Bernard is here today to tell us how we can use our, or other people’s, retirement accounts to fund real estate transactions. Not only does that help us get deals done, but also helps people earn better returns with their retirement money. We’ll learn about the tax advantages, as well as what is not allowed by tax law. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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Bernard Reisz Background:
– CPA and Principal of ReSure Financial and combines tax, financial, and investment expertise
– Advises on the use of self-directed IRAs and Solo 401(k)s for real estate investing and lending
– Specialized in real estate debt and equity investing using retirement funds, and personally invests in that way
– Based in New York City, New York
– Say hi to him at: https://www.401kcheckbook.com/
– Best Ever Book: Phishing for Phools
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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any fluff. With us today, Bernard Reisz. How are you doing, Bernard?
Bernard Reisz: Doing great! Great to be with you, Joe, and with all the Best Ever listeners.
Joe Fairless: Yeah, we don’t wanna forget about them too, you’re right! Welcome, Best Ever listeners, and welcome, Bernard! Welcome, everyone!
First, Bernard, we’ve got to tell the Best Ever listeners a little bit more about your background, because it’s definitely relevant for our topic at hand. Your background – Bernard is a CPA and Principal of ReSure Financial and combines tax, financial and investment expertise; basically, he’s an expert on self-directed IRAs and the compliance and usage of those self-directed IRAs and Solo 401(k)s for real estate investing and lending. He’s based in New York City, New York. His website, which is in the show notes, is 401kcheckbook.com.
We’re gonna talk about self-directed IRAs and compliance responsibilities, so if you have a self-directed IRA or are curious about self-directed IRAs and you know a little bit about it, well perhaps we’re gonna educate you (and me) on some compliance factors that we need to be aware of. With that being said, Bernard, do you wanna give the Best Ever listeners a little bit more about your background and your current focus?
Bernard Reisz: Absolutely. My background is CPA; I’ve been involved in consulting, I’ve worked with some of the country’s largest corporations, Fortune 500 companies, and with individual investors. With that experience I’ve learned a lot about investing, tax and finance, and have seen that investors and individuals can really benefit by being put in the driver’s seat, by taking control of their own finances, rather than being sold to. There’s a lot that people don’t see, and through self-directed accounts and real estate they can dictate their own futures.
Joe Fairless: Amen! So with self-directed IRAs, real quick – let’s not assume everyone knows what it is, so can you quickly define it? I think 95% of the people listening do, but can you quickly just give us an overview of that and Solo 401(k)s?
Bernard Reisz: Absolutely. These retirement accounts, contrary to what Wall Street leads us to believe, can be invested in nearly any asset. So the tax code doesn’t define what you can and can’t invest in your retirement accounts. The tax code outlines the few things that you can’t, and those are collectibles and life insurance for IRAs. Other than that, for your 401(k) defined benefit IRA, if you can imagine it, you can invest in it.
Practically, the most popular investment for self-directed retirement accounts are real estate and some other angle in real estate, be that tax liens or private lending. There are so many ways to get into real estate and to leverage real estate in retirement accounts; there’s a way for everybody to get involved.
Joe Fairless: How are the profits taxed when you make money on a deal after you invest with a self-directed IRA?
Bernard Reisz: Okay, so there are a couple of stages to analyzing that. Some of that relates to all IRAs and some of that is unique to self-directed IRAs or IRA LLC’s and Solo 401(k)s. In general, with IRA taxation and 401(k) taxation there are two routes – there’s what we call traditional contributions and then there are Roth contributions. With traditional contributions you’ve got a tax deduction for all the money that flows into your account. Everything grows tax-deferred, but at some point, usually around age 70, those funds have to start being distributed from the account, and then it’s taxed as ordinary income. So you get the power of 50, 40, 30, 20 years of tax deferral and upfront tax deduction, but there is ultimately taxation.
The other approach is the Roth approach. With the Roth approach there’s no current tax deduction for putting the funds in, but subsequently all gains come out completely tax-free. So you’ve got great deals, you’ve got things that have the potential for high appreciation, you want a Roth, because everything will be completely tax-free.
Joe Fairless: Yeah, so the other scenario would be if you think you’re gonna be making more money at age 70 than today, you’d wanna do Roth, correct?
Bernard Reisz: Absolutely. Because if you’re in a higher income tax bracket, then you wanna get all the Roth funds out completely tax-free. That’s exactly it.
