Why Smart Investors Use Self-Directed IRAs for Real Estate

0:00Can you set up a brokerage within your self-directed IRA? So, let's say if I get, you know, paid back a loan that's a $200,000 loan and I'm not doing another loan for six months, could I invest in some mutual funds in the meantime within my self-directed IRA or is it just alternative assets? — That's a great question, and that's that's a question that a lot of people come to me with. Because you know like you said when you cash flow this properly you end up with a pretty good problem to have but you end up with a lot of capital that's sitting in the self-directed retirement account that isn't generating any type of return passively because of the you know the self-directed nature and the the active the way that those returns the way you get those returns is through active investing right

0:49So people come to me and they say hey I've got you know all this capital sitting in this retirement account. What can I do with it? And the I have I typically have two answers for them because when you're looking at the when you're looking at the self-directed structure itself, it's really built in the it's really built to be the opposite of these Wall Street IAS. And when I say that, I I mean the the Wall Street IRA, these conventional IAS are built to be really efficient to invest in these conventional assets, stocks, bonds, mutual funds with with no service or or no infrastructure to do any sort of self-directed investing in alternative assets.

1:31And on the flip side, you have this self-directed structure which is really efficient and and really great for investing in alternative assets. Real estate, crypto, notes, leans, tax deeds, really anything that that that is allowable by law. But where it does fall short is efficiencies in being able to invest in tradition conventional assets, stocks, bonds, mutual funds. And what a lot of people will do is they'll open some type of entity account.

2:06So, for the structure, you have an IRA that owns either an LLC or a trust with the checkbook control structures that we set up. And if you can find a brokerage that will allow you to open a brokerage account for your entity, for that IRA owned entity, the IRA LLC or the IRA trust, then you can use that that entity to invest in stocks, bonds, mutual funds, and it will it's essentially a sub account of your IRA. The problem a lot of people will run into is that Fidelity, Schwab, these brokerages will look at this and say, "You want us to open an entity for this LLC that is owned by an IRA, but you don't want us to open an IRA for you?" No, I don't I don't think we're going to do that.

2:51If you want to have an IRA brokerage account with us, you're going to open an IRA with Schwab and then and then you're going to invest in these these products that we have on the shelves for you. So, a lot of those bigger brokerages won't allow you to be able to invest with like an LLC or a trust checking account that's owned by an IRA, but there are a few smaller brokerages that I'm aware of that will allow you to do that. I know Tasty Trades and Trade Station are a couple that come to mind that clients have used, but but even then a lot of people are like, you know, Nick, that sounds great, but I really don't feel comfortable with a Tasty Trades or a Trade Station, this brokerage I've never heard of and and putting my retirement capital in there.

3:36And I think that's totally fair. And so that's really where it leads to the other option is is this self-directed IRA is really a vehicle to help you diversify. And if you come to this point where you have capital overflowing in this account and you don't have that next deal to continue the to continue the snowball effect, then by all means, yeah, let's let's take that those funds that you have and get them back into a conventional IRA. Let's transfer those back over into a into a Wall Street IRA and let it do what it does best over there.

4:12So, it's really what you can really do and what a lot of people opt to do is to have both a conventional IRA, right, and a self-directed IRA. And they'll diversify their their assets between the both and if they have, you know, deals lined up, maybe they'll take some capital from their conventional IRA that's available, move it over into their self-directed IRA, and vice versa. You know, if they don't have deals lined up and they just need that passive income and that's a good opportunity for you to transfer those funds back into a conventional structure.

4:45— Interesting. Okay. I didn't realize you could have both at the same time, a conventional and a self-directed. Okay. — So, what's how what's the how long does it take or what's that process if you wanted to transfer money between them? — Yeah. What you're looking at is is really a a direct a direct trustee to trustee IRA to IRA transfer. When you're working through I mean it really depends on who you're working with and what their capabilities are. If it's an institution that can send a wire for a transfer, you're looking at that taking maybe a week to get approved and another, you know, week to have those funds actually delivered.

5:24But there are some custodians out there who only do transfers by check and then you're looking at, you know, either waiting on snail mail, can they expedite the check? Generally speaking though, it's a pretty it's a it's a pretty approachable process that if you planned for can be really effective. And you're the great thing is too you're you're not limited in any way in the amount that you can transfer between accounts. It's not like, you know, you have $100,000 in this IRA and you have to transfer all $100,000 in to the other IRA if you're making a transfer.

