May 1, 2012 at 2:07 pm #17600
What is the best way to structure an IRA to hold property? LLC or Holding Co? Is it best to stay away from trying to hold real property in an IRA?May 2, 2012 at 6:34 pm #27216
I think it depends on what you want to do with the property. You are not allowed to personally benefit from the property until you retire and take a distribution from your IRA. If you get caught using the property for personal use before retirement (i.e, vacation home), the IRS will rule that the property has been disbursed from the IRA and you will owe current taxes and penalty. If you want to run a rental business then an IRA will work.
This gets me to your second question about whether it makes sense to hold real property in an IRA. I would take it a step further and ask if it even makes sense to have an IRA at all? To my way of thinking, an IRA is just another government program. They have broken promises in the past. What are the odds that a desperate insolvent government will change the rules in the future? Maybe raise the age at which you can begin withdrawing funds? Or raise the early withdrawal penalty? Or raise income tax rates so that you end up paying more in the future?
I posted a story a couple of days ago under the “connection requests” category. I set up an offshore LLC inside my IRA to do offshore banking/trading. I won’t repeat the story here, but it was a big hassle and it never worked as advertised. Maybe I just had bad luck. Maybe it is different with real estate. One thing I do know is that it is an expensive way to hold property. In addition to set up fees, you will pay an annual maintenance fee for the LLC, plus an annual fee to the IRA custodian based on the value of the account.
I guess it also kind of depends on your personal circumstances. My wife and I are in our mid fourties and have been contributing to 401k and IRA accounts for years. One day I sat down and figured out the percentage of our assets that were trapped inside retirement accounts. I was shocked to see how much of our net worth was tied up in these plans. An IRA just gives the government too much control over too large a portion of the portfolio.
I have been slowly withdrawing IRA funds over the last several years and investing the money elsewhere. For me, the ten percent early withdrawal penalty is a fair price to pay to eliminate all the IRA rules and restrictions. And I won’t be stuck paying IRA custodial fees until I die. Yes, I have to pay the income tax now… but I’m betting that rates are lower now than they will be in 20 years when I retire.
Of course, this is all just my opinion…May 14, 2012 at 8:53 pm #27226
I agree that assets trapped in IRA’s have risks and the taxes are unlikely to go down. With estate taxes likely to go up at the end of this year, selling the IRA assets seems to be good ‘estate planning’.
My husband and I are old enough that we can avoid the 10% penalty so intend to liquidate our IRA accounts this year. There is all kinds of advice on the benefits of Roth conversions, but very little written comparing a Roth conversion to paying the taxes and holding the assets in taxable accounts.
I tend to think that the tax benefit may not outweigh the government control over Roth IRA assets.
I thought I could put the funds in a Roth, and just withdraw them whenever we decided we did not like new IRA regulations, but I worry about the requirement to wait 5 years to withdraw assets from a Roth conversion could be too long! Does anyone have any advice regarding using a Roth rollover to invest in real estate?May 15, 2012 at 12:50 am #27227
Anita, thanks for asking that question. And thank you Todd for adding your thoughts. Oh, and to Sherilynn, who apparently posted while I was over in “Word” composing my post. She brings up a question I had not considered, but will include a comment on that in my text before posting this.
I think this question weighs on the minds of many Bonner subscribers. As much as we’d like to have as few assets as possible under any kind of government control, many of us have made much of our money in the companies we have worked for. Thus, we end up with significant assets in 401Ks rolled into IRAs. Whether we have assets in IRAs or not may be a foregone conclusion. I have been considering the same real estate question. And writing this post may even help me clarify my own thoughts. I welcome any clarifications or corrections to this.
There are many scenarios in which real estate in an IRA may be the only way to satisfy a 35% allocation as Bonner suggests. If half of your assets are in IRAs (or other tax sheltered accounts), and you want a 35% real estate allocation outside of IRAs, that leaves only 15% of total assets that are not real estate assets to be in taxable accounts. That may not be comfortable. In another example, if 75% of assets are in tax sheltered accounts, then there is no way to have 35% of assets in real estate without some of it being in a tax sheltered account.
