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May 23, 2024 | read

150. How You Can Become an Accredited Investor Without The Income or Net Worth Requirements

Thomas Castelli

In this episode, Thomas Castelli explains an alternative way to become an accredited investor without the income or net worth requirements.

This episode is sponsored by our free Tax Smart Investors Facebook Group.

Full Transcript:
This podcast has been transcribed using AI, please excuse spelling, grammatical, and other errors.

Thomas Castelli 0:00
You’re now listening to the real estate CPA podcast.

Brandon Hall 0:04
Your source for all things real estate, accounting and tax. Here we reveal our secrets that can save you 1000s in taxes, streamline your accounting process and help grow your business. Stay tuned to hear insightful interviews with industry experts, successful real estate investors and current clients on what strategies they use to grow their business, and how they steer clear of Uncle Sam.

Thomas Castelli 0:31
Hi, everyone, thanks for tuning in Thomas Castelli here and today we’re going to discuss how you could become an accredited investor without passing the income or net worth test. Now, for anybody who’s familiar with the world of private real estate syndicates and funds becoming an accredited investor can give you access to some of the most lucrative and broadest range of private real estate offerings out there. But becoming an accredited investor can be challenging, so there’s an alternative path. And that’s exactly what we’re going to discuss today. Before we dive into the episode, so explain how to become an accredited investor with this alternative path.

