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Alternative Asset Purchases In IRA

I want to get you excited about alternative asset investing by showing you some recent examples of deals done in my self directed IRA and solo 401k. I constantly wonder why people are so “stuck” on buy stocks and bonds only and don’t even consider investing in real estate, notes, private lending, tax liens, gold and so on. I know once people see the potential returns and the relatively low risk as compared to the traditional assets they will switch into alternative assets. Let’s look at a few examples of a real estate purchase, note purchase and private lending to an investor.

Real Estate Purchase

I purchased a single family house in South Carolina and after doing cosmetic repairs, the property was rented for 9 months before the tenants purchased the property for $120,000. This resulted in an annual cash on cash return of 36%.

Purchase price: $91,000
Repairs: $5,100
Rental: $1,195/mo
Rental profit: $10,755 (9 months)
Sales price: $120,000
Sales profit: $23,900
Annual return: 36%


Mortgage Note Purchase

I purchased a first lien mortgage note on a single family property in Florida. The note was purchased for $15,900 and the monthly payment was $656/month. The property value is $48,000 which gives a low loan to value of 33%. The note has great upside potential with an UPB (unpaid principal balance) of $79,000.

Note price: $15,900
Property valve: $48,000
LTV: 33%
UPB: $79,000
Payment: $656/month
Annual return: 49%
Upside profit: $63,100

Private Lending

I met a real estate investor who wanted to buy, fix and flip a residential property. The investor had a purchase and sale agreement for $36,000 and the ARV was $79,000. The property needed about $14,000 in repairs. I agreed to lend around $29,000 (a very safe position). The loan was repaid in 6 months for a net annual return of 14%.

Property value: $79,000
Purchase price: $36,000
Loan amount: $28,800
LTV: 37%
Interest rate: 10%
Points : 2%
Term: 6 months
Annual return: 14%

I really hope that these examples and high returns inspire you to go out and think big for your retirement savings plan whether it is in a solo 401k or a Self Directed IRA.

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Subtle IRA Prohibited Transaction Rules

When a person first discovers that his retirement accounts don’t have been chained to Wall Street stocks his mind starts to think about the investment possibilities. However, prohibited transactions is an important topic when looking into self-directed IRA and Solo 401k investing. Typically people are limited by the investment options (only stocks, bonds, mutual funds, etc) but that can be eliminated by setting up a proper solo 401k account or setup an account with a proper custodian that allows such transactions. The other limitation is one that is bound by IRS rules and cannot be removed but is fairly simple to follow.

The general premise behind prohibited IRS transaction rules is that the government wants you to grow your retirement account as big as possible because they plan to tax it later on when you distribute the funds to yourself for spending. Without prohibited transactions rules, anyone in their right mind would grow their retirement account and then make losing investments that actually put their retirement funds into their own hands. The prohibited transaction rules make the above scenario illegal. In order to be legally compliant, every retirement plan transaction must involve a genuine effort to benefit the retirement plan itself without benefiting the plan owner or his relatives.

Here are some common strategies that are wrongly believed to successfully circumvent the rules. One is when two people what to benefit from each other and each others IRA. They swap benefits for personal gain. For example, Bob and Tom each have a self-directed IRA. Tom’s IRA loans $10,000 to Bob and Bob’s IRA loans $10,000 to Tom . This doesn’t break the rules that are most focused on, but it does break the usually ignored rules. For each loan transaction the borrower is not a disqualified person. However, the loan is a conflict of interest for the IRA owner because he expects to receive a loan back from the other person’s IRA. Because his decision to extend the loan from his IRA involves the expectation of a chain of events that is designed to benefit him personally, this is a prohibited transaction. Another example would be if Bob’s IRA and Tom’s IRA each bought a vacation home and each let the other person stay in the condo. When An IRA owns real estate its owner and any disqualified individuals are not allowed to make personal use of the property even if paying rent. When Bob vacations in a property owned by Tom’s IRA and Tom vacationed in property owned by Bob’s IRA this is a prohibited transaction. Again, what makes it prohibited is the fact that when the IRA owner made the decision to enter into the transaction, he expected to receive a personal benefit (whether direct or indirect) as a result of the transaction.

