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How To Create A Self Directed Roth IRA For Your Real Estate Portfolio
How to Create a Self-Directed Roth IRA for Your Real Estate Investments. I go into a good deal of detail about how I’ve structured my own retirement account and how you can do the same for yours and end up protecting yourself from having to pay any income tax at all when you finally retire on this money. I hope you like it. Hit the subscribe button, hit the like button, and enjoy the class.
[Joe] Would you like me to talk about retirement accounts and how those things work before we go –
[Joe] Everybody needs to understand retirement accounts and everybody has – especially as an investor because you know, you’re not going to have a pension, you’re not working for a company anymore. You need to find a way to have a retirement. Now, your portfolio’s going to do that for you, but an IRA, a Roth IRA, is the way to go.
I’ve moved all of my regular SEP, my IRA, my defined benefits, all that stuff I moved, because I had different versions of that over the decades. And I moved them all into my Roth. And I was able to transfer them all into my Roth and to do that I had to pay taxes on that money that I transferred. But by doing that, and I still had – I did it like 10 years before I retired, so I was in my late 40’s or early 50’s when I did it. And before that 59½ year magic number. So I put – I did them all that time, moved them into those, and the assets there I had to pay taxes on, which that was a big hit for a couple of years because I paid them over a few years and made that happen.
But, once I got them into the Roth now they continue to grow. And over the last 10 years they’ve gone up, you know, dramatically. So most of those properties have doubled in value. So all the money that I lost in taxes was miniscule compared to the value that they’ve gone up now. And if I want to pull that money out of that Roth I don’t have to pay any income tax on those properties at all. And neither do my kids.
If I die and give my Roth IRA to my kids, they can keep it. They’re not required to liquidate. Whereas with a regular IRA you are. You have to liquidate a certain amount after a certain period of time. With a Roth IRA you can just keep it in perpetuity and continue to take your income out without paying any taxes on it. And so I set this thing up – and I set it up so that – and you have to follow the rules, so make sure you understand how a Roth IRA works with investors, or with investment properties because most people use their Roth to invest in stocks and I’m not doing that. I’m doing it with real estate. And I think it’s much more effective, but you have to have a CPA who understands how it works. So find a CPA who understands how to use a Roth IRA with real estate investing so you don’t break the rules. Because if you break the rules, and if you intermingle your funds between one LLC and another LLC, it’ll invalidate, potentially invalidate your Roth. And if it invalidates your Roth then you’ve got to pay taxes on all that income. And that would be catastrophic financially for me. So, I’m really careful about how we do that, making sure that we don’t break the rules. So you have to follow the rules on holding that money.
The problem with a Roth before you’re retired, is you can’t pull any money out of there without big penalties. You have a 20% penalty on any money you pull out of your Roth, plus you have to pay taxes on it. So you don’t want to do that.
What that forced me to do – and what I did was I had deals outside my Roth because I needed – I wanted income – and I wanted depreciation and I wanted tax deductions and all that stuff. So I had properties outside my Roth and I had properties inside my Roth. And I can’t touch the ones inside the Roth until you’re 59½. So all I could do was just accumulate stuff there. I couldn’t use any of that and I had to assume that I was going to live until 59½. Meanwhile, on this outside, you know, whenever I had a cash crunch – which I did in 2008 because we had a 20% vacancy set up. You know, I’m used to 3% vacancy. And suddenly it went to 20% vacancy and I had all those subject to’s. So I had a cash crunch that I had to worry about.
But I couldn’t take – and I had a bunch of cash in this, you know, in the Roth, which I – because of 2008 I was able to buy a ton of properties, but I couldn’t buy any of my outside-the-Roth properties because you can’t buy your own stuff. So I had to buy stuff that was outside of my own ownership. Which created a lot of complications. But, you know, I also had other businesses that were bringing in income so I was able to do it. And I had reserves. I always kept reserves on my stuff. So, even though it created a cash crunch I was never in a position where I had any chance of losing that because I know what losing everything is like because it’s happened to me back in ’91. And I never wanted that to happen. So, keeping, you know, a cash position is really important to me. I try to keep a cash position all the time, you know, so that I don’t have that happen to me.
