March 2, 2019

JF1642: Leveraging Self Directed IRA?s For Real Estate Investments & Paying Minimal Taxes with Edwin Kelly

Many people would like a way to invest in real estate and pay less taxes. Well what a lot of people may not know, is that they may have the capital available to do this, they just have to move it around, get it into a self directed IRA, and have some professional guidance. Listen in for tips on executing this strategy. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!


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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 of that fluffy stuff.

With us today, Edwin Kelly. How are you doing, Edwin?

Edwin Kelly: Joe, I am doing fantastic, man, and I am glad to be here.

Joe Fairless: Well, I’m glad that you’re here. A little bit about Edwin – he’s an expert on self-directed retirement accounts and self-directed investment strategies. He is the CEO and co-founder of Specialized IRA Services. He’s got more than 24 years of experience in the financial services industry. Based in Albuquerque, New Mexico, he’s got clients across all the states.

With that being said, Edwin, do you wanna give the Best Ever listeners a little bit more about your background and your current focus?

Edwin Kelly: Yeah. I’ve been in self-directed, as you just mentioned, for a long, long time… So for folks who are listening, if you wanna invest in real estate, tax liens, notes – any of these investments that so many of us are doing, and you wanna do that and eliminate taxes from the equation, then the best way to do that is to do that through a self-directed retirement account. But to do that, you actually need what we call a truly self-directed IRA provider; that’s what Specialized IRA Services does, in a nutshell. We’ve just launched a second company, called Specialized Trust Company, so you’ll hear both of those names going forward… But what we specialize in is allowing clients to take their retirement — and there’s two ways, actually, Joe, to use self-directed retirement accounts. The first way is use your own retirement account to create tax-free wealth inside of it. What happens is is that a client will open up an account with us, transfer money in if they have a retirement account someplace else, and then they’re able, once that money is in the account, to invest in all kinds of things, like real estate.

The other way that a lot of investors are using self-directed retirement accounts is not by doing transactions so much in their own account, but using other people’s self-directed IRAs to act as the bank and fund their investment deals. So those are two ways that they come together, and again, to do all those things, you need a self-directed retirement account provider as part of your team to make that happen.

Joe Fairless: Why launch Specialized Trust Company?

Edwin Kelly: So the way it works is to do the business that we do, you have to be licensed by a state, and you get a trust license. So when we originally launched, we launched as an administrator, and worked with another custodian.

What happened was after the first few years we grew enough, and we were growing very rapidly, so we decided to start our own trust company and jettison the other trust company that we were operating under, hence that’s where Specialized Trust Company came in. We’re really proud of that.

Just as a side note, the two best states to get a license in are New Mexico and South Dakota, hence why I’m sitting in Albuquerque; you’re not in Albuquerque with me, but I’m in Albuquerque, and to get a trust charter is one of the most grueling, difficult tasks you can imagine… But to put that in perspective, our license number is 31, because they have only issued 31 of these licenses in the entire history of the state of New Mexico. So it is not something that gets handed out easily or regularly.

Joe Fairless: I’d love to learn more about that… First off, why is — did you say South Dakota?

Edwin Kelly: South Dakota and New Mexico.

Joe Fairless: So why are South Dakota and New Mexico the two best states for being registered?

Edwin Kelly: It has a lot to do with the state rules on the books. It’s kind of like how a lot of people go to Delaware to get a corporation set up. It would be a similar concept, except we’re talking about a trust charter. So the rules and regulations are very favorable for trust companies and trust company clients in those two states, which is why we looked at those two states — and I was not gonna move to South Dakota, so New Mexico was it.

Joe Fairless: What about the rules are more favorable for trust companies and trust company clients? What are some bullet points?