Another common work around is when people want to sell their house and can’t find a buyer. So the person finds a friend to buy the house and later the friend sell the house back to his/her IRA. People think this does not break any rules since the friend is not related and thus is not a disqualified person. The IRS see the friend as a strawperson who is involved for all the wrong reasons and really does not want the house but is helping to add separation to the real estate transaction. The law removes the strawperson to examine the real transacting parties. The IRS sees it as you sold your house to your IRA and that is a prohibited transaction.

You need to clearly understand the rules and don’t enter into these types of transactions. Focus on growing your retirement account without engaging in conflicts of interest.

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Tax Liens In Your Self Directed IRA

One investment that fits very well into your Self-Directed IRA are tax lien certificates. They are reasonably simple to understand and with a modest amount of research you can purchase certificates that will provide you with safety and a very attractive rate of return. Approximately half of the states are tax deed states, which means the actual property is auctioned off at a county place of location, and half of the states are tax lien states, meaning you can purchase and become holder of a tax-lien certificate.

A tax lien is a lien on a property for not paying taxes. Every year owners of real estate have a financial obligation to pay taxes on their real estate. If they are not paid, the county government will either auction a tax lien certificate or it can be purchased over the counter for the property. The winning bidder is in essence paying the taxes on behalf of the real estate owner and receives a tax lien certificate as proof of purchase. By paying these taxes, you are also helping the county as this money is used for roads, education, fire, and police. The benefit to you is you hold first position lien on the property above all other lien holders.

As the owner of the certificate, you can expect one of two possible outcomes. One, the owner will redeem his property by paying you, the lien holder, all the back taxes plus interest and fees, or two, if the owner does not pay you, since you are in first position on the lien, the bank holding the mortgage then has the option to pay you or relinquish the land or home to you as payment for the back taxes. Due process of foreclosure is required.

After purchasing the tax lien certificate, you wait for the redemption period if the state has one, which is typically one year (some state are more and some are less), or until the property owner pays the back property taxes owed. If the property owner decides to pay their tax obligation, he or she must pay a visit to the county tax collectors office where they will repay what you paid to acquire that tax lien certificate plus a pre-determined amount of interest. The interest rate is subject to state requirements. The county government will contact you, ask you to return the certificate, and upon receipt of the certificate, the county will generate a check in the amount you paid to acquire the tax lien certificate plus interest.

This can be a very safe and lucrative investment. Your interaction is with the county not the homeowner and your investment is backed by real estate or land. Tax Liens fit very nicely inside your Self-Directed IRA. As with any investment, be sure to do all of your research. You want to learn all you can about the property. It is imperative to do a proper title and bankruptcy search on the property. A certificate holder does not have priority over creditors and the Internal Revenue Service in a bankruptcy situation. This could eliminate the value of your tax lien certificate. Once you have checked out the financial and title situation of the property, you or someone on your behalf, should visit the property. There is a potential risk in purchasing a property, note or tax lien certificate sight unseen. Know what you are buying and how much you are willing to pay for it.

Look at each scenario and decide what your strategy would be if that scenario came to pass. Could you make money if you had to foreclose? Would you want to own the property? What would you do with the property if you did have to foreclose? Is the property going to need repairs?

There are tremendous opportunities with tax lien certificates. Be cautious, be smart, and find tax lien certificates that will enhance your portfolio.

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Advantages To Seniors Buying Real Estate In A Self Directed Roth IRA

In a self directed IRA you can buy real estate as many people know. The best way for a person about to retire to setup a substantial income stream for life is to buy real estate from your IRA and then rent the property. The rental income can be your retirement income tax free if you are over 59 1/2 and have had the account open 5 years or longer. This article explains why they should use a Roth IRA rather than a traditional IRA to do this.

Normal tax laws have always made real-estate a good tax shelter. Since real estate is generally purchased with a mortgage, tax laws allow you to deduct the annual mortgage interest as well as your real estate property tax. In addition, selling profits are taxed at long term capital gains rates. Owners who live in their property are can exclude up to $250,000 of gain if you’re single and $500,000 if you are married. Those that rent out their property for rental income can additionally depreciate their property yearly for a further annual tax deduction. This, along with the mortgage, property tax and maintenance expenses deductions, can actually shelter the rental income from tax and perhaps other income they receive too.

