We have a great episode today! Alex and I are talking with Edwin Kelly, who’s expert in self-directed IRAs, which are meant for retirement accounts.
But as you’ll hear in today’s episode, they play a very important role to investors in several ways. But, there are also several issues involved and you have to make sure you’re using IRAs the right way.
So, Edwin will cover the good stuff about investing with IRAs and the things to be wary about in today’s great episode.
Away we go…
Listen and enjoy:
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- 4:45 – Edwin’s background and how he got started in financing and REI
- 8:45 – The REI deals you can and can’t do with IRA money
- 15:25 – Other caveats when fixing and flipping your own deals inside of your own IRA
- 26:00 – Exactly how things should be paid for when using an IRA and borrowing money from it for REI
- 28:37 – Wholesaling and IRA strategies
- 42:00 – The first step to using an IRA for investing
- 46:20 – Edwin’s recommendations for wholesalers who are actively looking for people to invest their IRA money
Mentioned in this episode:
- Alex and Joe’s Fast Cash Survival Kit: Real Estate Investing Mastery
- Edwin’s website: Specialized IRA Services
Download episode transcript in PDF format here…
Intro: Welcome. This is the Real Estate Investing Mastery Podcast.
Joe: Hey everybody, welcome this is the Real Estate Investing Mastery Podcast. I’ve got an exciting show ready for you. And Alex, I think I hear you in the background walking around in your new house?
Alex: Yeah, you can hear it’s quite echoing in here. I’m in an office full of boxes and just getting ready to get in this place.
Joe: Well, it’s about time. You’ve been building that thing forever.
Alex: I know it seems like forever but it’s come out really nice. We’re really excited about it, and I can’t wait to get everything set up.
Joe: Good for you, man. That’s exciting. We’ve been talking about building our own house. We don’t know… It’s a big deal. It’s more work than you thought it would be, right?
Alex: Well, in the beginning, it was a little bit uneasy side with the framing and getting all of that together, from foundation to framing to plumbing to electrical and all of that stuff. It’s just here at the end. The little things just get here. It’s like that… Yeah, I did some kind of crazy things. I mean, at the end, I was like, “Okay, yeah, I throw in the pool. Okay, yeah, I throw out in the system all the way around the house, not the drive way and all of that stuff.” So that’s my fault obviously but it looks really good. And this is very involved, very involved with the all the work that goes into it. And then also making sure your neighbors on either side are being taken care of.
Joe: Because you blocked their view, didn’t you?
Alex: Oh, yeah. That’s very bad, yeah.
Joe: And they’re probably listening to this podcast right now.
Alex: Oh, no, so I got to keep it cool. So one of the neighbors did say he looked me up and saw my website. I said, “Okay, that’s cool. Give me a good review.”
Joe: Well, cool, very good. We are… I’m actually homeless right now. You are moving into a new house; I’m homeless. We don’t have a house to go back to. We are going to… We are in Prague right now. We’ll be here for three months total and we‘re just… It’s like a working vacation. I’m still working, right? But we’ve been having a blast and travelling a lot, and I’ll be talking more about that in the future. But when we move back, we’re either going to be buying a house or building a house. And yeah, if we decide to build a house, I’m not sure where we are going to live in the meantime. But we’ll figure that out. Maybe we’ll be living in our camper.
Alex: I have some room here if you want to come hangout?
Joe: Yeah, so let’s jump in though on the show. We have Edwin Kelly from specialized I-R… I can’t… IRA services.
Edwin: I do the same thing when I have bellies in my coffee too, Joe. Don’t worry about it.
Joe: IRA, specialized IRA services. Edwin is an expert in self-directed IRAs which is very important…
Alex: There we go. That’s meant for retirement account.
Joe: Yes, a very important topic especially to real estate investors for multiple reasons. One of them being it’s a great way to grow, like if you’re making good money to grow your income, your money tax-free through investing. And it’s also a great way too, if you’re getting… if you’re raising private money to help educate some of your private investors on how to invest in IRAs so you can start borrowing the money.