6:00It can be a partial transfer. It can be a full transfer. And as long as you're doing that as a direct transfer, a direct trustee to trustee transfer from custodian to custodian, there there shouldn't be any limitations on to how often you can do that. — Interesting. Okay. And and I mean transferring it from, you know, Silera, your self-directed IR IRA to the conventional is it would be just a wire, right? I mean it's there's like you can initiate that yourself because there's no approval process, right?

6:31— What you're looking at for Yeah, that's a really I'm glad you brought that up because that's a really important distinction when we're looking at these checkbook controlled funds. So generally with investments, right, when you are when you have this checkbook control structure, you have an IRA that we talked about that owns an LLC or it owns a trust that you manage. You have full control of that entity, right? So when you're looking to invest in a property, you don't turn around to seller and say, "Hey, Soler, can I pretty please invest in this property?

7:03Can you approve this?" There's no process like that for investments. But what the custodian is in place for and the role that they do serve is in keeping these these IRA transactions compliant. So, when you're transferring funds from an IRA to an IRA or when you're rolling over funds from a previous employer pan to your IRA, the custodian still does need to be involved to make sure that those are being coded properly, that the proper, you know, filings are being made for those so that when Uncle Sam's looking at those transactions, he can check those off and smile to himself and be happy to know that that went from one qualified plan to another.

7:44Right? So, the custodian is is still there to have your back and help you be compliant with a lot of these IRA transactions. And when I'm saying IRA transactions, I'm talking about contributions to the plan. So, personal money that you're contributing to the IRA, distributions, so that's money that you're taking out of your IRA personally to yourself, or any rollovers or transfers, and that's money that's typically going from one qualified plan to another. So for any transactions like that, the custodian will be involved.

8:15And that's where you actually do want the custodian to be involved and have those processes in place so that you don't have to worry about, oh, I just I just rolled over these funds to a 401k. I got to file a 1099R. I got to I got to make sure that this is filed as a rollover and not a distribution for my plan so that Uncle Sam doesn't come after me. So, it's those it's those instances where you do want that custodian in place and and the custodian custodians like Silera are there to to take care of those processes. — Got it. Okay, that makes sense.

8:46Okay. And and so if we can talk like we talked about how the the self-directed IRA opens up options for you and you can invest in almost anything. Can you talk about some of the biggest rules when it comes to self-directed IRA funds? Like maybe it's around what what you can invest in or what you can't invest in and then also maybe how those transactions like you just talked about the contributions and the the rollovers, that sort of thing. But then also the investments themselves, how that money has to flow.

9:23— Yeah. So, when you're looking at the way the IRS outlines, excuse me, when when you're looking at the way the IRS approves or outlines approved investments for a self-directed IRA, they really don't have like a like a standard list that you can go to to look at, okay, like A, B, C, D, E, FG, these are all approved investments. They really only have a small list of prohibited investments. So, when you're looking at that list, really the only things they prohibit is first they won't allow you to invest in any life insurance policies or contracts.

10:01That's the first thing that they take completely off the table. Second, they take collectibles off the table. So, anything deemed a collectible, they do have a good list of what they consider a collectible. Cars, wine collections, stamp collections. They have a really great list again of what those are. Those are completely off the table. And the last thing that they really outlined that they say absolutely you cannot invest in this no ma no matter what the circumstance is subchapter S corporations which typically doesn't affect a lot of investors but really besides those three prohibited investments anything else is on the table.

10:39Now, that's not to say that there aren't, you know, additional rules and compliance items to consider, but just when you're looking at what can I invest in, the first thing that you want to look at that that first checklist is am I investing in a life insurance policy or contract? No, we're probably good. Is this a collectible? No, we're probably good. Is this am I investing directly with a subchapter S corporation? No. And that's that's really that first checklist you can go through to say, "Okay, this is this is an approved or this is this is not a prohibited investment for the IRA itself." — Okay, got it.

11:16Yeah, that that's super helpful. And then I know also when it comes to prohibited investments, a big thing is around self-deing or family members. So I think a lot of people first hear this and they're like, "Wow, this is great. I've got so much money in my 401k. I'm going to go self-direct it and use it to start investing in real estate deals that I own or fund real estate deals that I own or a a family member owns. What What are the specifics around that so that people can understand what they're allowed to do and what they're not allowed to do?

11:48— Exactly. Yeah, that's that's really that next big rule. So, you've got your prohibited investments and then the next thing just like you mentioned is those prohibited transactions. First one, you nailed it right on the head, no self-deing. And that really extends to who that really extends to who are prohibited or disqualified persons to your IRA. So we have prohibited investments and we also have disqualified persons. These are the people that your plan is not allowed to transact with.

