by Mat Sorensen | Apr 22, 2014 | Retirement & IRAs, Tax & Legal Updates and Policy Changes
In 2012, the SEC and NASAA issued Investor Notice 5866, Self-Directed IRAs and the Risk of Fraud. In the notice, the SEC and NASAA outlined how self directed IRAs can be susceptible to numerous types of fraud and how self directed IRA investors can be bilked. The notice outlined some significant cases where investors with self directed IRAs were involved and where the investors incurred significant losses as a result of fraud and misrepresentations in the companies where the self directed IRAs invested.
The due diligence issues for self directed IRAs are not any different from the due diligence issues for individual investors. The concern, however, is that for many self directed IRA investors, their retirement account is their largest source of funds. Consequently, those accounts can be targeted by crooks. The bottom-line point of the SEC Notice is that self directed IRA owners should carefully conduct due diligence before investing their self directed IRA funds.
I have my own thoughts as to appropriate due diligence, which are in accordance with the SEC Notice, and I have outlined those thoughts in the following due diligence “top ten list”.
DUE DILIGENCE TOP TEN LIST
Before you invest your self directed IRA into a “non-traditional” private business or into a real estate investment, you need to ask some hard questions to the person or business receiving your money. Here are some tips to minimize investment risks with your self directed IRA.
- If you don’t understand how the business or investment makes the returns being promised, then don’t invest.
- If you aren’t given adequate documents outlining what has been explained to you verbally or what has been put into a presentation, then don’t invest.
- If you’re told that you can get a commission for bringing others to invest into the same company and if you don’t have a license to receive such commissions, then don’t invest. If the investment sponsors are willing to violate the law to pay an non-licensed person to raise money from others, then what’s stopping them from misappropriating your IRA investment? It is only the law preventing them, which they’ve proved they will disregard.
- If your self directed IRA is loaning money for a real estate venture, then demand a recorded deed of trust or mortgage on title to the property, protecting your investment. Also, make sure that you get a copy of the title report or commitment showing what position your loan is being placed into when the deed of trust or mortgage is recorded. Many savvy investors (and what all banks do) create lending instructions to the title company or attorney closing the real estate transaction that instruct the closing agent to only use the funds being loaned when the borrower signs the note/loan documents, when the closing agent verifies the priority of the deed of trust or mortgage you are getting (1st position, 2nd, etc.), and when all other defects to title have been cleared.
- If you’re investing into a PPM, a private offering, or a crowdfunding offering, you should receive numerous documents outlining the investment, the use of funds, the background of those managing the company, and also documents regarding your rights as an investor (e.g., offering memorandum and LLC operating agreement or LP limited partnership agreement). Also, check to see if the PPM or private offering was properly filed with the SEC by going to SEC.gov and checking the company name in the SEC database. If no filing record exists for the PPM or private offering with the SEC, then the person raising the funds has possibly disregarded the law. As stated earlier, if someone is willing to disregard the law to get your money, what is stopping them from disregarding the law to not pay you back (it’s just the law)?
- Investigate the background of the person(s) with whom you are entrusting your money. When you are investing with others, you need to think like the bank and do what the bank does. What is this person’s credit worthiness? What is their employment or prior business experience? What is their business or investment plan? What are the terms of the investment? Is there a realistic rate of return that fairly recognizes the risk being taken?
- If you’re pressured that this opportunity will pass if your self directed IRA doesn’t invest now, then let the opportunity pass. Most scams use this technique, and most legitimate investments never have this funding crisis.
- Make sure a lawyer representing your interests reviews the documents. If a lawyer drafted the documents, it is still important to have a lawyer look at the documents as they relate to your interests and with an eye towards protecting your self directed IRA. Sometimes, unfortunately, the devil is in the details, and many investments have clauses that can significantly impact your ability to get your money back or that give the company raising the money the ability to pay whatever compensation to themselves that they desire. These are obvious problems that will eat into the bottom line of the profits you may be expecting.
- Seek the opinion of another investor, business owner, or friend whose opinion you trust. Sometimes, when you explain the investment to someone else, he or she can help you find issues to consider and questions you should be asking.