And there’s a whole bunch of issues involved with that and a lot of issues involved with that, and you’ve got to be really careful to make sure you’re doing it right. You’ve got to make sure that you’re working with the right team. And we’ve known Eddie for a little while now. He’s one of my masterminds, the collective genius and he travels a lot all over the country. And we are honored to have him here. Edwin, how are you?
Edwin: I’m terrific, Joe. Thanks so much for having me.
Joe: Good. We’re going to be talking about self-directed IRAs, how to buy real estate tax free, and how to use other people’s money to fund your deals through self-directed IRAs. Can you give us a little background, Edwin, of your story?
Edwin: Yeah, so it’s pretty interesting, Joe. I remember the first time; I was really aware of wanting to be successful and make money when I was in sixth grade. So I was pretty young and I started doing odd jobs and mowing lawns, and whatever I could do that somebody would give me money for. And what I did was I actually saved all of that money. And by the time I got into junior high middle school, I was able to open up what’s called an UGMA account.
And an UGMA account is basically a stock trading account or brokerage account where someone under the age 18 is able to open that account as long as you have like a responsible individual on that account who happened to be my grandfather. So I had somebody in that account and I decided I was going to make my first investment. And the very first investment I made was I bought a stock in a company called Chuck E. Cheese. Now as its parent’s right, we got to love to hate that place. I mean, we loved and we hated it all at the same time.
That was a great learning lesson for me, because what happened was I bought that stock… It was between $18 and $20 when I bought it and it went up to $42 in about a year later. And I said, “Wow, this is great,” so I told my grandfather… I said, “Okay, now I want to sell it,” and he says, “No.” He says, “You don’t sell it.” He said stocks are… Investors are for the long run. I said, “I understand that.” I said I don’t want to spend the money. I said I just want to sell out of that and look at something else. It’s gone way up in price. I think I should get out of it.
He says, “No.” He says, “You need to hold it,” so I did. Well, the company ended up filing bankruptcy and this is something that a lot of people are not aware of when it comes to traditional type of investing stock market investing is that…
Alex: Chuck E. Cheese went bankrupt?
Edwin: Chuck E. Cheese went bankrupt. This is going back… This is going to date me that was back in the ‘80s. And here’s what happens is that when a company files bankruptcy in some cases, the court will allow the company to wipe out all previous shareholders and do a new stock offering. So the company still exists today, but my shares became worthless back when they declared bankruptcy. So I incurred 100% loss on that. But that was a learning lesson for me, because I said, “You know what? The first lesson I learned was I don’t like to lose money.”
And the second lesson I learned was is that there’s got to be a different way to do this and create wealth. So that’s where I really kind of started my journey where I began to years later learn about real estate and notes and mortgages and deeds of trusts, and all of these other things. And one of the biggest issues that we face when you sit down and look at this stuff and you start thinking about making money, because as I was making money then I started paying a lot of taxes and I didn’t like that either. That was… The government was taking all my money.
So I started looking at, “Well, how do you really create wealth? What are the wealthiest people doing?” And that’s where I kind of came into this whole thing and created the system and a company where we basically are able to protect money from taxes, even eliminate them in many cases completely, which people have a hard time believing that’s even possible while growing and creating consistent predictable streams of income through notes in real estate.
Joe: Notes in real estate. Now you’re… Would you talk about…? Well, let’s do this. I was going to ask you to go into notes. But will you talk about what kind of real estate can you do invest with your IRAs in? Are there certain types of real estate you can’t do, certain types of deals you can do, certain types of deals you can’t? Does that make sense?
Edwin: Yeah, and that’s a great question. The great thing about a self-directed IRA retirement account, and I’m going to use the word IRA as a general term to represent like all retirement accounts and parts of different ones and there are some real cool benefits to some of these different accounts but I’ll use IRA as a general term. And the way the rules work, when these rules were written and they’re enforced by the Department of Labor and the IRS… These are two regulatory bodies that’s a federal level that oversees these things.
