April 15th fast approaching, many of us have taxes on our minds.
Mostly, we are thinking, "How come I'm paying so much and where
is it going?" This topic is so time critical and I've had several
premium members ask me questions about how to invest in tax liens and
real estate using their retirement accounts.
a quick reminder for those of you who would rather focus on an online
tax lien or tax deed sale, California has tax deed sales going on right
now. In fact, Kern County's sale is on Bid4Assets.com
. Or, take what we
learned last month and visit SRI-taxsale.com
for the Jasper County,
Indiana sale going on now and scheduled to end on April 13th. I'll be
happy to address any questions you have on either sale, during our
conference call. Next month, we will have Florida tax lien sales in
full gear and I will profile a Florida sale.
Now, back to investing without paying taxes...
One of the best ways to maximize your investing returns is to become
tax efficient by investing through an invidual retirement account
Imagine being able to invest in real estate, tax liens or even businesses tax free or tax deferred. Well, amazingly you can.
many estimates the retirement industry is in the mulit-trillions and
yet only about 2% of that money is invested in non-traditional
retirement investments like real estate or tax liens. I have to admit
that I have only known about
true self-directed IRAs for a few years. The problem is that many of us
think we have a self-directed IRA through our brokerage
company and it's far from being truly self-directed.
What you may not realize is that you can also buy
any of the following with a true self-directed IRA:
- Real estate – raw land, single-family
homes, multi-family units, apartments, mobile homes, commercial
Whether you’re buying and selling foreclosures, holding on to rental
properties for an extended period, purchasing tax liens or buying
notes, Uncle Sam is anxiously awaiting his cut of the profits. If
you’re like me, you don’t mind paying your fair share, right? The
point is to minimize your tax liability. You are not trying to get
by without paying taxes; rather, you just want to make sure that you
only pay what is required.
Tax Rates - Beware They Are Changing
If you buy and sell property and make a profit, you incur
capital gains. Long-term capital gains are generally taxed at a rate
lower than your personal income tax rate. The IRS (Internal Revenue
Service) considers long-term investments as being more than one year.
Short-term capital gains and interest income are taxed at your normal
income tax or marginal rate, which is generally 25 to 28 percent for most
taxpayers, but could be as high as 35 percent for some taxpayers. The
current federal tax rates (retroactive for the 2003 tax year) are 10,
15, 25, 28, 33 and 35 percent.
The long-term capital gains rate is 15 percent for most taxpayers. If
you fall into the 10 or 15 percent tax brackets, for 2008 to 2010 the
long-term capital gains rate is 0 percent.
The rates are changing and this makes retirement investing even more
Starting in 2011, the long-term capital gains and dividends revert back
to pre-2003 levels or 10% for those below the 15% marginal rates and
20% for those above that rate. In essence, most taxpayers who own real
estate will now pay at least 20%.
On March 21, 2010, Congress signed into law the new Health Care Reform Law. This
law increases taxes on medicare for individuals making over $200,000 or
couples earning over $250,000. The surcharge imposed is approximately
3.8% on all income making the long-term capital gains
rate as high as 23.8%.
All of this is to say that investing inside of a retirement account is
getting more and more attractive.
An Individual Retirement Account or, as the IRS now calls it, Individual
Retirement Arrangement (IRA) is a savings account that allows you to
set aside investment income allowing it to grow tax deferred
(Traditional IRA) or tax free (Roth IRA). Depending upon your modified
adjusted gross income, you may qualify for a tax deduction in addition
to the tax deferred or tax free earnings growth.
Most of you have heard of IRAs and many of you probably have an IRA
account. To qualify for an IRA account all you need is a social
security number and earned income equal to or in excess of the amount
that you contribute. In other words, if you only make $1,000 in income
for the year, you can only set aside up to $1,000. Additionally, when
you reach age 70 1/2, you are required to start taking distributions or
dipping into your account.
