person.

The material in Appendix B illustrates the dreaded prohibited transaction rules. These rules list the types of transactions that an IRA cannot enter into if any disqualified person is involved. The penalties for violating these rules include disqualification of the IRA, which may lead to taxes, penalties, and interest owed on what you thought was tax-free or tax-deferred investment income. Understanding and complying with these rules is critical to your success as a Self-Directed IRA investor.

Although the information contained in the appendices is not exciting reading, it is vitally important material for you to understand if you want to self-direct your IRA. The relevant statutes covering disqualified persons and the prohibited transaction rules are summarized in plain English, or at least as plain English as possible. As you get more into Self-Directed IRA investing, use these chapters as a resource to help you avoid costly mistakes when making your investment decisions. If you’re serious about investing through a Self-Directed IRA, you will benefit from taking the time to read and understand the materials contained in Appendices A and B.

In Appendix C I have included a brief glossary of acronyms for your reference.

This book is not a treatise on all the rules for IRAs. The style of writing is intentionally conversational to make the book more readable. Lots of stories are included to flesh out what otherwise might be dry material.

WHAT IS A SELF-DIRECTED IRA?

PLEASE NOTE: This chapter introduces the basic concepts of Self-Directed IRAs. If you are already familiar with Self-Directed IRAs, you may choose to skim or skip this chapter.

What is a Self-Directed IRA?

A Self-Directed IRA is simply an IRA in which the IRA owner directs all investments in the account. There is no legal distinction between a Self-Directed IRA and any other IRA, except that with a truly Self-Directed IRA the account agreement allows for the broadest possible spectrum of investments. Unlike the more traditional brokerage IRA, you are not limited to the more traditional investments in stocks, bonds, mutual funds, or annuities. Common investments in Self-Directed IRAs include real estate of all types, promissory notes, and private placement investments, including limited liability companies (LLCs), limited partnerships, private stock, and a whole lot more. With a Self-Directed IRA, you do not have to think outside the box, because the box is bigger than you think. You are not limited in your investment choices with a Self-Directed IRA. Most people do not understand that the box of investments allowed within IRAs is much broader than stocks, bonds, mutual funds, and annuities.

What are the primary benefits of a Self-Directed IRA?

There are many benefits to a Self-Directed IRA. All the self-directed accounts are tax-advantaged in some way. Some of the accounts defer taxes and some of them eliminate taxes if you take a qualified distribution. Self-Directed IRAs are a great tool for diversification if you don’t want to risk all your hard-earned money in the stock market. You have complete flexibility in the type and timing of your investments. The two most important benefits are the ability to take control of your precious retirement dollars and invest them the way that you see fit, and to invest in what you know best. By taking control of your retirement funds, you can reduce the risk of investing by purchasing something for your retirement that you know and understand. For many Self-Directed IRA owners what they know best is investing in real estate in some form or another.

Are there any disadvantages to a Self-Directed IRA?

Yes, there are disadvantages to a Self-Directed IRA. Investments in your Self-Directed IRA must be for your retirement only. Neither you nor any other disqualified person may receive any current benefit while the investment is still in your IRA. If you are purchasing real estate within a Self-Directed IRA, you will not be able to take advantage of depreciation or other write-offs traditionally associated with owning real estate, although in some limited circumstances the IRA itself may take advantage of those deductions. If you are putting money into a Self-Directed IRA which is tax-deferred, as opposed to a tax-free account, taxes may be higher when you retire. Distributions from tax-deferred IRAs are taxed as ordinary income, which means that if you have invested in real estate your income from the sale of real estate may be taxed at your marginal tax rate as opposed to the potentially lower capital gains tax rate.

What are the primary risks of a Self-Directed IRA?

The best thing about a Self-Directed IRA is that it is self-directed, which means you get to choose your investments without the more restrictive choices of the traditional brokerage IRA. However, the worst thing about a Self-Directed IRA is that it is self-directed, which means that you are 100% responsible for choosing your investments. If you are a good investor, then this is a powerful tool to build your wealth. However, if you are a novice investor who has little experience and no mentor, a Self-Directed IRA may not be the best fit for you.

