Performing Due Diligence Before You Invest & The Due Diligence Top 10 List

by Mat Sorensen | Apr 23, 2013 | Uncategorized

Before you invest your hard earned savings or your self directed IRA into a “non-traditional” business or real estate investment of another you need to ask some hard questions to the person or business receiving your money. Here are some tips to keep you out of legal trouble and to help you avoid bad investments or structures.

1. If you don’t understand how the business or investment makes the returns being promised, then don’t invest.
2. 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.
3. 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 sponsor is willing to violate the law to pay an un-licensed person to raise money from others then what’s stopping them from misappropriating your money you invested? It is only the law preventing them, which they’ve proved they will disregard.
4. If you are loaning money for a real estate venture, then demand a 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 closing the real estate transaction and tell the title company to only use the funds being loaned when the borrower signs the note/loan documents, when the title company verifies the priority of the deed of trust you are getting (1^st position, 2^nd, etc.), and whether all other defects to title have been cleared (and if not cleared, disclosure of what they are).
5. If you’re investing into a PPM or private offering you should receive lots of 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)?
6. Investigate the background of the person you are entrusting your money with. 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?
7. If you are pressured that this opportunity will pass if you don’t invest now, then let the opportunity pass. Most scams use this technique and most legitimate investments never have this funding crisis.
8. Make sure a lawyer representing your interests reviews the documents. If a lawyer drafted the documents already it is still important to have a lawyer look at the documents as they relate to your interests and with an eye towards protecting you. Sometimes, unfortunately, the devil is in the details and many investments have clauses that can significantly impact your ability to get your money back out or that give the company raising the money the ability to pay whatever compensation to themselves they desire. These are obvious problems that will eat into the bottom line of the profits you may be expecting.
9. Seek the opinion of another investor, business owner, or friend whose opinion you trust. Sometimes, when you explain the investment to someone else they can help you find issues to consider and questions you should be asking.
10. 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.

Don’t be scared about investing into non-traditional investments. Just remember though that you may need to get out of your comfort zone by asking lots of questions, by demanding additional documentation, or by simply saying no. Remember, you are the best person to protect yourself.  So do it.

Obama Budget Includes Wish to Limit Retirement Account Size to $3 Million

by Mat Sorensen | Apr 9, 2013 | Uncategorized

Many clients have e-mailed me about President Obama’s new budget proposal which seeks to limit the collective size of an individuals retirement accounts (including IRAs and 401(k)s) to $3 Million dollars. This measure does not contain specifics but does indicate that it will raise $9 Billion dollars over a decade for the federal government to spend. Opposition to this measure has been significant and I was surprised to hear that the government would seek to limit how much one could save and invest for their retirement in a retirement account. As I heard about the proposal and read other articles on this new cap on retirement plans I realized that I needed to go to the actual budget proposal to see for myself what it contained. When I read the actual budget I learned two important things.

First, the budget proposal as a whole actually has some provisions that are good for retirement plans and encourages American savings. Obama’s budget includes a proposal to exempt accounts with $75,000 or less from required minimum distribution rules. Also, the budget proposal provides rules requiring employers with 10 or more employees who do not offer a retirement plan to at least offer direct deposit IRA accounts to their employees to be funded by employee contributions. Also, the IRS would double the federal credit from $500 to $1,000 to employer’s who offer employer sponsored plans such as 401(k)s to their employees. So, there are some good things for retirement plans in the President’s agenda. The $3 Million cap has understandably overshadowed everything else though.

The second thing I learned is that the budget is a wish list of sorts for President Obama that doesn’t reflect reality of what he has already signed into law and what is politically practical. For example, the budget proposal includes measures to reduce the estate tax exemption to $1M and to increase taxes on individuals making more than $200,000 a year. If you recall, President Obama signed into law an estate tax exemption of over $5M and raised taxes only on individuals making $400,000 or more.  And this was only three months ago. So, keep this proposal in context, as it requires the approval of house republicans and a closely divided senate. Bottom line, many of these provisions, including the retirement plan cap proposal, amounts to a long shot wish list and we will have to see how the proposal gets sorted out over the coming months. In the meantime, write your Congressman and Senator if you don’t like having a cap on how much you can invest and grow your retirement account.

The Not So Well Known Benefits of Roth IRAs

by Mat Sorensen | Mar 11, 2013 | Uncategorized

Many investors and financial professionals are familiar with the primary benefits of a Roth IRA: that after you pay taxes on the money going into the Roth IRA that the plans investments grow tax free and come out tax free.  That being said, there are so many more benefits to the Roth IRA that need to be noted. I’ll note just three.

First, Roth IRAs are not subject to RMD. Traditional retirement plan owners are subject to rules known as Required Minimum Distribution rules which require the account owner to start taking distributions and paying tax on the distributions (since traditional plan) when the account owner reaches the age of 70 ½. Not being subject to RMD rules allows the Roth IRA to keep accumulating tax free income (free of capital gain or other taxes on its investment returns) and allows the account to continue to accumulate tax free income during the account owner’s life time.