For 2010 the contribution limit is $5,000. If you are over 50 years old
you can increase your contributions by an extra $1,000 per year.
You are not allowed to withdraw money or assets from a traditional IRA
before age 59 1/2 without paying a 10% penalty.
For Roth IRA’s, you are allowed to withdraw your contribution amount
penalty free, but not the earned interest amount. There are some
exceptions to the withdrawal penalty amount, such as:
- Unreimbursed medical expenses that exceed your
75% adjusted gross income
- Distributions to buy, build or rebuild your
- Beneficiaries of a deceased IRA owner
- “Qualified” higher education expenses
For the latest rules (2009 and 2010) on IRAs, refer to IRS Publication
find the publication, go to IRS.gov and type 2010 publication 590 in
the Search Results. The latest PDF document is actually still a 2009
For 2009, the money you contribute is tax deductible if your adjusted
gross income (AGI) is below $89,000 as a joint return or $55,000 as a
single taxpayer or head of household. The deduction phases out for
joint taxpayers between $89,000 and $109,000, and $55,000 to $65,000
for single taxpayers or heads of households.
For married individuals filing a separate return, the deduction only
qualifies if you make less than $10,000.
For 2010, the AGI limits increase for single taxpayers to between $56,000 and $66,000; for single taxpayers or
heads of households and joint filers the limits remain the same.
Also, if you or your spouse is not covered by a retirement plan at
work, you may qualify for the full deduction. Unfortunately, this
exception used to be unlimited. For 2010, the limits are $167,000 to
Even if you don’t qualify for a deduction, you can still contribute up
to the maximum annual contribution and the taxes are deferred until you
pull out your money during retirement. If you are over age 50, you can
set aside even more using the government’s “Catch Up Limits.”
||Single/Head of household
||$55,000 - $65,000
||$89,000 - $109,000
||$56,000 - $66,000
||$89,000 - $109,000
Contribution Limits for Traditional and Roth IRAs
The Roth IRA was named after the late William Roth, a Senator from
Delaware. Roth IRAs are an ingenious design, which allows you to pay
taxes on the front end and receive tax free earnings on the back end.
For real estate investors this is almost too good to be true. You can
setup a Roth IRA and you will be required to pay taxes upfront. In
other words, you don't get the tax break now on what your contribute,
but your earnings are tax free later.
Example: You set up a Roth IRA and contribute the maximum. You are age
52 so you can contribute up to $6000. You use this money to purchase a
tax deed for $3500. You then hold the deed for two years and sell it
wholesale to another investor for $15,000. Assuming your expenses are a
total of $2500 with taxes, insurance and realtor fees. You are in it
for a total of $6000 so your profit or capital gain is $9000, which in year 2012 would
have been taxed at 20%. You save $1800 in taxes.
|Year||Single/Head of Household||Married/Joint|
|2009||$105,000 - $120,000||$166,000 - $176,000|
|2010||$105,000 - $120,000||$167,000 - $177,000|
Again, if you are married and filing separately, your limit is $10,000.
A Simplified Employee Pension Plan (SEP) is a retirement plan that
allows you or your company to set aside retirement savings under the
umbrella of an IRA. The maximum percentage of annual compensation that
an employer may choose to contribute is 25% of the participant’s salary
or $44,000, whichever is smaller. A SEP is considered as a Defined
Contribution Plan and according to IRS guidelines you cannot contribute
more than the maximum contribution ($46,000 for 2009 and $49,000 for 2010) to all Defined
Contribution Plans (refer to IRS Pub 560, Chapter 4).
SEPs can be set up anytime up to the date of the employer’s return,
- Are 21 years of age or older
- Have worked for the company for at least 3 years of the last 5 years,
- Have received at least $450 in compensation.
Your business can establish less restrictive requirements.
To set up a SEP plan, your business must put together a formal written
agreement (Form 5305 – SEP) to provide benefits to all eligible
employees. You are also required to provide information regarding the
SEP to your employees.