Like Todd, this is all my opinion (or current thoughts); actions should all be done under proper professional advisement. I will discuss four things:
1. Two ways of getting money out of an IRA before age 59.5 without paying any penalty.
2. A possible positive for having foreign real estate in an IRA.
3. Consider a Roth IRA for holding real estate.
4. A holding company or LLC may be overkill if only used for real estate.
Getting money out of an IRA before age 59.5 without penalty:
You can make penalty free withdrawals from a Traditional IRA before age 59.5 if you set up a withdrawal plan that pays out the same amount year after year. There are strict rules. More than I’m describing here. But they are easy to follow. Once you start, you have to keep it up until after you are 59.5, and no other deposits or withdraws are allowed. However, the rules apply on an account by account basis. So you can separate some IRA money into a given account for following this plan and leave the rest unencumbered by these rules. If later you want to start withdrawing more, you can split off yet another amount to another account for the same purpose. Ask your accountant about tax rules for 72t and SEPP. They are both the same thing.
Conversions to a Roth IRA can also be useful. It allows you to get money out of your traditional IRA, pay tax on the conversion amounts at current tax rates (without penalty), and never pay tax again on that money (withdrawn or not) even if it grows tenfold in the future. Unlike the 72t/SEPP plan, you can decide each year how much to convert, and limit your amounts to stay within a chosen marginal tax rate. Of course, it is still monitored and watched by the government, and subject to promises broken by a desperate government. But I guess you could say that about all of our money in any kind of account.
Sherilynn brings up the question of the five year rule for withdrawals from a Roth, which requires money to be in the Roth for five years before you can withdraw it. That is certainly a consideration. And it indicates that both of the above strategies may work better the younger you are. But it may be worth looking into the details of the rules. I’m not sure, but I think the five year rule may apply to when the first deposit was made to a given Roth account – not to individual deposits. So let’s say you opened a Roth with a $50K conversion in 2010 and converted an additional $50K into it each year for five years. You may be able to withdraw all $250K (plus growth) anytime after 2015 penalty free. You may not even have to be 59.5 if you’ve satisfied the 5 year holding period. These are questions worth asking a tax accountant to be sure. But it may add previously unknown flexibility.
As far as government control is concerned, it’s hard to say what might happen. They have the power to tax our money regardless of where it is at. So IRAs and the associated promises may not be in any more danger than taxable accounts. One concept that my accountant mentioned is something like the low hanging fruit thing. Or in this case, if they are going to break a promise they’ll want to do it once (or few times) and get as much as they can for it. When it comes to Roth IRAs, there may not be that much for them to pursue. For many years (until 2009?) conversions were restricted to people with Adjusted Gross Income of less than $100K. So those who were eligible didn’t have much to convert, and those who could most benefit from large conversions were not eligible. Since then, many who should have been converting still have not. Roth IRAs in aggregate may be too small of a target to bother with the uproar for what could be extracted by breaking the promises. Roth IRAs may remain under the radar.
A positive for foreign real estate in an IRA:
One thing I think about is: Once I get money out of the country, I want the option of keeping it out of the country. I’ve been told that distributions from IRAs legally must come through the US based IRA administrator (or custodian, or something like that) in order to be disbursed. So let’s say you’ve bought stock on a local foreign exchange, or gold with BullionVault or GoldMoney to get assets out of the country. If you do these things in an IRA, liquidated funds must come back through the US before you can take them as distributions to a foreign bank account. If capital controls have been imposed, that could be an opportunity to trap the assets in the US. There may be ways around it with foreign LLCs or trusts, but the above is my understanding of cash distributions, or perhaps any assets that are portable.