Second, a surviving spouse who is the beneficiary of a Roth IRA can continue contributing to that Roth IRA or can combine that Roth IRA into their own Roth IRA.  Allowing the spouse beneficiary to take over the account allows additional tax free growth on investments in the Roth IRA account. A traditional IRA on the other had cannot be merged into an IRA of the surviving spouse nor can the surviving beneficiary spouse make additional contributions to this account. Non spouse beneficiaries (e.g. children of Roth IRA owner) cannot make additional contributions to the inherited Roth IRA and cannot combine it with their own Roth IRA account. The non spouse beneficiary becomes subject to required minimum distribution rules but can delay out required distributions up to 5 years from the year of the Roth IRA account owner’s death and is able to continue to keep the tax free return treatment of the retirement account for 5 years after the death of the owner. The second option for non-spouse beneficiaries is to take withdrawals of the account over the life time expectancy of the beneficiary (the younger the beneficiary the longer they can delay taking money out of the Roth IRA). The lifetime expectancy option is usually the best option for a non-spouse beneficiary to keep as much money in the Roth IRA for tax free returns and growth.

Third, Roth IRA owner’s are not subject to the 10% early withdrawal penalty for distributions they take before age 59 ½ on amounts that are comprised of contributions or conversions. Growth and earning are subject to the early withdrawal penalty and to taxes too but you can always take out the amounts you contributed to your Roth IRA or the amounts that you converted without paying taxes or penalties (note that conversions have a 5 year wait period before you can take out funds penalty and tax free).

Roth IRAs are a great tool for many investors. Keep in mind that there are qualification rules to being eligible for a Roth IRA that leave out many high income individuals. However, you can convert your traditional retirement plan dollars to a Roth IRA (sometimes known as a backdoor Roth IRA) as the conversion rules do not have an income qualification level requirement on converted amounts to Roth IRAs. This conversion option has in essence made Roth IRAs available to everyone regardless of income.

Utilizing Multiple LLCs & A New Series LLC State

by Mat Sorensen | Mar 5, 2013 | Uncategorized

Last year Kansas became the ninth state to adopt a Series LLC statute and their law is now in full effect. A Series LLC allows a real estate investor with multiple properties to increase their asset protection by minimizing their liabilities between properties.  But before we explain how Series LLCs work and the states where it is available it is helpful to first explain how many properties you should hold in a regular LLC.

Most real estate investors use a limited liability company (“LLC”) to hold their properties as the LLC protects the owner of the LLC from the liabilities of the business/property. In other words, if something goes wrong on a property the tenant/plaintiff is forced to sue the LLC and cannot sue the owner of the LLC personally or get at the LLC owner’s personal assets. However, the plaintiff in a suit against an LLC is able to go after the assets of the LLC, which would include the property and anything else in the LLC. So, if you have multiple properties in one LLC the plaintiff can go after all properties. In order to avoid this liability situation investors can separate out the properties among multiple LLCs so that if something goes wrong in one property that liability is contained in the LLC that holds only that property and the other properties held in their own separate LLCs are outside the reach of the plaintiff. The benefit to multiple LLCs is that you can have separate liability protection for each property but the downside is that you have additional costs in setting up and maintaining additional LLCs.

When determining whether to put multiple properties in one LLC or whether to put separate properties into their own LLC the primary issue is how much equity is between the properties because the equity in the properties is what is being protected in a multiple LLC scenario. As a general rule we typically advise clients to use multiple LLCs when they have $200,000 in equity between properties in an LLC (or will have with a new property).  At this level of equity there is enough value to protect between the properties to outweigh the cost of the new LLC set up. If there is only $10,000 in equity between multiple properties in an LLC, because each property is fully mortgaged, then there is less equity to protect and we wouldn’t recommend separate LLCs for asset protection purposes. Additional factors to consider in determining whether to establish multiple LLCs for your properties are the type of properties (e.g. multi-family would be more in need versus single family) and the location of the properties.

In nine states as well as the District of Columbia and Puerto Rico, a real estate investor can set up what is called a series LLC. A series LLC provides for what are called sub-series and each sub-series (essentially its own LLC) holds its own property and gets separate liability protection. This is all accomplished in one Series LLC filing to the state and then one tax return for the series LLC but allows for an unlimited amount of sub series and as a result allows real estate investors to have each property they own treated separately for asset protection purposes. So, for example, a series LLC owner would own one property in Series 1 of ABC Investments, LLC, a series LLC, and then Series 1 would own one property. If something happens on the property in Series 1 then the liability is contained there and Series 2, 3, 4,5 etc. cannot be attached or otherwise subject to the liability of Series 1.

The Nine states with a true Series LLC statue are; Delaware, Iowa, Nevada, Utah, Illinois, Oklahoma, Texas, Tennessee, and now Kansas.