Special Note: A SEP-IRA cannot be set up as a Roth IRA.
If you are self-employed, special rules apply to how you calculate your
deductions using a SEP-IRA. Self-Directed 401(K) Plans
Individual (K) or Solo 401(K) Plans
are designed to bridge the gap between the benefits that an
individual would receive working for him or herself versus working for
a large company with a 401(K) plan. The catch here is that it is only
designed for sole proprietors or businesses where only the owners or
spouses are covered. In other words, outside employees would not be
Okay, so how does this work? Well, if you or your spouse earn income
through self-employment, as a sole proprietor, partnership, LLC,
corporation or as an independent contractor without any employees, then
you are eligible for this unique retirement plan. Like IRAs, you must
decide whether you will tax defer your income or use the Roth
alternative and delay your gratification for a potentially huge
Roth versus Traditional Solo 401(k) plans allow you to set aside up to $15,500 for year
2009 or $16,500 for 2010. If you are over 50, you may be able to include a catchup amount. With the Roth alternative, the
first portion of your income goes to the Roth and the rest goes to your
traditional solo 401(k).
Again, imagine buying an investment like a tax deed for $4,500 and selling it
for $50,000 without paying any taxes on the capital gain. Imagine
purchasing a short sale foreclosure for only $9,000 (it’s possible in
some locations) and selling it for $76,000 without paying any taxes.
Or, imagine buying a piece of paradise (beach front property) for only
$50,000 and selling it for over $120,000 all tax free. Your Roth can
make this happen and the benefit of a Roth 401(k) is you can set aside
about three times more than you can with a Roth IRA.
can’t take an immediate tax break with a Roth, but your benefit comes
later when you pay no taxes on the interest, income or capital gains of
With a Traditional 401(k) your contribution is deducted from your
adjusted gross income and you receive a nice deduction on your current
taxes. For example, if you made $76,000 and you set aside $15,500, then
your new adjusted gross income is only $60,500. Or, in simple language,
you are not taxed on the $15,500. This can be a real life saver when
April 15th (tax day) rolls around, plus it is a forced way to save.
Now, when you withdraw this money during retirement, you will be
required to pay taxes on it plus any interest earned.
Here are the requirements for a Solo 401(k)
1. You must establish an account before the end of the tax year so the April 15th date doesn't apply.
2. You can begin taking distributions at age 59 1/2. You are required to
take distributions at age 70 1/2 with a Traditional solo 401(k) plan.
3. You cannot contribute more than you make.
4. Your income must be 1099 or W2 income; it cannot be distributions,
such as K1 income.
5. For tax years 2009 and 2010, you can set aside up to $16,500 in
income plus 25% of revenue from a business or 20% from a sole
proprietorship. Your spouse can set aside the same amounts. If you are
over 50 years old, you can set aside an extra $5,500 in income per
6. You must hold it in the plan for at least 5 years.
If you know anything about IRAs, already you will recognize that you
can set aside more money by far in a solo 401(k) plan than an IRA.
Currently, the limit for IRAs in years 2009 and 2010 is $5,000 or $6000
if you are over 50 years old.
Here is what you can’t do in a Solo 401(K)
1. Invest in, sell to, lease to or exchange property with a
disqualified person. The following are disqualified persons: you, your
spouse, mother, father, kids, grandparents or any person you designate
as a beneficiary.
2. Use your 401(k) for certain investments, but the requirements are
not as stringent as IRAs.
3. Use your 401(k) as collateral for a loan.
4. You or a disqualified person cannot receive a benefit or goods or
services from your 401(k).
5. Invest in a business of which you own more than 50 percent or of
which a combination of you and/or disqualified persons own greater than
The fees to set up a self-directed 401(k) account range from about $50
to $250 per year, with a setup fee of about $100.
While there are Administrators who will help you set up a solo or
individual 401(k) plan, most are brokerage houses that will limit your
investments to stocks, bonds and mutual funds.