Edwin Kelly: A lot of it just has to do with the favorable regulatory environment. There’s some states where the regulatory environment is more restrictive, which then can show up in terms of the state or the regulator saying “Hey, we don’t like this kind of an investment, so we don’t wanna see a lot of these on the books.” That’s a direct impact to the client. So by operating in a state and getting licenses in a state where they have very favorable rules and they’re very flexible, and the state is very supportive of trust companies and the rules and regs, and allows clients to do anything that’s allowed by the government – those are the best places to kind of hang your hat, if you will.

Joe Fairless: What would be an example of something that because you all founded in New Mexico you can do, that if you were founded in California you wouldn’t be able to do?

Edwin Kelly: Well, it’s not that black and white, but as an example there might be some regulators that say “We don’t like to see unsecured notes”, or “We don’t wanna see a lot of those. So if you have a few, that’s fine, but we don’t wanna see a lot of those kinds of investments.” Then that puts a challenge on the company, and they have to put rules in place that will restrict maybe that type of an investment, clients who wanna do those.

Joe Fairless: Okay, understood. When you take a look at how the policies have changed over 24 years that you’ve been in the industry, in terms of the financial services industry and self-directed retirement accounts, what are some policy changes you’ve seen take place?

Edwin Kelly: The most significant ones deal with the Roth IRA or the Roth retirement account. If people are not familiar with the Roth, the best way I can summarize it is that it’s the one legal way that I know of in this country right now that you can go from forever taxed to never taxed. Because every dollar of profit earnings income that you make inside of a Roth account, when you go to spend that money, you distribute it to yourself and go spend, it comes out 100% tax-free; no Federal tax, no state tax, no local tax, no Medicare tax, no capital gain tax, no tax at all. There’s just no tax. It’s 100% tax-free income.

And when they originally introduced the Roth to the 1997 Taxpayer Relief Act, and you could start opening a Roth in ’98. So that’s when the original rules were written. Now, since that time, if you wanna know what the government is going to do or what’s important to them, you look at the legislation that’s being passed. What happened was when they introduced that in 1998, there were some limitations on if you made too much money, you couldn’t put money in a Roth. The conversion income limit was done away in 2010, so that was a big, big thing.

In 2006 they expanded and allowed Roth accounts to be opened inside of a 401K plan, or a solo 401K, which is a type of an account that a lot of our clients use. So that was another positive change.

In 2013 there was a rule change put in that allows for what they call in-service conversions. In other words, a lot of people have money in these tax-deferred accounts, but they wanna be in a tax-free account. Well, if the money was in a current existing plan, you had no way of putting the money into that Roth portion of the plan. So in 2013 they said “We’re gonna remove that, so now you can – if you have tax-deferred money in a 401K, you can move some of it or all of it into the Roth portion now of that solo 401K now.”

So all the legislation, the most significant legislation, in my opinion, that’s been coming down, has been very favorable for investors and for us, because they’re allowing us to do more with those tax-free accounts and expanding what we’re able to do and how much money we can put in it.

Joe Fairless: As you’ve navigated and continually made updates to your business as these policies have changed, which policy or which one of those was the hardest or most time-intensive to accommodate and adapt to?

Edwin Kelly: I would say in terms of the changes — and this is kind of a minuscule thing that probably most people aren’t even aware of… But I would say one of the most significant things is that a lot of people haven’t heard about self-directing, right? So it’s brand new to a lot of people. It’s been around since the ’70s, but the reality is that most people still are not aware that they can do it. So every year what happens is there’s a tax form called the 5498 that’s published, and it goes to the account owner and it goes to the IRS. It’s just basic information – name, social account number, account value, firm where it’s held. Pretty basic stuff. But a couple years ago they amended that because self-directing is becoming so much more prevalent that they said (this is what the government is thinking) “You know what, we just kind of assume that all the money was gonna sit in mutual funds”, and now people are able to do all these really cool things, like invest in real estate notes, private equity entities, Bitcoin.

So one of the changes that they’ve made was they said “Okay, now we’re going to have multiple asset classes on there, so any of the asset classes that someone would hold in that account, you check the box, so to speak.” So that was one of the things that we had to adapt to a couple years ago, and being compliant with that new type of tax reporting. Clients were unaffected, but it was something that hit us as custodians and trust companies.