Joe Fairless: What are some common questions that you get from your clients who ask about self-directed IRAs and doing a Solo 401(k)?
Bernard Reisz: One of the most common issues that comes up relates to self-dealing. So while it’s really exciting to be able to invest tax-free in real estate, there are certain limitations. One of the things that we like to make clear at the outset is that you can buy real estate with your retirement plan, but you can’t buy real estate from yourself or from your spouse or from a child or a parent. So the IRS has set this up to try to keep your present self from benefitting, and restricting the benefit to your future self.
So you can buy real estate, but you’ve gotta be aware of those restrictions, and that, I think, is a very common issue that comes up the first few minutes of every conversation.
Joe Fairless: What’s a use case where someone would be doing it incorrectly?
Bernard Reisz: Somebody may have a property that they see is profitable and there’s appreciation, and they get excited about moving that into a retirement plan and having that tax-free. That’s one of the things that gets people excited, which unfortunately cannot be done; you’ve got to buy the property with your retirement account in the first place.
Joe Fairless: Okay. If the property is owned by your retirement account, then that is either tax-deferred, or it’s taxed immediately and then not taxed on the exit, depending on either traditional or Roth.
Bernard Reisz: That’s exactly it.
Joe Fairless: Okay. What’s another question that you get?
Bernard Reisz: There’s another common question that relates to people that want to invest in the type of real estate that involves more than long-term buy and hold and flips; they wanna invest in hotel kind of properties, and that brings up an issue related to something called UBIT – Unrelated Business Income Tax. This I’d say relates to the tax question that we spoke about a few moments ago.
Retirement accounts are tax-free, but occasionally you could inadvertently engage in a transaction that can result in tax within the IRA, and that kind of tax is something called UBIT, and Congress enacted that to keep tax-free accounts from having an unfair competitive advantage over other active businesses.
Joe Fairless: I’m having trouble following you on this one. Will you give an example?
Bernard Reisz: Absolutely. When you get engaged in something that’s active business and it’s ongoing and continuous, Congress enacted a tax on tax-free accounts, and that would apply potentially on flipping real estate. So if you engage in lots of flips inside a retirement account, that potentially results in taxable income to the retirement account.
Another example would be the hotel scenario we’ve described, where you’re going beyond providing the traditional landlording services and providing room services and things of that nature, and the IRS says that’s not an investment business, that’s an active business.
Joe Fairless: Oh, okay. Do you have to be passive?
Bernard Reisz: You certainly do not have to be passive; on the contrary, there are great deals that are available even after the tax, and I think this is a great segue into some of the great benefits of self-directed retirement accounts. Why would you use your retirement account for real estate? The benefit is many-fold, depending on each investor’s stage in their real estate investing career.
For some that are experienced and they’ve got their team in place, they’ve got their strategy, they’re gonna do better in real estate, their returns are great and they identify great deals – they should be deploying all their capital in real estate; as much as they can get into it, that’s what they should do because they’ll do better there than anywhere else.
So even after these taxes, they’ll still do better in their IRA, putting their IRA into real estate, than having it in the traditional space.
Joe Fairless: And I just wanna close the loop in my mind on the unrelated business income tax – you mentioned flips and the hotel scenario… Let’s just go with the flip scenario. If you have an LLC that has, say, 100k and you flip a house and then you take the profits and you keep it in that same LLC that’s through your self-directed IRA and you just keep flipping houses… Say you do one a month – then that would be a red flag?
Bernard Reisz: It’s not a red flag. Actually, it’s perfectly legal, but there would be an income tax to pay, and it wouldn’t be an income tax of the individual that has the IRA, but the IRA would get its own EIN, and it would file its own income tax return to pay taxes on that income.
Joe Fairless: Okay, because it’s more of a business versus an investment.
Bernard Reisz: Exactly.
Joe Fairless: It seems like that would be a grey area, for if it’s a business-oriented investment.
Bernard Reisz: Very grey area, very murky. There’s really nothing in the tax law that outlines what the guidelines are for when something crosses a threshold to an act of business. There was a tax case that went to tax court in which there were nine flips done in the retirement account in a year, and there was no assessment of UDFI; there was no assessments of such tax. That doesn’t establish a precedent, but that just shows us that it’s really grey, and you could potentially go up to quite a few flips without incurring the tax.