With (foreign) real estate, you can take it out of your IRA as a distribution without selling it in order to use it for your personal benefit after you retire, as Todd described. However, although the money trail may still be required to pass back through the US, the physical asset is absolutely non-portable and it would it be difficult to prevent you from using it. So regardless of any government actions, foreign real estate will remain out of the country. So at least some of the reasons why Bonner suggests foreign real estate are not diminished by it being in an IRA.
It could make sense to weight IRAs with foreign real estate for this reason. That can free up more portable assets in taxable accounts in a way that you can get it out of the country and keep it out; and end up with a higher total percentage of your assets permanently out of the country.
Consider a Roth IRA for holding real estate:
So, assuming you arrive at a decision to hold real estate in an IRA. You still have to decide whether to hold it in a Traditional IRA or a Roth IRA. If it is purely an investment that you intend to sell within the IRA, it may not matter. But if it is real estate that you intend to use personally in retirement or for any reason intend to take it as a distribution without selling it within the IRA first, I vote for a Roth IRA.
I believe when unsold real estate is “distributed” it must be done so as an all-or-nothing event; and you must do so before you can use it personally. If it is being distributed from a Traditional IRA, the entire value (however it is determined) is taxable at ordinary income rates in that year. It could be a huge tax event that throws you into a very high tax bracket. And because you haven’t sold the property, you’ll have to find money somewhere else to pay the tax bill.
If you are holding the property in a Roth IRA, you can “distribute” it unsold from the IRA tax free so that you can use it for personal benefit in retirement. It is still an all-or-nothing event and still needs to be reported. But by definition of Roth IRA, all taxes were paid in the year of deposit and all distributions are tax free.
If all the money is in Traditional IRAs instead of Roth IRAs, consider a plan to convert increments of it to a Roth over a number of years, controlling the tax implications each year, then purchase the property within the Roth.
Are LLCs or other structures overkill?
Offshore LLCs and other structures have been advertised as allowing just about any kind of investment, and I’m sure they do. An LLC provides flexibility beyond what is required to own real estate in an IRA. But like Todd said, they can be costly and complicated. I asked my local new wave IRA administrator about such things because I was interested in real estate within an IRA. Their belief is that you don’t need an LLC to buy real estate within an IRA. You can do it direct from the IRA. It can be simpler and less expensive that way. They are even willing to pursue owning foreign properties direct in an IRA but they state that it could depend on the local government’s willingness to recognize the IRA as a legal owner. There could be other issues, but it seems worth pursuing.
I hope these thoughts can help. I am by no means an expert. These are only ideas I’ve run across in reserch for establishing my own strategies. They may not be complete. But it may provide a basis for additional discussion with each other or our profesional advisors.May 16, 2012 at 9:58 pm #27232
Great thread. I have been working on this issue for the past few years doing due diligence for my mother’s Traditional IRA that she inherited from my late father.
Income taxes are likely not going to get any lower than they are today. Especially with the end of the Bush tax cuts at the end of 2012. With this in mind, I think a Roth conversion is something people should seriously consider. Whatever dollar amount from your IRA you want to convert is treated as additional ordinary income in the year you convert. Paying now is the equivalent of buying out the government’s ~40% share of their ownership of your IRA money and it’s future growth. This assumes you have enough assets outside your IRA to pay the tax bill (though you can withdraw some from your IRA if you need to, it reduces the benefits somewhat since you are cutting into the principal used for future tax free growth). Paying these income taxes now is painful, but it also reduces the size of your estate and thus likelihood of paying more in estate taxes later. And it makes what is left in your estate more valuable to you and your family. There is really nothing as tax beneficial as a Roth IRA.