Joe Fairless: So what’s a mistake that investors commonly make whenever they’re putting together their first self-directed IRA transaction?

Edwin Kelly: Good question, and I will tell you the number one mistake that I see most people make when they’re self-directing, or particularly when they’re starting out, is also the easiest one to fix… But this is the most common mistake that I see across the board. So the way to think about this is that when you are purchasing, say, a piece of real estate, and if you have a self-directed retirement account, the way to think about it is that there’s three places – and sometimes it helps to think about it as individuals; each of these are individuals – for individuals that could buy that piece of real estate. Joe, you could buy it in your own personal name; if you have an LLC or a business, you could buy that piece of real estate in the business, or if you have  a self-directed retirement account, you can also buy that piece of real estate in the retirement account.

So the easiest way to avoid the mistake is when you go and you’re looking at an investment you’re going to purchase or invest in, what you wanna do is decide first who do you want to own that property? Do you want it in your business, or do you want it in your retirement account? Now, if you want it in your retirement account, then what we do is we simply initiate that from the very first step, and the very first step in a real estate transaction is typically an offer to purchase. So we’re talking about the purchase contract. So on that purchase contract, if you want your IRA to own it, you’re not gonna put your own name down, because you’re not buying. And you’re not gonna put the business name down, because the business isn’t buying it. What you’re gonna put down is the name of your retirement account.

In this case, what you would put on there is Specialized IRA Services FBO (for the benefit of) Joe’s IRA” and the account number. And then you would sign as agent on behalf of your retirement account. Then what happens next is that that offer gets accepted, and you would submit a direction to invest to Specialized and say “Hey, I’m buying this property. Send some earnest money over, and then the rest of the money is gonna go to this title agency to close the transaction.” And because everything was initiated in the name of the IRA, when that goes to closing, the title agency is going to record your IRA as the owner on that property.

Joe Fairless: Thank you. That’s a very straightforward and easy way to think about it. That’s helpful. If an investor were to initially have it under their name, is there any way they can go back and make it with their self-directed retirement account?

Edwin Kelly: Good question, and I will say that is a very grey area. Say the person put their name on it personally, but there was no financial exchange – then could you kind of void out that contract and issue a new one? Yeah, because they didn’t actually own anything yet. But what happens if they put earnest money into the deal? Well, the problem is that because they now have their name on it, and they’ve put personal money into it, that usually means it’s prohibited, because now that individual owns that asset personally, or controls it personally.

Once it’s owned personally, then there’s no way to move that into the IRA. But that’s what people will do, particularly if they’re new to self-directing – they’ll go out, because they don’t understand, a lot of times, so they will put their own personal name on the contract, thinking they’re gonna buy it in their IRA. Then they pay for it, and then they let us know seven days before closing, “Hey, I’m gonna buy this property.” The problem is everything is in the client’s name.

So by simply knowing that one thing, you will avoid — and I’m telling you, when it comes to self-directed, people talk about “Well, it’s complicated, this and that”, it’s really not that complicated at all. In fact, we do a lot of education and training for our clients on how to do it, and how to do it in a compliant way. But the interesting thing is probably 90% of the mistakes we see are that one right there. So literally, if you just are aware of those three places that you could buy real estate, and you know ahead of time where you want to buy it, the key is to put the correct buyer on the purchase contract, and you eliminate 90% of the mistakes that investors make.

Joe Fairless: Great stuff, very helpful. Based on your experience in the industry for 20+ years, what is your best advice ever for real estate investors, as it relates to your area of expertise?

Edwin Kelly: The number one thing, I would say, if you’re a full-time – or even if you’re a part-time investor – if you have a business set up, my number one recommendation is to set up a Solo Roth 401K. The reason for that is there are several benefits to the 401K and specifically the Roth 401K. When you have a Solo Roth 401K, you could invest in anything allowed by the government. Any type of real estate, notes, everything we’ve been talking about; cryptocurrencies, whatever you want to do, so long as it’s allowed by the government (and there’s only a few things that are not allowed), then you can invest in virtually anything with the 401K.