Joe Fairless: Okay, now going back to the benefits… The first one you mentioned is if you’re good at real estate, you might as well put more money into real estate to make you more money, and that will likely outweigh the taxes you’ll pay. What are other benefits?
Bernard Reisz: That’s for the experienced investor. For many people that are just getting started, real estate provides an opportunity that’s not available in traditional markets. Traditional markets are fairly efficient – there’s something called efficient market hypothesis; you’re not gonna build incredible wealth in the stock market, and you’re gonna have to deal with the volatility.
Real estate can be an inefficient market; there are opportunities there that can be life-changing for people that get into the game with the proper team. The question is “How do you get in? Where is your capital?” Real estate requires some sort of capital, and IRA LLCs and Solo 401(k)s provide that entry point.
There are people who have capital tied up in retirement accounts that aren’t doing much – they can use that capital to make their initial foray into real estate; they can leverage the IRAs of other folks (of friends and family) that are not disqualified persons to get funding for deals. Beyond that, they could become private lenders. If you’d like to get into real estate and you know somebody that’s successful and is active in real estate and you wanna get his guidance, you can say “I’ve got an IRA. We’ll lend this money on your deals” and this way you can get your feet wet and learn about real estate and get into the game, which is really the only investment opportunity that can be really that life-changing.
Joe Fairless: You just can’t lend to your family?
Bernard Reisz: That is again tax code! So you can’t lend to what the tax code calls “disqualified persons”, and there are lots of family members that are disqualified, and there are lots of family members that are not disqualified. The list of disqualified family members would be a spouse, children and the spouses of children, and parents. Spouses of parents are not disqualified, meaning somebody that’s not a biological parent and married one of your biological parents. Siblings are not disqualified, friends are not disqualified, boyfriends and girlfriends and domestic partners are not disqualified, nephews and nieces, in-laws… So the list of people that are related that are not disqualified persons is pretty broad.
Joe Fairless: Is checkbook IRA another way of saying self-directed IRA?
Bernard Reisz: Definitely not. Checkbook IRA is an exciting way to take self-directed IRAs to the next level, to make them really flexible and really cost-efficient. When we talk about a regular self-directed IRA, we’re talking about an IRA that sits at a custodian; the custodian controls the funds. Every single transaction, every single document has to be processed by the IRA custodian. That can take time, that incurs fees.
Each time you’ve got a deal that you’re pursuing and you need to get that deal before somebody else does, which happens in real estate all the time, particularly looking at REOs, share of sales, you’ve gotta be nimble and move quickly. Having it at a custodian can be an obstacle.
The checkbook IRA is a very creative workaround that puts you in total control of the funds. To get a checkbook IRA involves setting up an entity that’s held by the custodian, so we usually use an LLC. All the funds move into that LLC; that LLC has a bank account over which the IRA owner has signature control, so it can be run like a regular business. Is that clear?
Joe Fairless: That is clear. What type of liability do you open yourself up to as the owner of the Checkbook IRA versus having a third-party handle all of the stuff for you?
Bernard Reisz: The potential of engaging in a prohibited transaction increases. You’ve got total control, and when you have those funds you wanna make sure you don’t accidentally use the money in that bank account to buy groceries, you don’t wanna use that for any personal funds… It’s gotta be clear that those are IRA funds to be used for investment purposes only. Don’t accidentally or inadvertently use them for yourself.
Joe Fairless: How come retirement accounts are called tax-free when in fact you get taxed, either on the entrance or on the exit?
Bernard Reisz: There is a tax deferral. Roth IRAs we’d say are tax-free on the earnings… When we say tax deferral, among us, financial professionals, we immediately know what that means. To most of the people out there that are not CPAs, the term deferral would throw them off, but it’s a way of saying that there are incredible tax benefits to using these accounts.
Joe Fairless: So it’s not accurate, because it’s not actually tax-free.
Bernard Reisz: Yeah, a traditional IRA is gonna be taxed on the way out; it’s tax deferral. Roth IRAs are tax-free on all the profits and gains, but the money that goes into it is not tax-free.
Joe Fairless: Right. In some form or fashion you’re getting taxed, in any of these accounts.
Bernard Reisz: Yes, absolutely.
Joe Fairless: Okay. Because I always say as a multifamily syndicator our investments are tax-deferred, and then if I hear not an investor but a tax person say their investments are tax-free, I just was always wondering that question. So they’re all tax-deferred.