I should note that Minnesota, Wisconsin, and North Dakota offer an LLC called a Series LLC but it is confusingly different from what I have described as a Series LLC as these states only allow for different interests of ownership of the LLC but don’t allow for separate treatment of each series for assets and liabilities. Be weary in these three states when creating a Series LLC, as it may not be what you are expecting.

Keep in mind that the Series LLC structure only works when you have properties in the states that recognize Series LLCs. For those with properties in states without a Series LLC statute, we recommend the traditional multiple LLC structure described above to obtain the increased asset protection amongst multiple properties. For assistance in analyzing whether your asset protection structure would benefit from multiple LLCs or a Series LLC please contact the Law Firm at 435-586-9366.

Navigating the 2013 Capital Gain Tax Maze

by Mat Sorensen | Feb 19, 2013 | Uncategorized

Before the new 2013 capital gains rates went into effect taxpayers had a relatively simple way of understanding their capital gains taxes as there was only two rates for long term capital gains: zero percent for low income earners and 15% for middle and upper income earners. The fiscal cliff tax bill, the affordable care act, and numerous expiring tax cuts have all created a new and confusing system for long-term capital gains. The bottom line is that everyone will be paying more under the rules so careful planning is only that much more important as you have much more to lose by failing to plan.

Here’s a breakdown of the changes for 2013 forward.

1. CAPITAL GAINS TAXES. There are now three rates for long-term capital gains taxes. The applicable rate depends on your taxable income. Taxable income, not to be confused with adjusted gross income, is your taxable income after retirement plans and HSA deductions as well as your itemized deductions of mortgage interest, charitable deductions, etc. The rates and income brackets break down as follows.

I.         0% Rate- Single filers with taxable income of $36,250 or below and joint filers at $72,500 or under.

II.         15% Rate- Single filers with taxable income of $36,251 to $400,000, or joint filers with $72,500 or $450,000 of income.

III.         20% Rate- Single filers with taxable income of $400,001 and above and joint filers with $450,001 and above.

2. 3.8% NET INVESTMENT INCOME TAX. This tax was a result of the affordable care act and adds an additional tax to capital gains of 3.8%. The rate applies after a taxpayer reaches $200,000 of adjusted gross income for single tax filers or $250,000 adjusted gross income for those filing joint. Keep in mind that these income limits are based on adjusted gross income, which takes into account retirement plan contribution deductions but does not take into account itemized deductions such as mortgage interest or charitable deductions.

Because the new tax rules and the new higher rates are based on income levels it provides for a number of planning opportunities for families and others wishing to minimize taxes. Here are a few things to keep in mind when planning for these new rates.

Older High Income Earners- They may want to hold onto assets until death rather than sell. Now that the rates are significantly higher older high-income earners not in need of the capital from the sales of stocks, real estate, or other assets that would generate a capital gain may want to hold onto their assets and allow their heirs to inherit them. One of the key benefits to inheriting property is that the heir inherits the property at the value of the decedent’s death and all of the gains in the asset are wiped out so that if the heir sold the property then the heir would avoid capital gains taxes entirely.

Real Estate Investors Looking to Re-Invest. Real estate investors looking to re-invest in another property should strongly consider selling their property and repurchasing a replacement property using a 1031 exchange. A 1031 exchange can be used to defer capital gains taxes by effectively rolling them into a new property such that when you sell the new replacement property you would pay the taxes due. The idea here is that delaying and deferring payment of taxes is always better than paying taxes now. There are some procedures and timelines that need to be followed here to properly complete a 1031 exchange but this is a great strategy for real estate investors who plan to buy more real estate when selling a property.

The Sale Of Home Exemption Is Still Alive. The sale of home exemption is still in place and joint filers who have owned and lived in their home for 2 out of the last 5 years can sell their home and avoid paying taxes on up to $500,000 of capital gains ($250,000 if single filer).

Gift Appreciated Assets for Your Charitable Contributions. High income earners facing the higher capital gains rate and the new net investment income tax may want to consider gifting their appreciated assets to charity as opposed to selling the asset, paying the capital gains and net investment income tax and then gifting the proceeds from the sale of the asset. This could result in as much as a 35% tax savings depending on the taxpayer’s income and state of residence (20% federal capital gains rate, 3.8% net investment income tax, plus state taxes from 5% to 10% on average, depending on your state). Under current law, a taxpayer may gift a certain level of assets to charity and can take the fair market value of the asset as a charitable deduction and then the charity sells the asset and avoids paying any taxes too. The net result is the asset transfers to the church or charity you intend and the capital gain (and net investment income tax) ends up disappearing. Many large charities, universities, and churches have departments set up to receive these assets and  to assist and encourage contributors.

The bottom line is that rates have gone up so planning for the sale of an asset has only become that much more important in order to minimize your tax burden. Please contact us at the office at 435-586-9366 to speak with one of the attorneys or CPAs about your specific tax situation and planning needs.