The other nice thing about it is that you can make larger contributions to that account and you can build it up faster by being able to make larger contributions to it. Another benefit to the 401K is that if you ever need money outside the plan — and this is what happens, a lot of clients open up a 401K and they say “You know what, I could really use some extra money in my business, but I know I can’t invest my retirement account into my business”, but this is a great benefit of the 401K for entrepreneurs and investors… You can borrow up to 50% or $50,000 from your 401K account. And when you borrow that money, it comes out tax-free, penalty-free; so no tax, no penalty, and that money, when it comes out of the plan and goes to you, you could use it for any purpose you want. You can use it as a line of credit for yourself or your business almost. That’s how I kind of explain it.

And there’s two other benefits to that loan provision; one benefit is the fact that  — I call it a zero cost of capital. Now, there is an interest rate on the loan, and it’s set by the administrator. The way we define it is that it’s prime [unintelligible [00:17:57].28] But here’s the deal – you’re paying the interest to where you borrowed it from, which is your own account. So effectively, all you’re doing is moving money from one pocket to another; that’s it, that’s all you’re doing. So that’s why I call it a zero cost of capital.

And another huge benefit of that loan is that that loan is not reportable to credit bureaus. So nobody knows that you have that loan, other than you and I.

Joe Fairless: Are you gonna tell them about it?

Edwin Kelly: Yeah… [laughs] You know what, here’s another benefit – by law, I’m not allowed to tell anybody. [laughter] So I can’t tell anybody. But here’s the interesting thing – we actually have clients who will bump up their credit scores pretty significantly within a short period of time, because they can take out a 401K loan, and if they’ve got credit cards and other things that they’ve been using to maybe fund some business expenses, or whatever, they can pay off those credit cards, so now the credit utilization numbers change, and everything else changes… So you’ll actually see a bounce — we see significant bounces for clients who wanna bring their credit score up, within 90 days of setting up a 401K and then setting up the loan and then using that loan to restructure some of those debts.

So the 401K — and I could go on and on and on… There’s so many other benefits. If you wanna talk about them, we can, but those are a few, just to kind of give you an idea.

Joe Fairless: That’s good stuff. You gave a lot of info on the Roth 401K and the benefits of it, and you’re a fan, that’s clear, and it’s good to hear the different points for why that would be an option that would make sense.

We’re gonna do a lightning round. Are you ready for the Best Ever Lightning Round?

Edwin Kelly: Yes!

Joe Fairless: Alright, let’s do it. First, a quick word from our Best Ever partners.

Break: [00:19:47].23] to [00:20:47].21]

Joe Fairless: Best ever book you’ve recently read?

Edwin Kelly: The best ever book I’ve recently read – Losing My Virginity.

Joe Fairless: Who wrote that?

Edwin Kelly: Richard Branson. It’s not about what you might think… [laughs]

Joe Fairless: Yeah, it’s probably a branding thing, if it’s Richard Brandon, right? On Virgin Airlines…

Edwin Kelly: Exactly, because all his companies are called that… But I’ll tell you what, it’s funny – just to tick off my kids’ mother, I bought all my boys his autobiography. I gave it all to them for Christmas. [laughter] I’m sure that rubbed her the wrong way… But it’s actually a terrific book; there’s so many great lessons in there, and a lot of them apply to us as investors. Very, very important lessons in there, so I would highly recommend that book. It’s a long book, entertaining read, but terrific book.

Joe Fairless: What’s the second most common mistake you see real estate investors make when they’re setting up their self-directed IRA account?