- Be comfortable saying no and only invest what you are willing to lose. Non-traditional investments have made many millionaires over the years, but they have also caused lots of financial ruin. Just keep the risk in perspective and don’t “bet the farm” in one deal.
I don’t want investors to be scared about self directed IRA investments, but I also don’t want investors going into them without having conducted adequate due diligence. It seems that some investors determine whether their IRA can invest based on the prohibited transaction rules but they neglect to determine whether their IRA should invest. Keep in mind that you can make great investment decisions that result in large gains in your self directed IRA, and you can also make terrible decisions that can result in huge losses for your self directed IRA. It’s all up to you.
Just remember that you, the self directed IRA owner, may need to get out of your comfort zone by asking a lot of questions, by demanding additional documentation, or by simply saying no. Remember: you are the best person to protect your self directed IRA.
This article is a modified except from The Self Directed IRA Handbook.
By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook.
by Mat Sorensen | Apr 1, 2014 | Retirement & IRAs
Crowdfunding is the newest form of raising capital for small businesses and start-ups and it will eventually dominate as a primary method of raising capital in amounts under $1,000,000. In essence, Crowdfunding relaxes the current securities law restrictions, which make it nearly impossible for a small business or budding entrepreneur to raise capital from others. The basic premise of the Crowdfunding exemption to the securities laws is that the laws are loosened so long as the total amounts being raised are capped ($1M) and so long as each investor is only allowed to invest only a small portion of their income or net worth. For a breakdown on the details of the Crowdfunding rules, check out my prior article here. Keep in mind; the final rules still haven’t been put in effect so Crowdfunding hasn’t started yet. But we’re getting close.
Because the typical investor of a Crowdfunding company is likely to have more investible funds in their retirement account then in their personal account, it is my prediction, and this is shared by many, that self-directed IRAs will become a very popular investment vehicle and funding source for Crowdfunding deals. A self directed IRA is an IRA with a custodian or administrator whereby the IRA can invest into any investment allowed by law. The IRA is not restricted into only investing into publicly traded stocks, bonds, or mutual funds but can instead invest into real estate, private companies, or in a company via a Crowdfunding offering. The companies who offer these types of IRAs are referred to as self-directed custodians.
Before IRA money is invested in a Crowdfunding offering, the parties involved (investor, offering company, portal) should be aware of the following issues that are unique to Crowdfunding where an IRA is involved.
- UBIT Tax. There is a tax that can apply to an IRA called unrelated business income tax (“UBIT”). IRC 512. This tax doesn’t apply to IRAs in passive investments like rental real estate, capital gains, or on dividend profits from a C-Corp (e.g. what you get from publicly traded stock owned by your IRA) as those types of income are specifically exempt from UBIT tax. However, one situation when an IRA is subject to UBIT tax is on profits from an LLC or LP where the profits are derived from ordinary income activities like the selling of goods or services. So, for example, if my IRA bought LLC units in a company that manufactured and sold a new yard tool then the profits that are returned to my IRA is ordinary income (where no corporate tax was paid) and will be subject to UBIT tax. The UBIT tax rate is 39.6% once you have $12,000 of annual net profits. Being subject to UBIT tax isn’t the end of the world and there are some structuring options to minimize the tax such as a c-corp blocker company which can cut the tax rate in half in many instances.
- Avoid Perks. Many Crowdfunding offerings promise free products or special services to the shareholders/owners that invest through the Crowdfunding offering. Unfortunately, these perks to self-directed IRA owners will likely constitute a self-dealing prohibited transaction and will result in disqualification of the IRA. A self-dealing prohibited transaction occurs when and IRA owner receives personal compensation or otherwise personally benefits from an IRA’s investment. IRC 4975 (c)(1)(F). As a result, perks to self-directed IRA owners should be provided only when it has been determined that they would not result in a self-dealing prohibited transaction.
- No S-Corporations. An IRA cannot become a shareholder in an s-corporation because IRAs do not qualify as an s-corporation shareholder under the tax laws. IRC 1361 (b)(1)(B). Consequently, IRAs should not invest in companies that are s-corporations.