What they basically say is, “We’re not going to tell you what you’re allowed to do. We’re going to tell you what you’re not allowed to do.” So that’s how we come into an understanding of what we can and cannot do. So just as a quick example, there’s nothing in the rules that anyone can read that says you are allowed to buy Apple stock as an example in your IRA. But there’s no place that prohibits it or says you’re not allowed to do it. So we are allowed to draw the conclusion we can buy Apple stock.
So the question that you’re asking is well, patience on any type of real estate or real estate transactions. And when you look at it, they’re really are many. So you can buy vacant land; you can buy farm land; you can buy single-family homes; you can buy condos; you can buy duplexes; you can buy commercial property; an interest in a commercial property. You can buy property in Missouri, Ohio, Florida, California. You could buy property in Prague, Joe. You could buy property virtually anywhere in the world.
Edwin: The only property you can’t buy… And this would be to any asset, okay? So just not property or real estate. The only real estate you’re not allowed to buy is real estate that you own already personally. Or if you have an LLC or a land trust or something where you control that piece of real estate, you own it but you might indirectly own it. Those are the only pieces of real estate you can purchase inside your IRA.
Joe: Okay, now you’ve mentioned the purchasing. As far as something you’re going to be buying and holding, you might hold a piece of rental property, a piece of land, a note, what about quick turning strategies? Can you buy up a property, fix if it up, sell it for a quick profit?
Alex: That’s the question right there.
Edwin: Yeah. And the answer is yes, and we have clients do that all the time. Few things to be aware of when you’re doing those types of transaction: the first thing is… So the answer is yes, you can do that. The second part of that is I’m going to say that with caveats. So as an example, one of the things that you want to make sure of is that you’re not doing any of the labor yourself. So if you’re a true investor and you’re hiring some contractors and everything to do all the work, that’s fine. You just can’t put any sweat equity into an IRA property that your IRA owns.
Alex: That’s cool. The IRA answers to not be doing the work when I lift a hammer. So that’s good; that’s encouraging.
Edwin: Yeah. And truthfully, that’s the way the people should be doing it and obviously most people we work with do that. But when people are starting out in the business, if they’re just getting started in real estate investing or something, a lot of times people try to save a few bucks here and there by doing something themselves, particularly if they have an expertise in a particular area. And I just always just point out to people don’t do that on your IRA properties.
Alex: You know the hard thing there with IRAs and I think we might have talked about this before in another call is getting the enough money into the IRA to do a deal like that, like from… So like if I have a new lender that comes on and he’s like, “Yeah, self-directed IRA, tax free. But I don’t have an IRA. I have a million dollars but I don’t have an IRA. How do I get that money into the IRA so I can start doing this and reaping those benefits?”
Edwin: Yeah, and that’s something that we… It’s funny one of our expertise. We do a lot of consulting work for clients. And there are actually various solutions to that problem that people come across.
Joe: Well, Edwin, before we jump ahead there, because I want to make sure we cover all the caveats. Because you only mentioned one, you can’t make… You have to make sure you can’t do any of the labor yourself, no sweat equity. And then that’s something I do want to talk about, like how do you start or create these IRAs? If you are an investor and you want to partner with somebody else, how do you get their money into a self-directed IRA so you can start using that or whatever? But are there…
Alex: Not the IRA. That should be a caveat because you can’t use… You’re going to be taxed on the percentage of the money that is in the IRA versus what you put into it, so that kind of ties into a caveat. Maybe that will be the last caveat that we can transition into.
Joe: Okay, well, that makes sense… Well, explain that a little a bit, Edwin.
Edwin: Yes. So I think, Alex, what you’re referring to is if you’re borrowing money in the IRA, is that correct?