Edwin Kelly: I think the second biggest one would be not being clear in their mind on what transaction they’re actually doing. As an example, let’s say that you have $50,000 in your retirement account, and you find a property and it’s $48,000, and you say “Perfect, I can go buy it.” So you go buy the property, and now it’s titled to the retirement account. And then they say, “Well, wait a minute, I need to rehab this property, and I don’t have the money in my account, so now what do I do?” So they’re stuck. That’s what I mean by thinking through what the transaction is.

What I always tell people is think through the transaction first, think about what the dollars are involved in it, and make sure that you have access to those dollars. Now, what do I mean by access – here’s a legal back-door to the contribution limit, and also having to rely on your own cash. One of the rules basically says “If we don’t have enough money in our account to buy an investment, our account is allowed to borrow it.” In other words, if the client has $50,000 in the account to buy the property, and then needs $30,000 for rehab, they can line up that $30,000 loan, and now they have the money to buy the property, rehab it and then sell it.

So that’s what I mean by thinking through the entire transaction, being very clear on what you’re doing and how you’re gonna do it. You need to know how you’re entering it, and you wanna know how you’re exiting it.

Joe Fairless: Best ever way you like to give back?

Edwin Kelly: Best ever way I like to give back… Wow, we do so many different things. I think one of the things that’s really important to me – and this is reflected here at Specialized – is that we reinvest a lot of money, or I should say… I look at it as investments, but they’re charitable contributions. We support a lot of local organizations here in Albuquerque and throughout New Mexico. That kind of goes along with one of our philosophies, because the reality is the way this country became great was guys like you, Joe, and guys like me, who have a vision and a dream, and we start out, we bootstrap it, we start things, we take risks, and we start businesses, and we make investments, and then that employs people.

I really believe that Wall Street does not serve our interests, they serve their own interests. So what I talk about is let’s get money off Wall Street and put it back on Main Street. That’s where it does the most good. So that’s reflected in how we give back, because since we’re located in Albuquerque, New Mexico, we are big on supporting local causes. We’ve done all kinds of things – we support an organization here that recognized top professionals across industries that work here locally… And we do that because there’s a lot of people who get educated and then they feel like they have to leave the state to go find a good job or career, and that’s not the case. So we really support things like that.

At Christmas time we usually support about 175 families, by buying gifts for all the family members, parents included – Christmas dinner, those kinds of things. We do the same kind of thing on Thanksgiving. So we kind of look at it as – we wanna make an impact in our local community, and I think that if everybody had that attitude, that would make a huge, huge difference.

So it kind of goes along with our investment philosophy, and that kind of drives the way we serve in other ways, as well.

Joe Fairless: How can the Best Ever listeners learn more about what you’ve got going on?

Edwin Kelly: The best way to do it is to go When you go to that website, you’ll see an offer there to get two things for free right now. One of them is my most recent book that I wrote, so we’ll give you that free, and the second one is a consultation with a self-directed specialist.

That consultation is super-valuable, because typically, one of the things that we hear when people are exposed to self-directing is they say “You know what, it sounds like a great thing… But I have questions, but I don’t even know what the questions are.” Well, that’s okay, because guess what – we’ve been doing this a long time, we know what the answers are.

So that’s where that consultation comes in extremely handy. They will spend time with you on the phone to review your situation, they will go over what your goals are, what you’re doing, what you have, and we’ll actually create a custom plan for you, and then you can decide if you wanna implement that plan, or how you’re gonna implement that plan, or if you’re gonna do it over time… So it’s extremely valuable. It’s a very customized approach, because this is not cookie-cutter stuff. So you can take advantage of both of those things absolutely free by going to the website and signing up.

Joe Fairless: Edwin, thank you so much for being on the show, talking about a lot of different things, but all related to self-directed retirement accounts… From the two states to do a trust charter in, which are New Mexico and South Dakota, where the best, most favorable regulatory policies are, to setting up a Roth 401K and the advantages of that, and everything in between.

Thanks again for being on the show. I hope you have a best ever day, and we’ll talk to you soon.

Edwin Kelly: Thanks, Joe. I really appreciate it.

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