In some instances, these tax benefits are often too advantageous versus buying and holding rental income property within an IRA. IRA tax rules wipe out the typical real estate tax advantages mentioned above and all real estate deductions are eliminated. And, you can’t live in any property you own within your IRA. However, for individuals about to retire, you can create a substantial income from putting property in a Self Directed IRA. Traditional IRAs only defer taxes on annual real estate rental income. And that, along with all other property gains, will be tax at your income rates when you withdraw them. However, I think that Roth IRA tax rules offer a better alternative and are more competitive with the usual real estate tax advantages. That’s because all yearly earnings and withdrawals are tax free and there’s no minimum required distributions after turning 70 1/2 either as with a traditional IRA.

Let’s consider the advantages for seniors who buy rental investment real estate within their Self Directed Roth IRA when they invest in high rental income real-estate that will significantly appreciate over time. First, they can pull their real-estate investment rental income out tax free for their annual use. A key advantage is that Roth withdrawals won’t produce higher taxation of their Social Security income or loss of some of its benefits. Second, seniors often don’t have a high income themselves. So, they don’t reap much for sheltering income that depreciation, tax and interest deductions would present if bought outside the Self Directed IRA. In fact, seniors receive social security income which is only partially taxed or not at all. Third, when their Roth IRA real estate investment values increase over the years they can do one of several options in a tax free environment. One option is to sell that real estate within their IRA and take out all the cash in any amount tax free. Another option is to distribute that real estate out of the IRA for their own use and if meet the criteria this is tax free as well. If they sell it sometime in the future, its basis for determining capital gains tax would be their total contributions to the Self Directed Roth IRA for real estate purposes. Finally, they could leave the real estate in the Roth IRA so their beneficiary can reap further appreciation of it. The beneficiary must follow required minimum distributions for inherited IRAs but whatever they do take out will be tax free.

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Recent Changes In Social Security And Medicare

The Social Security Administration’s recently announcement a Cost of Living Adjustment (COLA) in the form of a 3.6 percent increase in retirees’ 2012 monthly Social Security checks. This change, which hasn’t occurred since 2009, means the current average monthly Social Security check will rise from $1,082 to $1121. Not a huge amount but it sure doesn’t hurt in today’s economy. This great news came with the caveat that Medicare, which itself has not raised its premiums for the past couple of years, may end up raising them which would in turn be deducted from Social Security checks and the end result being that much of the COLA increase would disappear on your Social Security check.

The good news is that there will be a nominal increase with Medicare Part B which is physician and outpatient services, but it will be much less than earlier thought. Premiums in 2012 will be raised to $99.90 per month which is a $3.50 increase instead of the $10.20 raise originally projected by Medicare. The monthly premium for Medicare Part A which is hospital coverage will stay the same at $451.00. Of course this only applies to those who pay a premium. In addition, those who took the big leap into retirement in 2011 and are currently paying a $115.40/month for Medicare will actually see their premiums drop to the standardized $99.90 mentioned above. Finally, Medicare Part B’s deductible is dropping as well to $140 and Medicare Part A will rise only $24.00 to $1,156.00. This is pretty darn good news.

However, this all being said, this is small peanuts and really won’t impact your life as much as taking the time to explore alternative investments in a self directed IRA. I find most people hesitate and don’t really know what to do with their money so they stick the bulk of their retirement in stocks and bonds. How is that working for you? Most people think that diversification is put some money in one mutual fund and some in another and so on. This is not diversification, this is suicide. Why? Typically, the when the market moves up all the stocks move up and when the market goes down the entire market heads in the same direction. Even the “international” funds are not a great haven and are tricky.

I find it best to invest in what I know and what I understand. I don’t have to be a “guru” in the area but at least understand the underlying asset and the potential risk and reward. The best thing I ever did was to roll my 401k to a self directed IRA where I am now in control and have opportunity to take advantage of great moves in Gold, Oil, Real Estate, private equity deals and much more. I think you may be surprised at how easy it really is to get double digit returns.

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