Here's what you can do in a Solo 401(K)
1. You can self-direct your plan and set it up with check book control.
2. You can borrow up to 50% of your plan’s value, usually up to a
maximum of $50,000.
3. You can invest in S-corporations and some other investments not
allowed through your IRA.
4. You can set aside more money tax free and/or tax deferred than in an
5. There are no income requirements to qualify, like IRAs.
6. You can obtain a non-recourse loan for buying real estate without
triggering the unrelated business taxable income (UBTI) rules, unlike with
The Savings Incentive Match Plan for Employees is a type
of retirement plan that allows small employers (less than 100
employees) to provide the same type of retirement benefits that a large
company might have. SIMPLE plans can be set up as SIMPLE 401(k) plans or
SIMPLE IRA plans. According to the IRS (see Publication 560:
), an eligible employee must
have received at least $5,000 in compensation during any 2 years
preceding the current calendar year. An eligible employee must also be
likely to receive $5,000 in the current year. However, these rules are
the maximum requirements, so you can setup a SIMPLE as a business owner
and make the requirements less restrictive or you can completely remove
the requirements. You cannot make the requirements more stringent than
the $5,000 and 2 year maximums.
With a SIMPLE plan, an employer must match between 1% and 3% of each
employee’s compensation or an employer can choose to contribute using a
fixed contribution of 2%.
SIMPLE plans must be set up between January 1st and October 1st of any
calendar year. With a SIMPLE plan, you can tuck away even more than you
can with a traditional or Roth IRA. Compensation for employees is the
total wages required to be reported on Form W-2.
With a SIMPLE
Plan, you can contribue $11,500 + $2,500 if you are over 50.
Special Note: A SIMPLE-IRA cannot be set up as a Roth IRA.
If you or any other employees take advantage of another employer plan
during the same year, then the salary reduction contributions under the
count toward the overall elective total. You can also deduct
contributions to a SIMPLE IRA
plan, if they are made for that tax year and are made by the due date
(including extensions) of your federal tax return for that year.
Educational Savings Accounts
Educational Savings Accounts, also know as Coverdell Education Savings
Accounts, allow individuals to contribute money for a child’s
education in a tax-deferred environment. Although the contributions are
not tax deductible, the earned interest is tax-deferred. As of 2010,
the annual contribution limit is $2,000 per child and children are
considered 18 years or under. And you are eligible for a full
contribution to an Educational Savings Account if your modified
adjusted gross income is below $110,000 (individual) and $190,000 to
$220,000 (joint) the contribution is prorated.
What You Can’t Buy - Everything Else You Can
There are a few items that you can’t buy through an IRA and these are
included in IRS publication 590
In short, you cannot invest your IRA money in
Who Can Touch Your IRA Money
- life insurance contracts,
You are also not allowed to buy,
sell or exchange property or investments with a disqualified person, such
as you, a spouse, child, father, mother or others who are closely related to
you (refer to Publication 590).
Warning: It is possible to trigger a taxable event in your nontaxable
account, which could result in your entire account being taxable –
oops, we don’t want that. It may be a good idea to set up a separate
account and fund it gradually or only rollover a limited amount of your
retirement money; in other words, don’t put all of your “eggs in one
All income generated by an investment that
is owned by your IRA must return to your IRA
, in order to retain the
tax deferred or tax free status of the investment. An example would be
if you buy a rental house and it earns income, the income must return
to the IRA, not you. Make sure your renters write checks directly to
the IRA and send it to the IRA. You can request that your renters
submit a copy to you. Any expense should also be paid from the IRA, not
You Are Not Your IRA
Your IRA is Like a Business or Trust
You cannot have your IRA do the following:
- Buy real estate through your IRA that you currently own or will own
or that a close family member owns, such as your wife, son, daughter,
- Buy into a partnership or business that you currently own
- Receive unreasonable compensation for property management
- Invest in or start up a Subchapter S Corporation
You can not receive a personal benefit from your IRA.