So, anyway, always a balancing act. You know, there’s two things that you’ve got to think about when you’re building your portfolio. You have to think about asset protection and you have to think about tax savings in addition to just regular profits because profits are important too. But asset protection doesn’t always save you the most taxes. Whereas saving the most taxes doesn’t always protect your assets properly. So you have to find a balance between those things.
The Roth IRA is a pretty good asset protector. Especially if you’ve got multiple LLCs and you don’t have too many properties in one LLC. So what I did is you have the Roth IRA administrator at the top. This is a big tree of LLCs that fan out from the Roth. First of all you’ve got all the outside properties and those are their own structure and their own LLCs. But inside the Roth you have the Roth at the top, and the Roth owns an LLC that doesn’t own any property. What I did was I funded that LLC with some money from my Roth. I funded the Roth, funded the LLC and that LLC is a checkbook LLC. It’s different than the way the Roth’s usually do it, and the way the Roth’s prefer to do it. The way they like to do it is they’re in control of everything. But it’s such a pain in the neck and it’s really hard to move quickly because you have to wait for them to sign the papers and you have to go through all the paperwork every time you’re closing. It’s just a pain in the neck.
I want control so I did a checkbook LLC which basically we fund the LLC and then that LLC is the holding company for all the other LLCs. So that LLC owns a bunch of other LLCs and each of those LLCs owns multiple properties. So what I can do then is if I have, let’s say I’ve got one LLC here, it owns this LLC here. It also owns this LLC over here. And let’s say this LLC has a surplus of money because it’s been getting income or we sold a property and we got a bunch of cash in it. But I don’t want to buy any more properties here. I want to buy properties in this LLC.
So what I have to do is I take this money, I move it back up and fund the original LLC and then it pays this LLC over here and funds this LLC so we can buy more properties. That way I can keep a certain number of properties and spread out my risk a little bit. And the most that I have at risk, theoretically at least, is you know, one LLC. If one LLC gets a lawsuit, I could lose everything in that LLC. But it won’t touch my other LLCs. And because the holding LLC doesn’t own any property the likelihood that it’s going to get sued is very low because there’s nothing – it’s not doing any business. All it’s doing is owning these properties and they’re all LLCs. So, it makes it really much easier to keep control of it.
I haven’t pulled any money out of my Roth IRA at all. I’m 63 now, so I’ve been able to do it for almost four years. And I haven’t touched any of it. And I’m not really planning on touching any of it. Instead what I’m doing is reinvesting it. And we bought the storage vault with Roth money. We’re buying – almost everything we’re buying in – well, everything we’re buying in Illinois is with Roth money. The Indianapolis portfolio is – there’s a lot of stuff that’s outside the Roth, but there’s stuff inside the Roth, too. The Roth is where I’ve got most of my assets and I’ve migrated most of my assets into the Roth in order to protect it.
Because there’s also the idea that if you file bankruptcy, if something happened that I had to file bankruptcy, which, you know, it’s going to be hard – that’s unlikely for me, but, if it did happen, you know, it happened to Burt Reynolds, for example. And Florida’s different than Indiana, but, Burt Reynolds didn’t have to give up any of his retirement account. It happened to OJ Simpson, if you remember. He should have had to pay out all that stuff to the people, to the family of person he killed, and, but he didn’t have to because it was all in his retirement account. So it protected his assets. And, you know, that is my hope that if that ever happened to me, that I would be in that same situation. Hopefully, I won’t kill anybody, but….
So, you look at all the different ways that you can protect, you know, protect your assets, try to get the best benefit from your taxes. If you’re making a thousand dollars in income from a property and you’re in a 40% tax bracket, that means you actually make $600. If that money’s coming from my Roth instead of making $600 I make $1,000. I get to pull out $1,000. Because I don’t have to pay any taxes on it.