- Watch Out for Companies Owned or Managed by Family. The tax laws restrict your IRA from investing into companies where you or a family member (e.g., spouse, children, parents) are owners or members of management. IRC 4975(c). As a result, if the Crowdfunding offering is offered by a family member or if a family member is involved in management, make sure you consult with an attorney prior to investing your IRA into the Crowdfunding offering as it could result in a prohibited transaction for your IRA.
The rules regarding self-directed IRAs can be a little tricky at first, but once learned they can be easily applied to common Crowdfunding scenarios. In summary, before investing your self-directed IRA into a Crowdfunding offering, make sure you add the above items to your due diligence check-list. Failure to properly understand these rules can result in taxes (e.g. UBIT tax) or disqualification of your IRA (e.g. prohibited transaction).
By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook.
by Mat Sorensen | Dec 3, 2013 | Retirement & IRAs
The IRS recently announced the 2014 retirement plan contributions limits. The only significant changes in contributions amounts were for SEP IRAs Defined Benefit Plans. SEP IRA annual maximum contributions increase in 2014 from $51,000 to $52,000. Defined Benefit contributions increase in 2014 from $205,000 to $210,000.
Contributions limits for Roth and Traditional IRAs remain unchanged with annual contribution limits of $5,500 and an additional $1,000 for those 50 and older. Also unchanged are 401(k) employee contributions which remain at $17,500 annually with an additional $5,500 for those 50 and older.
On the HSA and FSA fronts there are two major changes for 2014. First, amounts placed into an FSA (flexible spending accounts) can now roll over from year to year. Previously, amounts placed in a FSA were subject to a use it or lose type system. HSA contribution limits increase in 2014 for individual accounts from $3,250 to $3,300 and for family accounts from $6,450 to $6,550.
All of these accounts provide tax advantageous ways for an individual to either save for retirement or to pay for their medical expenses. If you’re looking for tax deductions, you should determine which of these accounts is best for you. Keep in mind there are qualification and phase out rules that apply so make sure you are getting competent advice about which accounts should be set up in your specific situation.
By: Mat Sorensen
by Mat Sorensen | Sep 10, 2013 | Retirement & IRAs
Many self directed IRA investors misunderstand or are unaware of the protections afforded to their IRA (Roth or traditional) as it relates to creditors and judgments. This article seeks to address the key areas of the law that every self directed IRA investor should know.
First, your IRA is not always exempt from creditors up to $1Million. Many IRA owners believe that federal law protects their IRA from creditors up to $1M. While Section 522(n) of the federal bankruptcy code protects an IRA owner’s IRA from creditors up to $1M, this protection is only provided to IRAs when an account owner is in bankruptcy. If the IRA owner is not in bankruptcy then the creditor protections are determined by state law and the laws of each state vary. For example, if you reside are a resident of Arizona then your IRA is still protected from creditors up to $1M even without filing bankruptcy. The approach Arizona takes is the most common, however, many states protections for IRAs outside of bankruptcy are extremely weak. For example, if you are a resident of California then your IRA is only protected in an amount necessary to provide for the debtor and their dependents. That’s a pretty subjective test in California and one that makes IRAs vulnerable to creditors.
Second, while your IRA can be exempt from your personal creditors, as explained above, it is not exempt from liabilities that occur in the IRAs investments. For example, if your IRA owns a rental property and something happens on that rental property then the IRA is responsible for that liability (and possibly the IRA owner). As a result, many self directed IRA owner’s who won real estate or other liability producing assets utilize IRA/LLC’s which protect the IRA and the IRA owner from the liability of the property.
Third, if the IRA engages in a prohibited transaction under IRC Section 4975 then the IRA is no longer an IRA and is no longer exempt from creditors. Despite the bankruptcy and state law protections outlined in my first point above, if a creditor successfully proves that a prohibited transaction occurred within an IRA then account no longer is considered a valid IRA and therefore the protections from creditors vanish. There seems to have been an increase in creditors who are pursuing IRAs, particularly self directed IRAs, and I have been representing more and more self directed IRA owners in bankruptcy and other creditor collection actions in defending against prohibited transaction inquiries.