Alex: Yeah. Well, no… So let’s say I have an IRA I just opened up. I’m excited and I can only deposit probably like $5,000 bucks into it a year. That’s going to take me a long time to get to the point where I can do $125,000, $150,000 deals. So in the beginning, I can put up my funds into the IRA as far as, “Okay, $10,000 of this is coming out of my self-directed IRA.” So when the profit comes back, then it’s going to be based on the percentage of the amount I put in, correct?
Edwin: Okay, so yes. That’s yes. The strategy that Alex is referring to is, “If I have $5,000 in my account and I have $100,000 as an example outside of my account, how do I use both sets of money? Can I do that?” The answer is yes, because the IRA can partner with another person, entity, or IRA. So in that case, if the IRA… We refer to it as undivided interest. That’s usually how it’s recorded in title is… It owns undivided interest in the percentage of the profits that the IRA owns on a piece of real estate. That’s the percentage of profits that goes back to the IRA. That is correct. So that’s one way to structure a real estate transaction using a self-directed IRA.
Joe: If your money in the IRA only contributes 10% of the deal, you can only put 10% of the profits back into the IRA, right?
Joe: Okay, now what are some of the other caveats then for if you’re fixing and flipping your own deals inside of your own IRA?
Edwin: I’ll tell you the biggest one that we see where clients make mistakes if they’re just getting started. Once you do it once or twice, you figure it out very quickly. It’s just like riding a bike. Believe or not, the biggest mistake, the biggest challenge that investors have when they’re using their self-directed IRA is the simplest thing to solve for and it’s the titling. Most of the time, when investors are making and extending offers to purchase real estate, they use their entity name. That’s most commonly what we see or they might use their own personal name. Problem is… Remember what we were talking about in the beginning? I said that the only caveat on the real estate really is that you can’t purchase something in your IRA that you already own or control.
If you write an offer to purchase and it’s got your personal name or your entity name on there, then technically you now control the deal personally. It can’t go in your IRA. The key thing there is that when you’re writing offers to purchase, you have to have the correct titling. The way those deals are typically titled are specialized IRA services. “Joe McCall’s IRA account number 12345,” and you can put that on the offer to purchase, and you can sign as agent on behalf of your IRA when you extend that offer. That’s the number one mistake we see investors make when they are using their IRA. The second biggest mistake… I’m sorry. You’re going to make a comment or question on that, Joe?
Joe: Yeah, real quick. What if you only have $10,000 to put in the deal? How do you make the offer? How do you title the offer then?
Edwin: Then you show both parties on that offer to purchase. So it’s the IRA and then the other partner. And you can put down the percentages.
Edwin: Or approximate. The key is that as long as both names are on there, it’s very clear where the money is coming from and who’s controlling the deal and who’s purchasing it. That’s the key thing. Now the second thing that goes along with that is if you’re putting financial consideration on the transaction. As an example, if you had $1,000 on this money, well, if the IRA is purchasing it, then that $1,000 needs to come from the IRA. Simply, what happens is that people will call the office and say, “Hey, $1,000. I need $1,000 for earnest money.” The money has to come from the account. If you put your own personal money in the transaction, again that’s personal money. Now you personally control the deal. That negates the opportunity to have the IRA acquire it.
Joe: As if…
Edwin: And so that’s the second biggest mistake you see.
Joe: Is it? It sounds to me like maybe it’s just better if you’re going to invest your IRA money into a deal that it should maybe, be maybe 100% of your IRA or nothing else. Does that make sense?
Edwin: No, yeah. And the answer is not necessarily. I mean, we have clients who get started to Alex’s point who have smaller IRAs and they say, “Well, I want to use this IRA money. I want to put it to work.” Partnering on a transaction is one way that they do that and they are able to accomplish that. Partnering with the IRA is not a problem if you have all the cash in the accounts to do the transaction. That’s an opportunity. You know there are other things that we help clients structure so there’s numerous ways to involve the IRA in an investment.