Plus, it’s a lot easier to do the – my CPA doesn’t really do anything on those LLCs. Doesn’t have to do much at all. We have to do a note at the end of the year that we send over to the administrator of the Roth and tell them how much money we’ve got. That’s basically all we have to do. And then they charge us based on how much money is in the Roth. Which can start getting expensive, actually, as you start increasing your asset base, but it’s not terrible. It’s not as bad as what you pay for a regular IRA or that you would pay for some type of 401k or something like that. Because you’re paying administrative fees, especially if you’re paying into a stock market, you know, somebody who’s picking all your stock stuff for you. Those guys take a big chunk off of your income. They’re taking 2%, 3%, 4% of all the income that you’re making and if you don’t make income they take it off your assets, off your base. So they always make money. I’ve never liked having other people in control of my money.
I’ve also not liked the stock exchange very much because it doesn’t seem real to me. And I like real estate because it’s there. I can go see it. I know what the market’s doing. It’s tangible. I can control it. So I like it better than that, and don’t even get me started on crypto currency. Daniel and I have this argument all the time. I think it’s a pyramid scheme but he likes it.
So. Anyway. So that’s a Roth IRA. And that’s retirement account and that’s structuring your business so that you can save money on your taxes. And once you’re making $75K on a business, then you should have an LLC on it, according to my CPA. He says that’s when you start saving enough to make it worthwhile to file another tax return, which you have to do if it’s outside a Roth. Because you have to file tax returns on all these things. My taxes are as big as a phone book. That’s why it’s all done on .pdf these days. So, hopefully you guys will get into that same position, you know, before you retire as well.
[Student] Do you have something you recommend like, certain CPAs or like, how to go about finding the right person? Or do you have like, a network that we can maybe schedule consultations with when we get to that point? Or, how does that work?
[Joe] I’m happy to recommend my CPA. He’s always up for taking new business. He’s in Indiana, so you might want somebody who’s local, though. And so, if I was looking for a CPA, and it took me a while to find my guy, I just kept asking around about people who understood Roth IRAs and how to deal with real estate in Roth IRAs. And nobody that I talked to understood it. And I finally found this guy and I said I’m going to stick with you. Because I don’t know anybody else that knows how to do this stuff. And he did.
There are other people out there that know how to do it. You’ve just got to find people in the real estate community that do that. I don’t think it would be that difficult to find somebody. But, again, I’m happy to recommend him if you want to use him. And I’m sure he’d be happy for the business.
The CPA doesn’t do a huge amount of work. He does the end-of-the-year work and the bookkeepers are the ones that do all the work. So, finding a good bookkeeper is more important, maybe not more important than the CPA, but as important as finding a good CPA because they’re going to do the stuff everyday. My bookkeeper, she pays all my bills. I mean, what I do is all the bills that come in, you know, every two weeks I sit down, usually before one of our conference calls, I’m sitting down and I’m going through all the bills and I put them into an envelope and I mail them to Tina and she pays them. So I don’t have to write any checks. I don’t have to do any of that stuff. I do pay attention on what’s being paid. And she writes reports for me, you know, every month as well that she sends me and I look at the reports so I can see how much, you know, what we’re spending on our life and what we’re spending on our travel and you know, entertainment and what our houses are costing and all that stuff.
So I try to pay attention to that stuff because you know, if you let things go they can really get out of hand. So you want to pay attention, especially when you’re not – you know, when I go to the grocery and I swipe my card, I’ll leave the grocery and I’ll realize I didn’t pay attention to how much I spent. Because you just kind of get used to just having the money and having it paid off every month. The credit cards get paid off every month. And you don’t have to really think about that stuff. But when you go back and look at those numbers on the report, you say, wow, you know, getting a load of groceries these days costs $500. And so it’s, you know, you just kind of forget about that stuff when you’ve got – and I’m not saying this to brag, I’m just saying that this is a place that you can get in your mindset when you have you know, even if you’re making just six figures. You know, if you’re just making six figures your mindset about how you spend money is going to change a little bit.