In summary, the best way to protect your self directed IRA from creditors is to understand the rules that govern your self directed IRA and to seek counsel and guidance to ensure that your retirement is available for you and not just your creditors.
by Mat Sorensen | Dec 10, 2012 | Retirement & IRAs
By: Mathew Sorensen, Partner KKOS Lawyers
Good news. The IRS has announced increases into the amount of money individuals may contribute into their retirement plans in 2013. The IRS increased the amounts that may be contributed to Traditional and Roth IRAs. The IRS also increased the total amount that may be contributed as employee contributions into 401(k) plans. Here’s how the increased annual limits broke down.
Traditional and Roth IRAs- Increased from $5,000 to $5,500 a year. Those over 50 can still make an additional catch-up contribution of $1,000. Also, the income qualification limit for Roth IRA contributions increased from $183,000 to $188,000 for married couples and from $125,000 to $127,000 for those filing single.
401(k) Plans- The annual employee contribution amount that may be contributed into a 401(k) increased from $17,000 to $17,500. The catch up contribution from employee plans is still $5,500 per year for those who are 50 or older.
SIMPLE IRA- The amount that may be contributed to SIMPLE IRAs annually is increased from $11,500 to $12,000. Catch-up contributions for those over 50 stays at $2,500.
SEP IRA- The total amount that may be contributed annually increased from 25% of compensation or $50,000 to 25% of compensation or $51,000, whichever is less.
With increased tax rates on the horizon the tax benefits of making retirement plan contributions are only that more valuable. There are also tax credits for employers adopting new plans as well as savers credits for low income workers contributing to retirement plans. Please contact us at the law firm for assistance in determining which retirement plan is right for you.
by Mat Sorensen | Nov 13, 2012 | Retirement & IRAs
By: Mathew Sorensen, Partner KKOS Lawyers
The Affordable Care Act, also known as Obamacare, includes a new tax on net investment income of 3.8%. While the application of this new tax was slated for 2013, many lawyers, investors, and politicians believed that this law would never come into effect. That was before the Supreme Court upheld the law by one vote and before President Obama won re-election by less than 2% of the popular vote. Given the laws narrow survival in the courts and in the political process we now need to prepare for how the new 3.8% medicare tax will apply to us.
The tax is 3.8% on net investment income which includes; rental real estate, real estate capital gains, dividend income, royalty income, interest income, and passive business activity income. Essentially, think of income that is not taxed as ordinary income and subject to self employment tax. The new tax will apply to taxpayers whose adjusted gross income is $200,000 or more single or $250,000 or more married. It will apply whether the investment income comes from an s-corporation, LLC, or other entity that does not pay a corporate level tax. Keep in mind, the new tax only applies to net investment income so expenses and losses will offset income.
There are situations where the investment income tax will not apply. For example, the new tax will not apply to retirement plans such as 401(k)s or IRAs even if those plans are receiving these classifications of income outlined in the law (e.g self directed IRAs with rental income, capital gains, interest, etc.). Also, taxpayers whose business or trade is real estate are also exempt from the new 3.8% tax since their income is classified as income from a business or trade and not as investment income. In order to qualify for this classification a taxpayer must be deemed to have materially participated in the real estate investments, which participation requires a certain level of hours committed to real estate for the year. Many real estate investors will qualify as having materially participated but you need to be coordinating with your CPA so you understand how this law will apply to you and your investments as the hour requirement can differ from short term real estate deals versus long term rental properties. IRS Publication 925 provides additional guidance on this issue and exception. Unfortunately, the new law recognized this exception but included a new tax of 0.9% for tax on earned income so those who are in the business or trade of real estate don’t completely avoid the new Obamacare taxes.
If an exemption to the law doesn’t apply and an investor will be subject to the tax on the sale of real estate, an investor may want to consider a 1031 exchange whereby the real estate is sold and the proceeds of the sale are re-invested into a new property. A 1031 exchange is a strategy used by many real estate investors to defer the capital gains into a new replacement property purchased with the proceeds from the sale of a property. This 1031 exchange strategy will also have the effect of also deferring the application of the new net investment income tax from the capital gain on the sale of a property.
Page 9 of 9« First«...56789
