Dec 28

Are Distributions that Consist of my Roth IRA Contributions Ever Subject to Income Tax?

No, the portion of your Roth IRA that consists of your contributions is never subject to income tax when it comes out – even if you take it out the day you made the contribution. That is because all contribution you made were nondeductible – meaning you already paid tax on the money. In addition, any distribution you take from a Roth IRA is presumed to be a return of your contributions until you have withdrawn all contributions you made to it over the years. In other words, all contributions all recovered before earnings before earnings are recovered.

If I establish a Roth IRA is there a certain amount of time I am not allowed to take tax-free distributions of investment returns?

Are Distributions that Consist of my Roth IRA Contributions Ever Subject to Income Tax?In general, you should not take a distribution of your investment returns for five years. A distribution within five calendar years of when you first establish a Roth IRA can never be a qualified distribution. Thus, counting the year of your first contribution as year one, you will satisfy the five-year requirement if you wait until the sixth year before withdrawing any earnings.

However, simply satisfying the five-year requirement will not automatically make a distribution qualified. It must also be at least one of the following:

  • A distribution you take after reaching 59 and 1/2
  • A distribution you take after becoming disabled
  • A distribution to your beneficiary or your estate after your death
  • A distribution you take to purchase a first home (up to a lifetime withdrawal limit of $10,000)

Therefore, if your distribution satisfies the five-year requirement and falls into one of the above categories, it will be qualified and, hence, entirely tax-free.

Please contact one of our Roth IRA Experts at 800-472-0646 for more information.

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Dec 21

The Unrelated Business Taxable Income Rule And Flipping Real Estate With IRA Funds

Since the creation of individual retirement accounts (“IRAs”) the Internal Revenue Service (“IRS”) has always permitted an IRA or other retirement account to purchase, hold, or flip real estate.   In fact, it states it right on the IRS website. By using a Self-Directed IRA, one will gain the ability to buy real estate, such as raw land, residential or commercial property, flip homes, and much more without paying tax.  One of the major advantages of flipping homes with a retirement account is that all gains are tax-deferred until a distribution is taken (Traditional IRA distributions are not required until the IRA owner turns 70 1/2). In the case of a Roth IRA, all gains are tax-free.

When engaging in real estate transaction, such as a house flipping transaction, one must keep in mind the Unrelated Business Taxable Income Rules (also known as UBTI or UBIT) which can be found in Internal Revenue Code Section 512.

The Unrelated Business Taxable Income Rule And Flipping Real Estate With IRA FundsThe purpose of the UBTI rules is to treat tax-exempt entities, such as charities, IRAs, and 401(k) plans as a for-profit business when they invest in an active trade or business operated through a pass-through entity, such as an LLC or partnership (a C corporation would block the application of the UBTI tax rules) or use leverage (there is an exemption to the UBTI rules for 401(k) plans who use nonrecourse leverage).  The tax imposed by triggering the UBTI rules is quite steep and can go as high as 40 percent.

In general, most passive investments that a retirement account might invest in are exempt from the UBTI rules. Some examples of exempt types of income include: interest from loans, dividends, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate.

However, for real estate investors looking to buy and sell multiple real estate properties in a year or use leverage, one must be conscious of the application of the UBTI tax rules.  The key point when determining whether a retirement account real estate transaction or series of transactions rises to the level of a trade or business are based on the facts and circumstances.  In Mauldin v. Comr. 195 F.2d 714 (10th Cir. 1952), the court explained that there is no fixed formula or rule of thumb for determining whether property sold by a taxpayer was held by him primarily for sale to customers in the ordinary course of his trade or business. Each case must rest upon its own facts. The court identified a number of helpful factors to point the way, among which are the purposes for which the property was acquired, whether for sale or investment; and, continuity and frequency of sales as opposed to isolated transactions.  In addition, in Adam v. Comr. 60 T.C. 996 (1973), acq., 1974-1 C.B. 1., the Tax Court analyzed the following factors in determining whether the taxpayer was engaged in the operation of a trade or business:

  • The purpose for which the asset was acquired
  • The frequency, continuity, and size of the sales
  • The extent of improvements made to the property
  • The proximity of sale to purchase

Generally one or two real estate transactions in a year would not rise to the level of a trade or business and trigger the UBTI tax rules. The question then becomes what happens if your retirement account engages in three, four, or even ten flipping transactions in a year – would that be considered an active trade or business and, hence, trigger the UBTI tax?  Again, one must examine all the facts and circumstances surrounding the multiple house flipping transactions in order to determine whether the transactions in the aggregate would constitute an active trade or business. The burden falls on the retirement account holder to make the determination of whether the retirement account engaged in a trade or business and, if so, file the IRS Form 990-T. Therefore, it is important to work with a tax professional who can help one evaluate the transaction to determine whether the flipping transaction will trigger the UBTI tax.