No investments are provided or approved by the custodian. The custodian of your Self-Directed IRA is merely a neutral holder of non-traditional IRA investments. If you make a million dollars on your investments, that’s great. However, if you lose all your retirement dollars then you have no one to blame but yourself.

Another risk of a Self-Directed IRA is that it can be used by unscrupulous people like Bernard Madoff to scam people out of their retirement assets. Yes, this does happen. Always do your due diligence. Remember, your custodian will not do your due diligence for you.

How can a Self-Directed IRA help you save money on your taxes?

The accounts which can defer taxes until you take the money out include the traditional IRA, the SEP IRA, the SIMPLE IRA, and the Individual 401(k). It has been said that a tax delayed is a tax unpaid. While not completely accurate, the sentiment being expressed is that if you defer a tax for many years, you are paying that tax with cheaper funds because the value of a dollar is reduced by inflation. What $100 will buy in 2022 is a lot less than what you could purchase for the same amount in 1922. Even more importantly, you can accumulate wealth significantly faster without having to take the tax bite until the funds are distributed.

The accounts which can eliminate taxes on the profits of your investments include the Roth IRA, the Roth 401(k), the Coverdell Education Savings Account, and the Health Savings Account. Each of these accounts has restrictions on when you can take distributions from them tax-free, so you must pay attention to the rules.

How can a Self-Directed IRA help you now, as opposed to when you retire?

Investments made in your Self-Directed IRA must be for your retirement only. Neither you nor any other disqualified person may enter into or benefit from your IRA’s investments. But what if you need capital for your investments now? The solution is easy—borrow or do a joint venture with Other People’s IRAs (OPI) instead. By networking with other like-minded investors, you can create almost unlimited private funding sources.

I know of several investors who started their careers in real estate by helping others who had Self-Directed IRAs to invest in loans secured by real estate purchased by the investors. At any significant gathering of people, there are likely to be millions of dollars available to fund your real estate and other investments, but the people in the room may not know how unless they have heard of a Self-Directed IRA. That allows you to introduce them to Self-Directed IRAs and then help them invest in your real estate transactions.

You are not restricted to borrowing funds either. You can do a joint venture or form an LLC, a limited partnership, or even a trust to facilitate the transaction. The structure of the deal is up to you and is generally flexible.

A Self-Directed IRA can buy real estate, notes, and other non-traditional investments. If you have investments to sell, you can expand your potential market simply by knowing about and educating people on how they can purchase your investment product in their Self-Directed IRA.

Top Ten Things You Need to Know About Self-Directed IRAs

There is a lot of confusion over Self-Directed IRAs and what is and is not possible. Here are some of the most important things you need to know about self-directed IRAs.

1. IRAs can purchase almost anything.

A common misconception about IRAs is that purchasing anything other than CDs, stocks, mutual funds or annuities is illegal in an IRA. This is not true. The only prohibitions contained in the Internal Revenue Code for IRAs are investments in life insurance contracts and collectibles. Since there are so few restrictions contained in the law, almost anything else which can be documented can be purchased in your IRA. A Self-Directed IRA allows any investment not expressly prohibited by law. Common investment choices include real estate, including debt-financed real estate, options, secured and unsecured notes, including first and second liens against real estate, C corporation stock, limited liability companies, limited partnerships, trusts, and a whole lot more. The biggest limitation on what you can invest in is your imagination.

2. Seven types of accounts can be self-directed.

Traditional IRA—A traditional IRA is a tax-deferred account that generally gives you a tax deduction when you contribute funds to it, although there are some circumstances where you are unable to take advantage of the tax deduction. When you withdraw the money from a traditional IRA, you pay tax on the money at that time, unless the distribution includes a return of contributions with an after-tax basis. When an employee leaves a job that had a 401(k) or other employer-sponsored retirement plan, the employee normally has the choice to roll these funds into an IRA.

Roth IRA—A Roth IRA provides no tax deduction when you put the money into the account, but qualified distributions from the account are tax-free.

SEP IRA—A SEP IRA is an employer-sponsored retirement plan in which up to 25% of the employee’s wages or net earnings from self-employment can be contributed by the employer and deducted from the employer’s taxable income. The best part is that if you are self-employed, you can play the role of both the employer and the employee, which allows you to deduct the contribution on your personal tax return.