A few big benefits by switching to a Roth IRA:
– all future distributions and growth is income tax free (except distributions prior to age 59.5 – subject to 10% penalty still, except for a few exceptions like the SEPP rule Steve mentioned or if it falls under the first-time home purchase exception or qualified educational or medical expenses)
– you no longer have to take out required minimum distributions at age 70.5 if you don’t need the funds
– when your children inherit this, they will also benefit from income tax free growth and distributions for life; they will have to take out a percentage each year based on their life expectancy; and they can take out as much above that annually as they like
The downsides of keeping with an IRA (Traditional or Roth):
– lots of rules about prohibited transactions and disqualified parties to be aware of
I worked with PassportIRA.com on this, and I would highly recommend them. It’s the brainchild of Terry Coxon, who is a long time associate of Doug Casey. Jeff Schneider runs the daily operations for PassportIRA, and they offer a lot of educational materials and consultation time to walk you through the process. They can help you setup an LLC inside your IRA, which has several benefits. The biggest one for me is the “discount valuation” which can cut your Roth conversion tax bill significantly. Discount valuations have been used for decades by estate attorneys to reduce the valuation for tax purposes of estates and gifts. Since 2010 when the government allowed anyone to convert to a Roth (regardless of adjusted gross income), this opened the door for advanced techniques like using a discount valuation for a Roth conversion. It’s relatively new in this context, and may end up seeing some challenges by the IRS in the coming years, but most likely the IRS will only be able to challenge the amount of discount and not the entire discount if you did everything properly.
A “discount valuation” is essentially the concept that an LLC is not just worth the sum of the market value of it’s assets. A membership stake in the LLC has a fair market value equal to what a willing buyer and willing seller would pay for it. And if an LLC is written to abide by IRA restrictions and some other provisions that make buying and selling membership shares more difficult, it makes an outside party less likely to want to invest in your LLC for the full amount of the assets since they would not have the same level of control as the majority owner. Overall, this can result in you’re IRA assets being valued around 20% to 70% less than the full market value of the assets the LLC holds (a 35% discount is fairly common). That in turn can cut your income tax bill for the Roth conversion by 20-70%. The actual amount depends on various factors like what you are invested in when you get an LLC valuation done by a qualified appraiser (the more illiquid the investment inside the IRA-LLC, the better – think private placement or physical gold). Keeping the LLC in place will also lower your IRA’s valuation for estate tax purposes by 20-70%.
The LLC can be setup in any state, or it can be setup in a foreign country. For smaller IRAs, I would stick with a domestic LLC to keep things simpler with fewer expenses. For larger IRAs, an offshore LLC may make sense. It adds another layer of asset protection, and it allows you to invest in a lot more places internationally that may not otherwise accept US clients.
Todd Berry – I agree that it was not cheap. There are setup fees to PassportIRA, fees for an attorney to write the LLC operating agreement, setup and annual to an IRA custodian (though we found a custodian that charges a flat annual fee). And it adds complications for your CPA. But you should weigh those costs against the amount you are saving with the discount valuation. In our case, the benefits were far greater.
Sherilynn and Todd – about the 5 year rule. When I talked to a tax attorney about this, they explained that it primarily applies to any growth withdrawn during the first 5 years of each Roth conversion. So say you convert $100,000 this year, and it grows to $150,000 by the end of 5 years. Anytime within the first 5 years, you can withdraw up to $100,000 from your Roth IRA without any additional taxes. If you try to withdraw $150,000 before the 5 years are up, the $50,000 in gains would be treated as additional ordinary income plus potentially a 10% penalty (this part you may want to check with a CPA or tax attorney to be sure). Let’s also say next year, you convert another $100,000 to a Roth. That starts a separate 5 year waiting period for that converted amount. But if you pull out $200,000 in say year 3, your custodian should treat that as a distribution of just the $200,000 in principal that you put in, and no additional taxes would be owed. In other words, the IRS does not tax principal withdrawals within the first 5 years of a Roth conversion, and the custodian assumes you are withdrawing principal before growth. See the IRS Publication 590 for more details (http://www.irs.gov/pub/irs-pdf/p590.pdf). Here’s an article with more details: http://www.money-zine.com/Financial-Planning/Retirement/Roth-IRA-5-Year-Rule/
About real estate within an IRA, the government does say you can’t personally benefit from the property by staying there (or your lineal family staying there). You would have to distribute the property (possibly selling it first, or maybe possible to get a valuation done for tax purposes) from the IRA before you could technically use it yourself, even if you’re retired. Obviously this would be a pretty difficult thing for the government to prove, especially if the property is overseas. But the government is getting more broke and desperate by the hour, so the burden of proof may be on you to prove you bought the property for investment purposes and not recreation if they audit you.