This should not be taking as legal tax, financial or investment advice. And you’re going to want to speak to your own advisers to make sure that any transaction or investment opportunity that you’re pursuing makes sense for your situation. I also want to remind everybody about the tax smart real estate investor Facebook community, there are currently over 2300 members and counting with a ton of great conversations on real estate investing and tax is taking place right now with real estate investors have all levels to join, visit facebook.com/group/tech smart investors or simply search tech smart real estate investors on Facebook to join today. We’ll see you there but for right now we’re going to dive right into today’s episode. Alright, so to start everything off, I just want to discuss why becoming an accredited investor matters in the first place. Long story short, when you become an accredited investor, you have the opportunity to invest in private placement offerings under Rule 506 C as a passive investor. In the world of private real estate. These are often called syndicates and funds. Basically, you have sponsors who will go out there also called the general partners who go out and they identify properties to acquire they raise capital through equity from private investors and also obtain debt financing from banks. They then acquire the property and then they operate the property either to produce cash flow and or to increase the property’s value before ultimately selling it to provide a return on investment for their investors. So sponsors are responsible for managing the deal from A to Z. While their investors often call it limited partners can passively invest in these deals and reap the financial benefits without having to deal with the hassles of day to day management of the property. Now to raise capital for these deals. These sponsors typically will use one of two exemptions from registration from the SEC, rule 506 B and rule 506 C. Now rule 506 B allows up to 35 non accredited investors and an unlimited amount of accredited investors to invest in these deals. The downside is the sponsors cannot advertise and must have pre existing relationships with their investors before allowing them to invest. This is often called the family and friends exemption as often used by sponsors who are just starting out. Now, rule 506 C allows sponsors to advertise their offerings to the general public making a lot easier to gain access to a broader range of investors. However, only accredited investors are allowed to invest in rule 506 C offerings. The problem is many of the most experienced sponsors with the longest track records of success only use rule 506 C offerings. Now this is typically because they have already built their investor base up to the point where they no longer need to use rule 506 B, which streamlines their investor relations process, and also reduces their risk. And again, the biggest problem here is that some of the most experienced sponsors with the longest running track record of success only accept accredited investors. And like Warren Buffett says, When investing you want to invest with a strong management team, after all, the management team, also known as the sponsors in this case, are going to be responsible for the deals ultimate success or failure. So you will want to invest typically with experienced sponsor with a proven track record in order to increase your chances of success. Now, that being said, I’m not saying rule 506 B sponsors are bad by any means. It just typically you’ll find a lot of inexperience investors using rule 506 B to raise capital for the first offerings. And if you want to open yourself up for the most broadest range of opportunities, you’ll want to become an accredited investor. But then you run into another problem becoming an accredited investor is not always feasible for everyone, at least not in the short term. It might take a while to get there. Until recently before 2020 The way to becoming an accredited investor as an individual was typically to pass either the income or net worth test. So the income test is as follows. So as an individual, you have to earn at least $200,000 for the previous two years, with the expectation of earning the same amount or more in the current year, if you’re married, you can combine your income and earn $30,000, or more jointly for the prior two years with the expectation of earning the same amount or more in the current year. As for the net worth test, it’s going to be regardless of whether you’re single or you’re married, it’s a million dollars of net worth excluding your primary residence, and it’s either or test, you can either meet the income test or the network test. And as you can imagine, it can be difficult to become an accredited investor, or at least take you a while to get there. And if you’re want to be a passive investor, you want invest in private real estate offerings. Again, as we discussed, you want to become an accredited investor as soon as possible. So you have access to the broadest range of opportunities available up until 2020. These were the two main ways you would become accredited. But that’s changed as the SEC amended their rules to allow investors holding the following licenses to become accredited. And these licenses are the series seven, which is the general securities representative, this series six five, the investment advisor representative or the series eight to the private securities offering representative to obtain the series seven or the series A to you generally need to be sponsored by an organization who’s in one of these businesses already. So essentially, you’re working in the financial services industry. However, for the series six five, the investment advisor representative, you do not need to be sponsored by an organization. Instead, you can take the exam and become licensed as a sole proprietor. So I do want to point out that simply passing the series six five exam is not enough to become accredited, you must actually register as an investment advisor with your state to become accredited. In summary, there’s now a new path to becoming an accredited investor outside of the income and network tests. And that’s by passing the series six five exam and becoming a licensed investment advisor with your state, which essentially anybody can do. Now there are some exceptions if you’re a felon or something like that, but for the most part, anybody can do that, right. And this is important because if you want to be a passive investor, and you want to invest in the private real estate offerings, known as syndicates, and funds becoming accredited, will give you access to the broadest range of these opportunities available, including rule 506 C offerings, which some of the most experienced sponsors, with the longest track record of success, use to raise capital for their deals. Before we wrap up, I do want to say that I know some people out there might be listening and saying, Well, how feasible is it actually to pass the series six five exam and become a licensed investment advisor with your state. And I can speak from experience, the series six, five examination is not overly difficult. I studied for two months, a few hours a day, I walked into the exam and pass it with a breeze. And I don’t think it’s because I’m the smartest person or anything like that. I just don’t think it’s an overwhelmingly difficult examination. But as I mentioned before, simply passing the examination does not make you accredited an investor, you actually have to go through the process of registering with your state to become a licensed investment advisor. And I did that with my state of residency. And I’ll admit, it was a bit tedious, a little bit time consuming a little bit back and forth to get everything in place. But ultimately, I think it’s so it’s it’s not it’s not that difficult, you know, it’s something that you can achieve a it might take you a few months, a month or two to get there. When all said and done. But I it’s a pretty low bar and it makes you accredited. The last thing I’ll say is that there’s a reason why the income and net worth tests were put in place in the first place. And that’s because it was deemed that the people who had these income or net worth criteria, were more financially able to withstand a potential negative investment. And it’s important to remember that rule 506 B and rule 506 C are exemptions from SEC registration.

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So unlike your publicly traded companies, where there’s heavy rules, there’s audits there’s strict reporting requirements that have to be reported to the SEC in order to be offered on the public markets. These investments do not have stringent requirements, right? That’s why they’re the exemptions and they are inherently more risky as a result, or at least perceived that way. That said, what we discussed here on today’s podcast is for informational purposes only and should not be construed as tax legal, financial or other advice, you’re going to want to go ahead and speak to your advisors to make sure that any investment opportunity that you’re considering is appropriate for your circumstances. Thanks for listening. Have a great day and we’ll catch you on the next episode.

Brandon Hall 9:46
Thanks for listening to today’s show. If you enjoyed the show, please find us on iTunes and leave us a review. You can also email us at contact at the real estate CPA comm with any feedback or topics suggestions. We are always taking on new clients and with the new tax laws in play. You really don’t want to navigate this alone. Let us help you save money on taxes with your accounting and CFO needs. To become a client. Navigate to our client page at the real estate CPA calm and fill out a webform with as much detail about your situation as possible. Thanks so much for listening. Have a great rest of your week.

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