For more information about the UBTI rule and real estate transactions within your IRA, please contact us @ 800.472.0646.

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Dec 19

How You Can Use a Loan with Your Self Directed IRA to Invest

The Self-Directed IRA is a retirement solution that will unlock a world of investment opportunities. The Self-Directed IRA is a retirement investment vehicle that allows one to use their retirement funds to make traditional as well as non-traditional investments, such as real estate tax-free and without custodian consent. In most instances, investors using retirement funds to make an investment will use cash to make the investment. Whether the investment is in the form of stocks, precious metals, or real estate most investors using retirement funds to make the investment will not borrow any funds to make the investment. In other words, most investors using retirement funds will use cash to make the investment. One significant reason why retirement account investors will generally not borrow money (also called debt or leverage) as part of an investment of real estate acquisition is the Internal Revenue Code Section 4975 prohibits the IRA holder (you) from personally guaranteeing a loan made to the IRA. Pursuant to Internal Revenue Code Section 4975(c)(1)(B), a disqualified person (i.e. the IRA holder) cannot lend money or use any other extension of credit with respect to an IRA. In other words, the IRA holder cannot personally guarantee a loan made to his or her IRA. As a result, in the case of a Self-Directed IRA, one could not use a standard loan or mortgage loan as part of an IRA transaction since that would trigger a prohibited transaction pursuant to Code Section 4975. This type of loan is often referred to as a recourse loan since the bank can seek recourse or payback from the individual guaranteeing the loan. These loans are generally the most common types of loans offered by banks and financial institutions. Thus, in the case of a Self-Directed IRA, a recourse loan cannot be used. This leaves the Self-Directed IRA investor with only one financing option – a nonrecourse loan. A nonrecourse loan is a loan that is not guaranteed by anyone. In essence, the lender is securing the loan by the underlying asset or property that the loan will be used for. Therefore, if the borrower is unable to repay the loan, the lender’s only recourse is against the underlying asset (i.e. the real estate) not the individual – hence the term nonrecourse. In general, nonrecourse loans are far more difficult to secure than a traditional recourse loan or mortgage. There are a number of reputable nonrecourse lenders, however, the rate on a nonrecourse loan are typically less attractive than a traditional recourse loan.

How You Can Use a Loan with Your Self Directed IRA to InvestThe IRS allows IRA and 401(k) plans to use nonrecourse financing only. The rules covering the use of nonrecourse financing by an IRA can be found in Internal Revenue Code Section 514. Code Section 514 requires debt-financed income to be included in unrelated business taxable income (UBTI or UBIT), which generally triggers close to a 40% tax for 2016. In general, if nonrecourse debt financing is used, the portion of the income or gains generated by the debt-financed asset will be subject to the UBTI tax, which is generally 40% for 2016. Thus for example, if an individual invests 70% IRA funds and borrows 30% on a nonrecourse basis, 30% of the income or gains generated by the debt financed investment would be subject to the UBTI tax. For example, if a Self-Directed IRA investor invests $70,000 and borrows $30,000 on a nonrecourse basis (the IRA holder is not personally liable for the loan) – 70/30 equity to debt finance ratio, and the IRA investment generates $1,000 of income annually, 30% of the income or $300 would be subject to the UBTI tax. Note – the $300 tax base could be reduced by any pro rata portion of deduction/depreciation associated the debt-financed property. The rationale behind this is that since the IRS is treating the IRA, which is typically treated as tax-exempt pursuant to IRC 408, as a taxpayer by imposing a tax on the debt-financed portion, the IRS will allow the investor to allocate proportionally any asset expenses or depreciation in order to reduce the tax base. The IRS Form 990-T is the form where the UBTI must be disclosed to the IRS.

Interestingly, by investing in real estate through a Solo 401K Plan, if one uses nonrecourse financing, the Solo 401K plan will escape the UBTI/UBIT tax due to an exception to the Unrelated Debt Financed Income (UDFI) rules found under IRC 514(c)(9). This is one reason why the Solo 401K Plan is such an attractive investment vehicle.

To learn more about the rules surrounding using a loan with a Self-Directed IRA to make an investment please contact a Self-Directed IRA Expert at 800-472-0646.

