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In this episode, we're joined by Nate Hare. Nate is the Executive Vice President at Quest Trust Company, a company that serves self-directed IRAs, 401(k)s, and other retirement accounts that allow you to invest in alternative assets such as real estate. Nate was also a speaker at the 2020 Tax and Legal Summit. Nate's focus at Quest Trust is dealing with investors who buy real estate and lend within retirement accounts.
Today we discuss the various aspects of retirement accounts including the difference between a self-directed and regular retirement account, what you can invest in with a self-directed account, general questions he always gets, why the Unrelated Business Income Tax (UBIT) is often a non-issue, the strangest investments Nate has ever seen, and much more.
Self-Directed vs Traditional IRAs
Self-directed is really a marketing term. By rule, all IRAs are the same. The only difference is the type of assets that the managing company allows the investor to hold. The IRS allows for very diverse holdings in an IRA - traditional IRA providers only hold stocks and bonds because that's the easiest and most broad was for them to make money. At Quest, they allow the holding of any assets as long as the investor finds the asset them self. That includes real estate and hard money loans. If you want to hold non-traditional assets in an IRA, you must find a plan administrator that handles these investments.
Contribution Limits
Contributions depend on the types of IRAs, there are 3 categories.
Personal plans (traditional and Roth IRAs): $6000/year if under 50 years old, $7000/year if over 50 years old.
Employer plans: You may want to speak with your CPA about contributions to an employer plan. This is generally based on reported income. They'll look at Schedule C. This is a calculation based on income, generally up to 25% of a salary up to $57,000.
Specialty plans (health savings and education accounts): $3,500/year pre-tax for health savings (individual) and $7000/year pre-tax for a family. Contributions can be up to $2000 per child per year for education accounts
Categories: Tax Deductions vs Growth
The SEP (Simplified Employee Pension) IRA, Traditional IRA, and Health Savings account weigh heavier on the tax deductions side.
If growth is more important, then Roth IRA and Education Savings Accounts are great.
Unrelated Debt Financed Income (UDFI)
When an IRA makes an investment that's taxable to the IRA, UDFI is generated This occurs when an IRA borrows money for the investment. There is a tax on this. If you're buying debt-leveraged property in a 401(k), you're exempt from this UDFI.
People shouldn't be scared of the tax, just aware of the tax. You may not even have to think of the tax for several years. Some deals are structured in a way that payments or profit won't be realized for a few years. When it comes to selling the property, that's when the UDFI needs to be calculated when figuring out the capital gains that need to be realized by the IRA.
Capital gains in an IRA are only paid based on the debt-leveraged percentage at the time of sale and the 12 months prior. Over time, the debt leveraged percentage is reduced by paying down the mortgage and by property appreciation. In a perfect world, if the loan is paid off fully for a year before the asset is sold, then the capital gains would be zero. Quest Trust has a debt leveraged presentation to walk through this to help understand the cash on cash return side.
How do Banks Lend to IRAs?
Traditional banks don't lend to IRAs. There are banks that have found the niche of asset-based loans. They don't qualify it on income or credit, they qualify on equity. This generally involves a larger down payment, 30%-35%. This is a non-recourse loan, meaning that the bank only has claim to the asset, the property or land. These banks generally like to lend on income-producing property. Community banks are much more flexible and willing to work outside of the box than big banks.
Craziest SDIRA Investments
Nate has seen a client investing in horse sperm in Texas! He has also seen a client buy empty soy sauce bottles for resale. Some clients own restaurants or an ice cream shop. One client even owns a thoroughbred racehorse.
If you can hold title to something, it can be owned in a SDIRA, outside of life insurance contracts and collectibles.
Inherited IRA
Upon death, the IRA turns into an inherited IRA that is passed to the listed beneficiaries. With Inherited IRAs, the beneficiary can still live tax free off of the profits in that account. If you can accumulate rental property in a SD Roth IRA, this remains a tax-free vehicle. Those assets are still owned by an inherited Roth IRA and the same tax rules still apply.
Learn more about Nate and Quest Trust: https://www.questtrustcompany.com/