Use it as security for a loan.
example that I heard recently was a gentleman who bought a classic car
as an investment. Okay, so far so good. It is not restricted according
to IRS Pub. 590. However, strictly speaking he got into trouble when he
occassionaly drove it around on a Sunday afternoon. The proof was in
the odometer. What he could have done is rent it out at a reasonable
rate to his IRA or prove that he needed to take it to a mechanic using
IRA money and fix it or improve the value.
Another common mistake is to buy a vacation property with your IRA and then use it for personal benefit.
What about borrowing money for a rental house? Welcome to a whole set of complicated rules in tax laws called UBTI.
Tax on Unrelated Business Income.
Certain tax exempt entities, such as charities or universities, as well
as IRA’s, are subject to taxation of the portion of their income that
is not substantially related to its exempt purpose.
So, how does this apply to real estate investing?
In short, the amount of investment income attributed to debt financing
is taxable. In other words, if you use your self-directed IRA to
purchase a property and you finance (obtain a loan) any portion of the
property, the amount of income received from that financed portion is
Here is an example:
You purchase a rental property for $100,000 and use $20,000 from your
self-directed IRA. The remaining $80,000 is obtained from a hard money
lender through a mortgage. The amount you borrowed from the hard money
lender ($80,000) is referred to as acquisition indebtedness. You fix up
the property and sell it for $125,000. You would be liable for $25,000
in capital gains minus expenses (paid by your IRA). Assume $5,000 was
spent to fix up the property, you would be liable for 80% of the
$20,000 = $16,000 and your tax deferred portion would be $4,000.
Also, note that any rental income would be treated in a similar manner.
A portion of it would be taxable. Since this gets a little complicated,
you will need to speak with an accountant or IRA facilitator. (Refer to
IRS publication 598 at http://irs.gov/pubs/irs-pdg/p598.pdf
You may have heard of checkbook control. How does that work?Checkbook Control with an IRA
purchasing tax lien certificates with an IRA, it is often advantageous
to have your IRA own a separate business entity, such as an LLC
(limited liability company). In fact, your IRA will own the business
100% and either you can be the manager with no ownership rights or you
can designate a manager, such as your accountant or attorney.
point is to be able to use an employer identification number and bank
account to quickly and efficiently transact business. Otherwise for tax
lien certificates, you will be requesting money from your Trustee and
that can take 3 business days and create unnecessary fees.
This brings up a good point about valuing a business. You may be required to submit a valuation on an annual basis.
IRAs in Summary
You will need to contact another company that is set up to handle a true
self-directed IRA. You can find information from these companies on
rolling over an existing IRA or qualified retirement plan or setting up a
new IRA account. Any purchases or sales will need to be made in the
name of the IRA trust account, unless you have the IRA invest in an LLC
that you control. Then, you can truly realize flexibility.
A list of trust companies is presented below.
Remember, you can set up a traditional IRA and earnings are deferred
until retirement. You can also set up a Roth IRA by paying the taxes
upfront. Any earnings in a Roth IRA are tax free. That’s right. You do
not pay taxes on the earnings. The sky is the limit. If you have
children, like I do, consider setting up or rolling over an educational
savings account. If you’ve left an employer and have a 401(k) plan, you
can roll it over into an IRA. For small businesses, you should consider
setting up either a SEP or SIMPLE plan in addition to your standard or
Roth IRA, then you can truly recognize the power of savings and
Your IRA was designed to give you
flexibility in saving for retirement; however, it seems that only
brokerage companies caught on. They control much of the process and
they limit what you can purchase. After all, they don’t make any money
off of your purchase of a foreclosure or a tax lien certificate. Take
control of your savings now by contacting a qualified trust company. Be
sure to do your research, ask questions and make sure you are
comfortable with the company that you select.