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Dec 14

Bitcoin Exchanger Receives Summons – Using Self Directed IRA to Invest Becomes More Attractive

In a petition filed November 17, 2016 with the U.S. District Court for the Northern District of California, the U.S. Department of Justice (DOJ) asked the court for a John Doe summons to be issued on bitcoin exchanger Coinbase Inc.

The John Doe summons would require Coinbase Inc., the largest bitcoin exchanger in the U.S., to provide the DOJ with information related to all bitcoin transactions it processed between 2013 and 2015. The DOJ would then share the information received with the Internal Revenue Service to be matched against filed tax returns. The IRS would be looking for bitcoin transactions that have the potential for successful criminal investigation and prosecution.

The IRS has previously stated a position that virtual currency transactions, such as bitcoin, are property on which gain can be realized.  In Notice 2014-21, the IRS stated that it would tax digital money such as bitcoin like property, not currency. The IRS also believes bitcoin transactions provide an opportunity for tax evasion. In fact, according to the IRS, the potential for tax evasion is enhanced via bitcoin transactions, “because there is no third-party reporting of virtual currency transactions for tax purposes … and the likelihood of under-reporting is significant.”

Bitcoin Exchanger Receives Summons - Using Self Directed IRA to Invest Becomes More AttractiveAlthough IRS Notice 2014-21 did not address whether bitcoins would be considered an approved investment for retirement purposes, the fact that the Notice is treating bitcoins as property, like stock, and not as a collectible, it should be clear bitcoin is an approved investment for IRAs and would not violate IRC 408(m). If bitcoins were purchased using retirement funds, such as a self-directed IRA, there would generally be no tax on the gains from the purchase or sale of bitcoins.  The tax ramifications of purchasing bitcoins with retirement funds could get somewhat complex, especially if the retirement account investor is considered to be in the active business of trading bitcoins, which could generate a tax called the Unrelated Business Taxable Income tax (UBTI), which can go as high as 40%.

Anyone engaging in bitcoin transactions, particularly those transactions utilizing the exchange services of Coinbase Inc. during the 2013 to 2015 time frame, should take note of the DOJ summons.

If there are any bitcoin transactions that may be of concern, now is the time to consult with a tax professional and consider all your options, including voluntary disclosure.

Investing in bitcoins is perfectly legal, however, there are income tax implications for buying and selling bitcoins, which many taxpayers seem to be unaware of.  Using a self-directed IRA  to buy bitcoins could prove to be highly tax efficient, especially in light of the IRS’s recent scrutiny into bitcoin investments.

For more information about investing in Bitcoin, please contact us @ 800.472.0646.

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Dec 12

Using Your IRA to Start a Business

Leaving your job or thinking of leaving your job and have an IRA? Why not use your IRA to invest in yourself instead of a fluctuating stock market? Why put your hard earned retirement funds in the hands of Wall Street when you can use your IRA funds on a business you can run, manage, and even earn a salary from?

Using Your IRA to Start a BusinessWith IRA Financial Group’s Business Acquisition Structure, a new C Corporation is formed which will adopt a 401(k) Qualified Plan. Your existing retirement funds can then be rolled into the newly adopted 401(k) Plan tax-free. The 401(k) Plan will then purchase the stock of the new corporation. The new corporation will then use those funds to purchase a new business or franchise tax-free!

With the IRS compliant Business Acquisition Structure, you can earn a reasonable salary from your new business or franchise. You can also use your new 401(k) Plan to make high tax-deductible contributions – $53,000 ($59,000 if you are over the age of 50) or even borrow up to $50,000 for any purpose.

What does the IRS Say about this?

The Internal revenue Code explicitly permits the purchase of corporate stock by a 401(k) Qualified Plan. The IRS has repeatedly confirmed that the structure is legal but has expressed some concern about the potential for abuse by individuals not being properly advised by tax professionals. For example, the IRS has documented the following instances of abuse when it comes to using retirement funds to invest in a business: (i) employees of the business are not properly informed that a 401(k) qualified plan has been adopted by the business and that they are eligible to participate, (ii) the structure is established with no intention to use for business purpose and the sole purpose for establishment was to get access to the retirement funds without penalty, or (iii) the structure is being used to purchase assets for personal use with the retirement funds.

Therefore, the IRS has stressed that it is imperative that when using IRA funds to establish a new business or finance an existing one, it is important to work with qualified tax professionals who have experience in this area and could make sure the structure is established in full compliance with IRS and ERISA rules and procedures. Work with IRA Financial Group’s in-house tax professionals to help establish your IRS compliant Business Acquisition Solution.