SIMPLE IRA—A SIMPLE IRA is another type of employer-sponsored retirement plan which allows both employer contributions and employee salary deferrals.

Individual 401(k)—If you are self-employed with no common-law employees, you can create an Individual 401(k) that generally allows you to deposit the most money into a retirement account. It combines the best features of the SEP IRA and the SIMPLE IRA since you can contribute both deductible employer contributions and employee deferrals, which can be traditional pretax deferrals or, if the plan allows it, Roth 401(k) salary deferrals. The Roth 401(k) salary deferrals are not deductible by the employee, which means the employee must pay taxes in the current year on the deferred wages, but just like the Roth IRA, qualified distributions from the account are tax-free.

Coverdell Education Savings Account (CESA)—A CESA is used to pay for qualified educational expenses with pre-tax funds instead of after-tax funds. No deduction is permitted when the contributions are made, but distributions to pay for qualified educational expenses are tax-free.

Health Savings Account (HSA)—The HSA allows you the opportunity to both get a tax deduction for contributing to the account, regardless of your income level and still withdraw funds for qualified medical expenses tax-free. An HSA is the only type of account eligible for this double tax benefit.

3. Almost anyone can have a self-directed account of some type.

Although there are income limits for contributing to a Roth IRA, having a retirement plan at work does not affect your ability to contribute to a Roth IRA, and there is no age limit. With a Traditional IRA, the fact that you or your spouse has a retirement plan at work may affect the deductibility of your contribution, but anyone with earned income can contribute to a Traditional IRA. There are no upper-income limits for contributing to a Traditional IRA. A Traditional IRA can also receive funds rolled over from a prior employer’s 401(k) or another qualified retirement plan. You may be able to contribute to a CESA for your children or grandchildren, nieces, nephews, or anyone else’s children, if you are so inclined, provided you make less than the applicable income limits. If you have the right type of health insurance, called a High Deductible Health Plan, you can contribute to an HSA regardless of your income level. With an HSA, you may deduct your contributions to the account, and distributions for qualified medical expenses are tax-free. All of this is in addition to any retirement plan you have at your job or for your self-employed business. With all these choices, most people will qualify for at least one type of account. Even if you don’t qualify for any of these accounts, you can inherit an account.

4. Even small balance accounts can participate in nontraditional investing.

There are at least three ways you can participate in real estate investment even with a small balance IRA. First, you can purchase an option on real estate, which then can be either exercised, assigned to a third party, or canceled for a fee. The option fee must come from your IRA or another account that is making the investment. If you assign the option or cancel it for a fee, the assignment or cancellation fee is paid to your IRA or other account. If using a Roth IRA, a Roth 401(k), an HSA, or a Coverdell ESA, this profit can be tax-free if you take the money out as a qualified distribution. Second, you can purchase property in your IRA subject to existing financing or with a non-recourse loan from a bank, a hard-money lender, a financial friend, or a motivated seller. Investment from debt-financed property in your IRA may incur unrelated business income tax (UBIT), however. Finally, your IRA can be a partner with other IRA or non-IRA investors. There are other ways small balance accounts can participate in non-traditional investments as well.

5. There are restrictions on what you can do in your IRA.

There are three basic sets of restrictions on Self-Directed IRAs: people restrictions, transaction restrictions, and investment restrictions.

The investment restrictions are relatively easy to understand since the Internal Revenue Code only tells you what you cannot invest in, not what you can invest in. A Self-Directed IRA cannot invest in collectibles or life insurance contracts. Any other type of investment can be held in a Self-Directed IRA, provided you can find a custodian who is willing to hold the asset on behalf of your IRA.

The people restrictions are a list of persons who are classified as disqualified persons. These disqualified persons are deemed by the Internal Revenue Code to be too close to enter into a truly arms-length transaction with a Self-Directed IRA without having a conflict of interest or receiving a current benefit. They include you, the IRA owner, your spouse, your parents, grandparents, and other lineal ancestors, your children, grandchildren, and other lineal descendants and their