From my research and discussions with advisors, the easiest way the government may try to get more out of our retirement accounts without outright confiscation is to write a law forcing a certain percentage to be invested in Treasuries. This could be argued by liberals to be for our elderly’s safety so they don’t make bad investing decisions. This has been proposed as “Guaranteed Retirement Accounts” (GRA). From my perspective though, if this ever looks like it’s going to pass, I would hope there was at least a few weeks or months to get my act together and fully distribute the funds from the IRA custodian and send the money offshore (all the more reason to get an offshore account setup NOW before FATCA and potential capital controls make that impossible later).
If things in the US get really bad overnight, however, there are alternatives. Your IRA (or IRA-LLC) can own American Eagles (gold, silver, or platinum), and you can store them yourself anywhere in the world (hopefully with custodian you could easily reach or that offers to deliver the metals anywhere in the world). If you choose a different type of coin or bullion, IRA regulations force you to keep them stored with an IRA trustee such as a US bank. Technically the Eagles would have to be sold through your IRA (or IRA-LLC), and the money should be distributed back to you through your US IRA custodian. But in desperate times, you coud have gold coins in your possession.June 8, 2012 at 3:04 pm #27241
Thanks to everyone for the detailed information on this tricky subject.
If the IRA is cashed out early, is the 10% penalty tax deductable?June 12, 2012 at 2:46 pm #27242
If you want to hold Real Estate or Foreign Assets in your IRA, check out Sterling Trust ( http://www.sterling-trust.com/ ).
I’ve used them to purchase rental Real Estate in my Roth IRA. They are an IRA Custodian and allow all sorts of other alternative investments. Their annual fees are pretty reasonable.August 7, 2012 at 8:07 pm #27260
Thank you for your thoughts on the IRA-LLC. This may give us enough flexibility for investment options and control so I am confortable with a Roth conversion and not worry as much about government changes in IRA regulations within the 5 years during which withdrawal would be prohibited.
As I’ve been exploring various companies that offer the self directed IRA-LLC option some have specifically told me there could be no ‘valuation discount’ based on the LLC structure. Is this valuation discount unique to the Passport IRA structure? Are any of you aware of this valuation undergoing IRS audit and passing?August 15, 2012 at 6:42 pm #17974
I am not sure what the reasons are that the other companies did not believe a valuation discount was possible. The concept of valuation discounts has been used for a long time as an estate planning technique, but no one was really using it for converting IRA’s to Roth’s until after 2010 when the limits were removed on how much Adjusted Gross Income you can make and still fund a Roth. I had a 3rd party tax attorney review Passport IRA’s strategy, and they agreed the LLC discounts would apply for a Roth conversion. As of a year ago when that was done, they did not find any precedents set in tax courts where the IRS challenged the valuation discounts on a Roth conversion. I found that there really are no guarantees on what % discount is acceptable, as it is based on many factors and past tax case law. There is the possibility that the IRS could try to challenge the amount of the discount via an audit within 3 years of the conversion (or 6 years if they claim you were significantly off on the valuation). But if you use a licensed business valuation expert, you are standing on pretty firm ground. In the worst case of an audit, you may be pushed to lower the amount of the discount and pay more in taxes, but in my view, the benefits outweigh the risks. With no audit, you’ve saved a ton of money. If audited, you may have a hassle and extra legal & accounting fees, but you’ll still end up saving taxes on a conversion when tax rates are historically low.
I also realized I spoke too soon when I said previously that the Eagles held in the IRA would have to be sold to do a distribution. I believe your IRA custodian should be able to do an in-kind distribution of the coins, and the distributed amount for tax purposes would be the fair market value of the gold that day.
You must be logged in to reply to this topic.