And when you start doubling that and tripling that, quadrupling that, you’re going to start feeling like, okay, I’ve got a lot of assets and I’m going to be able to buy just about anything I want. And you can, but you can also – I’ve seen a lot of people that become wealthy, you know, overnight – especially this happens to doctors, you know, when they go through medical school and then they suddenly jump into making $250K a year at a job from making $50K a year.
And they feel like they’re rich. And they go out there and they just charge up everything and it’s very common for doctors in their first few years to file bankruptcy because they spend too much money because they have so much and they think they can keep spending money. And after 10 years of education and you know, all that debt, you know, they’re suddenly feeling like they’re free. And they’re not. You have to pay attention, even when you have money, because your toys just get more expensive and your houses get more expensive and your lawn care, and now you’ve got sprinklers in the yard. And now you’ve got somebody cleaning your house, and now you’re going to the expensive dentist, you know? Now your kids are going to the expensive school and so, more and more, that you really pay attention to that stuff.
I think that having an IRA like this, or Roth, it forces you to put money aside and make sure that you’ve got an asset base that you’re building so that when you do retire you’re going to be able to live the rest of your life. I mean, it seems likely to me that I’ll be alive for another 30 years. Hopefully more than that. And if I’m alive for another 30 years I want to make sure that if everything stopped for me right now that I still have these properties and I could sell them off. I can, I can do that. I can sell a house off and I can live on it and I could live more frugally and I could, you know, take less vacations and all that stuff. I could get through that without major pain.
Not everybody can do that. And I know that. And I feel blessed and fortunate and it didn’t come without paying attention. It didn’t come without hard work. But I also got lucky and you know, I was given a lot as far as brains and position and privilege. Even though my parents didn’t have any money. My dad worked at the Power & Light Company. But, anyway. I’m just saying that you can do this, too. And I know that there’s going to be struggles. And it’s just a matter of getting down to work and making it happen then starting to build it, paying attention to it as you build it, and learn more and more as you go.
As long as I’m doing this I’ll be around to help to. As long as you want to be part of what I’m doing, I’ll be around to help you and give you advice and help you build this because you know, the first six months in this program you’re going to be focused on just trying to make your first buck. Just trying to do your first deal. And what I find is that it’s the second year or the third year, that’s when you’re building this portfolio and you know, that’s when it starts getting exciting. And when I look at what Daniel did, what Bill did, what the others have done, building these portfolios, you know, after five years, after ten years, I’ve got students that have come back to me, you know, because I started teaching back in ’97. So I’ve been teaching this for 25 years.
So I’ve got people that have done, have been, you know, building multi-million dollar businesses and come back every once in a while and you know, at the last buying event we had a guy that had been doing this for, I don’t know, 8 or 9 years, you know, he’s gotten $4M or $5M worth of assets now and he’s just doing really well. So it’s exciting to see that stuff happen and see over a period of time what’s really possible.
Anybody have any questions about business structures and what you should do?
[Student] I do. You were talking about the control that you figured out how to keep control inside the Roth because you had that extra LLC that you put in place there. Did that give you control just inside the Roth or inside and outside the Roth?
[Joe] Well, outside the Roth you have it anyway. You already have an LLC with its own checkbook and all that stuff. Inside the Roth that’s the issue. Because the Roth owns these properties. So your Roth is the one that owns all these LLCs. And typically the Roth, you know, the LLC is owned by the Roth, and all the paperwork has to go through the Roth administrator. So when I buy a new property they have to sign off on it. They don’t have to approve it, they just have to sign it. But that means that you’ve got one, two, three days of paperwork that has to go through them and everything gets delayed. Whereas with me, I can just send a wire and buy a property. I can do within an hour and buy a property. And that’s what having checkbook control – so, what you might want to do is look up checkbook – what did I call it? Checkbook control LLC? Roth checkbook control – something along those lines.