Bernard Reisz: They’re all tax-advantaged. That’s the term I try to use, tax-advantaged.
Joe Fairless: Yeah, because the terminology might be a little bit different, depending on which one. What is your best real estate investing advice ever for investors, as it relates to your background and your expertise?
Bernard Reisz: I’d say real estate is something you’ve gotta get into; you’ve gotta get an angle, you’ve got to associate yourself with real estate pros in your neighborhood, and you’ve gotta take that leap, and you’ve gotta access the capital that you have available to you, and there is an abundance of capital that’s locked up in retirement accounts. Over 25 trillion dollars is sitting there in retirement accounts. That’s greater than the US national debt, which may change before we got off this phone call… But there’s just so much power locked up in there, and you should use that to get into the market.
Joe Fairless: Are you ready for the Best Ever Lightning Round?
Bernard Reisz: Let’s go for it!
Joe Fairless: Alright, let’s do it. First, a quick word from our Best Ever partners.
Break: [00:19:21].13] to [00:20:19].21]
Joe Fairless: Best ever book you’ve read?
Bernard Reisz: Phishing for Phools. That’s by George Akerlof, Nobel prize winner. He goes out and explains how there are so many places in the financial markets that we are being taken advantage of, and you’ve got to be aware and cognizant of that and look out for yourself.
Joe Fairless: Best ever resource other than that book that we can be educated on self-directed IRAs, Solo 401(k)s, checkbook IRAs, things like that?
Bernard Reisz: That’s a good one. I’d say we try to put up on our website a wealth of information, and we’re always refreshing it; we put links to the tax code, we go down deep into details, and we’re always refreshing that information with new angles and new ways to go about it.
Joe Fairless: And there’s a link to that in the show notes page. I didn’t expect to give you a layup, but hey, I’m on your side and you do have a bunch of good stuff, so we’ll go with that. What is a mistake you’ve seen one of your clients make as it relates to your area of expertise?
Bernard Reisz: I’ll give you more than one answer if I may, because I really want the Best Ever listeners to be aware of this. When you’ve got an IRA LLC, you may go to Home Depot, you’ll maybe go to a store and they’ll offer you a credit card. Don’t take it. That can be a prohibited transaction, because you’re taking and personally guaranteeing the liabilities of your IRA.
Joe Fairless: That’s a good one. You said you have another?
Bernard Reisz: The other would be when opening your IRA LLC account, I discourage funding the account with personal funds; that could potentially be interpreted as a prohibited transaction. Often times you go to a bank and you open the account for your IRA LLC or Solo 401(k) and the banker says, “Okay, you’ve gotta put some money into the account.” So you’ve gotta tell them, “We’re gonna move the money from my custodian. It’s coming over. I don’t wanna put personal funds in here.” We, as part of our services, we deal with the bankers and we iron that out.
Joe Fairless: That’s great. Those gotta be two common mistakes that come up, because those are kind of spur of the moment types of decisions people need to make, versus a decision where they’re in front of their computer, e-mailing or can call; these are in-the-moment type of things.
Bernard Reisz: Yeah, that’s it… And we’ve gotta be there for our clients to make sure these don’t happen and pre-empt that before they occur.
Joe Fairless: Best ever way the Best Ever listeners can get in touch with you?
Bernard Reisz: Best way to get in touch with me is direct e-mail, Bernard@ReSureFinancial.com. We’d love to hear from all the Best Ever listeners and help everybody out in the system and get in control.
Joe Fairless: Thank you for being on the show. I’ve done many interviews about this subject, and you’ve taught me some things that I haven’t learned in other conversations, so I’m grateful for that and I know the Best Ever listeners are as well.
Some things we can’t do, the last two things you’ve mentioned, that is don’t take a credit card out at Home Depot or wherever, because you’ll be personally guaranteeing against that, and it might be considered a prohibitive transaction. Then also when you open an account with your LLC at a bank, don’t personally fund it – again, a prohibited transaction, or it might be considered that. And then some limitations and some benefits as well, which we’ve talked about.
Thanks for being on the show. I hope you have a best ever day, and we’ll talk to you soon.
Bernard Reisz: Joe, thank you for having me, and thank you to all the Best Ever listeners for listening, and I look forward to being in touch.