IRA Financial Group’s Business Acquisition structure is IRS compliant and is the only legal structure that one can use to invest retirement funds into a business they will operate and be employed by. With a self-directed IRA LLC, an individual can invest retirement funds in a private business, but not a business that he or she would be involved in – that would be considered a prohibited transaction pursuant to Internal Revenue Code 4975. While, with a Solo 401K, an individual could only borrow up to $50,000 or 50% of his or her account value whichever is less and use that loan for any purpose, including starting or financing a business. However, if an individual requires more than $50,000 for a business, then the Business Acquisition structure is the only solution that will allow one to use their retirement funds to start or finance a business tax-free and without penalty!

To learn more about the advantages of using a Business Acquisition Structure to start or finance a business using retirement funds, please contact a retirement expert at 800-472-0646.

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Dec 09

What’s the Difference Between a Self-Directed IRA with Checkbook Control and a Regular IRA?

An Individual Retirement Account (IRA) is a tax-deferred retirement account for an individual that permits individuals to set aside money each year, with earnings tax-deferred until withdrawals begin at age 59 1/2 or later (or earlier, with a 10% penalty).

The Difference Between a Traditional IRA and a Checkbook Control Self Directed IRAMany “traditional IRA” custodians advertise themselves as offering a Self Directed IRA with “checkbook control”, but what that really means is that you can direct your IRA as long as you direct into one of their offerings. In other words, in a “traditional IRA” with no “checkbook control”, you are generally only permitted to invest your IRA funds in investments in equities, mutual funds, bonds or investments offered by the custodian. Whereas, in the case of a “truly” Self Directed IRA LLC with “checkbook control”, a limited liability company (“LLC”) is established that is owned by the IRA account and managed by the IRA account holder. The IRA Holder’s IRA funds are then transferred by the Custodian to the LLC’s bank account providing the IRA holder with a “truly” Self Directed IRA LLC.

With a “truly” Self Directed IRA LLC, you will have total control over your IRA funds and you will no longer have to get each investment approved by the custodian of your account like in a “traditional IRA”. Instead, all decisions are truly yours. When you find an investment that you want to make with your IRA funds, simply write a check or wire the funds straight from your Self Directed IRA LLC bank account to make the investment. A “truly” Self Directed IRA allows you to eliminate the delays associated with an IRA custodian, enabling you to act quickly when the right investment opportunity presents itself.

Please contact one of our Self Directed IRA Experts at 800-472-0646 for more information.

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Dec 07

Can You Have Both a Traditional IRA and Roth IRA in One Self-Directed IRA LLC?

Yes – you may have a Traditional IRA and Roth IRA account as members of your Self Directed IRA LLC.  Note: you should keep separate records for each account as the distribution and tax rules are somewhat different.

Can You Have Both a Traditional IRA and Roth IRA in One Self-Directed IRA LLC?There are advantages to having both types of accounts.  A traditional IRA is a tax-deferred account which gives you an upfront tax deduction on your contributions.  Taxes are not charged until you take distributions during retirement.  A Roth IRA is funded with after-tax dollars (no tax-deduction) but all qualified withdrawals are tax-free.  Plus, there are no required minimum distributions and you can contribute to it for as long as you have earned income.  Having both keeps your portfolio diversified.

 

Please contact one of our Self Directed IRA Experts at 800-472-0646 for more information.

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Dec 01

Things to Know About the Self-Directed IRA

This article recently appeared at usnews.com by contributor Rebecca Lake:

Investing in an individual retirement account is an effective way to supplement savings in a 401(k) or another employer-sponsored plan. According to a 2015 TIAA-CREF IRA survey, 18 percent of Americans save in an IRA and 56 percent of those who don’t have one said they would consider including an IRA in their retirement plans.

While traditional and Roth IRAs are relatively well-known, there’s a third option that retirement savers should be aware of: the self-directed IRA.

Self-directed IRAs, in a nutshell, put you in control of your investment choices. In addition to stocks, mutual funds and bonds, you can invest in real estate, precious metals, energy and other alternative investments.

“The primary advantage of saving for retirement in a self-directed IRA is that you’re able to invest in the kinds of investments you have specific knowledge of or expertise in,” says Mark Goldstein, president of SAFE-Money Alliance in Las Cruces, New Mexico.

That freedom, paired with the potential for tax-deductible contributions and tax-deferred earnings makes self-directed IRAs an appealing choice for investors whose focus lies on creating lasting wealth. That doesn’t mean, however, that a self-directed IRA is right for everyone.