The checkbook administrator that I use is Pacific Premier Trust. They used to be called PENSCO. And they’re pretty inexpensive to get started. And they have lots of training and information that you can get for free and they have people that’ll answer your questions. If you call them, they’ll answer your questions. It’s really a nice service for what they charge. The other one is Equity Trust.
[Student] What’s not clear to me is using your Roth money to invest outside of the Roth. Do you have control to do that?
[Joe] No. You’ve got to invest inside the Roth. And you can’t run a business inside the Roth. So, I can’t say I’m going to buy a storage vault and I’m going to run that business. I can’t be the person who’s running the business. That’s why Daniel’s doing it. I can invest in his business. So I’m investing in Daniel’s business. Technically I’m able to be an advisory, you know, and I do help, you know, but he’s doing the majority of the work. And he knew that going in that he’d have to do the work. And he’d have to be that person that’s running that business.
Now, I still have control of that business, you know, I have the controlling interest in that business and I can liquidate it whenever I chose. Although I wouldn’t do that without his permission, you know? He and I have built a lot of trust over the years and he and I, you know, I trust him and he trusts me and, but, I still have control. Ultimately if there was a dispute it would be me that had control. Me that could make the decision. And I think that you should build your business in that way, especially if it’s your cash, especially if it’s your retirement. Because I want to make sure that I get that retirement money so that I can live on it eventually.
[Student] Okay. I get it now. Thank you.
[Joe] It’s really worth doing and you know, I think a lot of – there are some other questions about doing Roth’s and whether or not they make sense. But I think the way that I’ve done it it makes a lot of sense. Especially if you’re doing properties that are going up in value dramatically or making income dramatically. So you can’t go buy a property in a Roth without cash unless you buy it with a nonrecourse loan. So you can’t go get a loan to buy properties inside a Roth. You have to get seller financing and do nonrecourse loans. So, and you could do subject to, that’s nonrecourse. So you can do as many subject to’s in your Roth as you want. And then as they go up in value then your Roth expands dramatically even though it didn’t cost you anything to buy those properties.
Because you can only put a certain amount into your Roth, so it makes it very difficult to buy more properties for cash. But eventually, you start building a lot of income and value into that Roth and you have a lot of cash in your Roth and then you can buy he cash properties. And that’s what I’ve been doing. Because I’ve been able to, you know, the Roth has built cash, so I have to do something with that cash. I can’t just leave it there. I want a certain amount to protect myself so I have a cushion, but you have to then invest, reinvest that money.
And you could buy, you know, free and clear properties, or you can buy land contracts as long as they’ve got a nonrecourse clause in them. So you put a nonrecourse clause in your land contract. Which is great, by the way, because I can go to my seller and say, yeah, we have to add this clause because I’m buying through my Roth. And that clause is they can’t come after any of my other properties. So, the only recourse they have on that loan is that property itself. There are actually entire states that are nonrecourse. California is a nonrecourse state. But Indiana is a recourse state. If I default on a loan here, they can go after my other assets unless I have a clause like that in the deal. So I have to have that clause in every deal that we do because it wouldn’t work in my Roth without it.
There’s also a thing called UBIT – I can’t remember what it stands for. What it is, though, is you have to pay taxes on income that was made on loaned, borrowed money. So, if I borrow money inside my Roth, that’s nonrecourse, and I borrow that money and that loan still exists when I sell that asset then I have to pay taxes on the profit from that loan. So let’s say I buy $100K property and I get $100K loan on it. And I end up selling it for $200K a few years later and it still has $100K mortgage on there. I would have to pay taxes on half of that profit.
Because I made money on that loan. But the way to get rid of that UBIT tax is to pay off that loan before I sell the asset. So as long as I pay off that loan then I don’t have to pay any tax on it even though I made that asset and that asset came because of that loan, but I paid it off the day before I sold the asset and now I don’t have to pay taxes on that profit. So when I found that out that was a beautiful thing and that’s when we started doing subject to’s and these other types of borrows. Because I was trying to use just my cash, you know, on those deals and I just ran out of cash. So I had to finance.