12:20It's not allowed to benefit. These people cannot put sweat equity into any of the assets and we can talk a little bit more about that. But these people are really you as the account holder your spouse or your partner and then anybody directly on your that that core family line. I think the the way that IRS speak the the terminology they use is any lineal ascendants and lineal descendants. So when we when we think about lineal ascendants it's really just anybody above the family tree from you.

12:56So parents and grandparents would be disqualified persons. And when we're looking at lineal descendants, we're really looking at anybody below you on the family tree, which ends up being your your children, your children-in-law, your children's children, anything like that. But what a lot of people will mistake or they'll just hear that it's your direct family and they'll say, "Oh, so my brother's a disqualified person. That's too bad because he has this property I wanted to go in on with him." And that's that's really not the case. There's still a lot of people even in your immediate family that you may trust and you may work with that that aren't disqualified persons that people I think just immediately write off because of an assumption.

13:36Right? So cousins, uncles, aunts, brothers and sisters, these are all people that you may have good working relationships with and and have really strong trust with that you can still actually invest with. Now it's it's still important that just because you're investing with your brother, this brings up another really important IRA rule is is the express benefit rule. Just because you're investing, let's say, for example, you sell a property to your brother.

14:06Your brother is going to purchase that property and he's going to live in it. So far, nothing there is triggering any, you know, prohibited transaction. He's not a disqualified person. Everything looks good there. But let's say you go to your brother and he's saying, "Look, money's tight. Like, is there any way like you could get us just like a little bit under like the market rate for what we pay for rent?" And you're thinking, "A man, he's my brother. Like, I really want to help him out. Sure, I I'll give you like a hundred $200 below market rate for your rent." And that's where I think a lot of people can get into trouble because sure he's not a disqualified person, but the decision that you made, did you make that with the express benefit of the IRA in mind or were you thinking more about the benefit of your brother?

14:54Even though he's not a disqualified person, you're breaking that express benefit rule, which just like it sounds like all decisions, all transactions do need to be made with the express benefit of the IRA in mind. So, that's where a lot of people can get tripped up and it can be tempting, especially with those people you have closer relationships with to, you know, feel like you can cut them a deal or or things like that. But, that's another big, I would say, top five rule for self-directed IAS that that a lot of people overlook.

15:26— Interesting. Yeah, I didn't realize that. That if you're not if you bend the the rules on what is the best interest of the IRA, that that's a violation as well. Regardless of who you're working with. — Okay. So then I guess a lot of people would say, "Well, then how do I buy real estate with my IRA?" So what does that look like? How what do you have to do if you if somebody finds a great deal, they've got money in their IRA, how do they invest in real estate without self-deing?

15:59— Yeah. So, so what you're really looking at is making sure that all income and expenses are flowing through the self-directed account and with the structures that we set up with checkbook control. I can kind of give you an example of what it would look like. So, just to kind of reiterate the the checkbook controlled structure, right? We have this IRA that is over the top, this umbrella structure that owns an LLC or a trust. We'll just use LLC for this example. So, this IRA owns an LLC. The member of this LLC and you as the investor get to be the primary authority on this LLC.

16:34So you are the manager. You manage this LLC and from this LLC you are you're going to send money and that's where that's where comes in as you know Kirby where you have this LLC checking account that you can direct funds out of. You have all the capabilities of a regular checking account. You can send funds via wire. You can write checks. You can send funds via a if people allow that, but you have all those same capabilities of sending money. So, let's say you you identify a property, you're looking to close the deal.

17:05It's really as simple as being able to wire those funds or or write a check to whoever is brokering that deal. The really important part of of purchasing that property is whose name goes on the title. Who actually owns this house? And that's where you really want to make sure you're keeping it under that that IRA structure. So, you're not putting your personal name. This is not an asset that you own personally. This is actually an asset that your LLC owns.

17:36This IRA owned LLC is now the the owner of this property. So that's that's that's really high level what the ownership looks like. And then let's say you purchase this property and you want to start renting this out to tenants. So you get a tenant in the house and they start paying you rent checks. Who does that rent check go to? Who are they paying? They're not paying you personally, right? Because this is not an asset that you own personally. This is an asset that owned by that LLC structure.

18:09So they're actually paying that LLC, right? So, really a really simple way to think about it is once you have that LLC, all expenses, so investments that you're purchasing, properties that you're purchasing, they go out through that LLC checking account. All assets are owned by that LLC. And any income from those assets is also going directly back into that LLC checking account. And that's really the the first step in in remaining compliant and and purchasing in a in a in a compliant manner is is just making sure that you're paying that that you're you're buying in the proper way with the the LLC checking account and that you're receiving income in the proper way, which is again just right back through that LLC checking

18:57Account.