Before adding one of these accounts to your portfolio, it’s important to understand what makes a self-directed IRA different and how it can impact your retirement outlook.

Your investing style matters. Every investor has a distinct personality when it comes to how they manage their investments and that can’t be ignored when the question of a self-directed IRA is on the table.

Kirk Chisholm, a wealth manager and principal at Innovative Advisory Group in Lexington, Massachusetts, says self-directed IRAs are best suited to investors who are meticulous about managing their accounts and prefer a do-it-yourself approach.

“Investing in traditional assets can be as easy as pushing a button on your computer, while alternative assets can be much more paperwork intensive,” Chisholm says.

Beyond that, investors must be aware of the specific rules that go along with investing in a self-directed IRA. For example, you can’t use a self-directed IRA to invest in things like collectibles, antiques or rare coins.

David Hryck, a tax attorney and partner at New York-based Reed Smith, recommends that investors educate themselves on how self-directed IRAs operate before diving in.

“A self-directed IRA gives you far more responsibility and forces you to really understand how to invest properly,” Hryck says.

Your investment goals and risk tolerance also come into play. Even if you have no trepidation about guiding your own investment choices, a self-directed IRA may still miss the mark if it doesn’t align with what you hope to accomplish or requires you to assume more risk than you’d like.

“Self-directed IRAs are ideal for people looking for portfolio diversification in areas they’re familiar with, outside of the typical choices,” Goldstein says.

He points out that experienced investors may feel that the risk involved in investing in assets they understand may be considerably less than the risk of investing exclusively in a conventional IRA. The opposite may be true for someone with a shorter history of investing.

Your choice of investments can also influence your perspective on including a self-directed IRA in your portfolio.

For example, let’s say you’re interested in generating steady cash flow through a rental property. If you were to purchase a property directly, any rental income received each month would go right back into your pocket. When you invest in a rental home using a self-directed IRA, on the other hand, the rental income must be funneled back into the IRA.

If your long-term goal is increasing your nest egg in a tax-advantaged way, then the self-directed IRA might make more sense. On the other hand, if you need an additional income stream right now, you’d likely be better off investing in real estate outside of your retirement accounts.

Look at the bigger tax picture. Self-directed IRAs can offer some tax benefits but there are some potential pitfalls investors need to be aware of.

“The primary advantage (of a self-directed IRA) is deferred taxation on growth,” says Colby Winslow, a certified financial planner with WaterOak Advisors in Orlando, Florida.

Another advantage of using a self-directed IRA is the ability to hold investments that would typically be held as taxable assets. When taxes can be deferred, the tax that would have been paid can be reinvested to earn growth on those savings.

At the same time, investors need to be aware of how investing in a traditional self-directed IRA can affect their tax situation.

“The money coming out of the self-directed IRA will be taxable upon withdrawal,” says Jimmy Lee, CEO of Las Vegas-based Wealth Consulting Group.

For an investor who ends up in a higher tax bracket at retirement, distributions from a traditional IRA can lead to a higher tax bill. Another host of issues can crop up once you reach age 70.5.

“If someone purchases fairly illiquid assets and they’re expected to take required minimum distributions, they may be forced to sell assets within the IRA to free up enough cash to transfer out,” Winslow says.

Failing to take required minimum distributions can trigger a substantial tax penalty, equal to 50 percent of the amount you’re required to withdraw. That could add significantly to your tax burden so you need to have a plan for managing illiquid assets before RMDs kick in.

Choose your custodian carefully. The custodian holds the assets in your self-directed IRA for you and it’s important to carefully vet your options. If you need a starting point, Lee encourages investors to consider the size of the custodian, since that can be an indication of the firm’s stability.

Jaime Raskulinecz, founder and CEO of Next Generation Trust Services in Roseland, New Jersey, says it’s also important to look at the services a prospective custodian provides.

While a custodian for a self-directed IRA won’t offer direct investment advice, Raskulinecz says they should be able to answer questions about your plan, efficiently manage the paperwork and reporting and regularly review your account to ensure that you’re not engaging in prohibited transactions that fall outside of IRS guidelines.

Chisholm reminds investors to consider whether a self-directed IRA custodian accepts the type of assets you’re considering investing in. Lastly, he cautions against choosing a custodian without thoroughly reviewing the fees.

“Each company’s fee schedule caters to a certain type of investor,” Chisholm says, and ultimately, you should be looking for one that best fits your investment strategy.

For more information about the Self-Directed IRA, please contact the IRA Financial Group @ 800.472.0646.

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