Joe: Right. Okay, but you have to have a custodian to help you do this, right? Because you can’t do this on your own?
Edwin: Correct. Now you need… One of the reasons why we get… We haven’t talked about tax benefits yet, but one of the reasons why people use retirement account is because just the incredible tax benefits that IRAs provide. They are simple; they are easy to use; and they’re simple to set up. Most people have so much time and money so they already have money setting aside. They can take money from an old 401(k) or company plan, or an IRA at a bank or broker and just transfer into a self-repairing. So it’s really easy to get started in IRA investing typically. Typically, what happens is that people have money in the accounts. You know they want to get started. They want to get just started using it and seeing those returns. And so that’s… There’s so many different ways. Just jump in and get going.
Joe: Okay, so are there some other caveats that are important for people to know about?
Edwin: Well, so we talked about the acquisition side of it, right? So that’s the titling and where that initial money comes from. Those are two key things. Once you’re involved in the transaction, the third key thing that we’ve already touched on, which is you don’t want to do any work yourself, put any sweat equity into the property, okay? And those are really the two biggest things.
Joe: If you’re putting $10,000 of your IRA into the money, into a deal and you have another $90,000 of your own, how can you not use any of your own money…? Like, I am still kind of confused. If you have to go and spend $1,000 on materials from your own LLC business checking account, can you still do that into the deal even though you have some of your own IRA money in the deal?
Edwin: That’s a good question. So yeah, exactly, good question. The answer is that when you have your IRA partner now… And by the way, there’s a difference between… Like Joe, you and I are not related, right? As far as we know, we’re not related.
Edwin: You and I could partner on a transaction where I could use my IRA and the rules could work a little differently than if I’m partnering with myself. Because I am partnering with myself as my IRA, those rules are going to work a little differently. As a general rule, if I have a transaction where I’m partnering with myself, you have to look at the total size of the deal. As an example, if you can say it’s going to take $100,000 for purchase and fix up and marketing or throwing any other the cost of financing, whatever expenses you’re going to have on that investment, the amount… If your IRA owns, say as an example, 10% to use a number, any expenses that are incurred on that investment need to be paid in their percentage of ownership if you will.
Joe: Oh, really.
Edwin: That’s one thing to keep in mind. So you want to have a pretty good feel for the numbers ahead of time. Now like I said, there’s other ways that you can work with those transactions. As an example, I’ll give you a quick example. I have a client who… Actually, we’ve known each other for years and he’s setting up an account for his wife and she’s funding that account. And what happened was is that is she doesn’t have enough money in this account to do that first transaction we want to do. But the good news is that I have ways to borrow money. And I said, “Well, your IRA is allowed to borrow money.”
Believe it or not, one of the things in the rules is that your IRA is allowed to borrow money. If you had as an example in that scenario, $5 or $10,000, you had $100,000 deal. So if you can get a loan from another investor that’s even… Well, I won’t go about the bank but in… Let’s just say another investor that would like to borrow and has all the money inside the account to do that transaction. There’s numerous ways. That’s why I said there’s numerous ways to get deals done.
Joe: Okay, so if you have $10,000 in the self-directed IRA and you use all of that money to purchase it, so now you have zero dollars left in the IRA. You might get in trouble, because if you have to go buy $1,000 worth of material at Home Depot and you don’t have any money left in your IRA to do that, you’ve got to… How do you get around that? Or do you have to think about that kind of stuff ahead of time? Does that make sense?
Edwin: Yeah, it makes perfect sense and it’s a great question, because one of the things that you want to keep in mind… And so it’s like, here’s a comparison I use. It’s really no different than say a business that you might own or operate. When you’re investing or if you hold rental properties for example, and actually I like to use this as an example because it’s a pretty good example to kind of illustrate the point, is that when you purchase a rental property, if you’re going to the bank for a loan, the bank wants to see a certain percentage of money in cash reserves, right? Because there are things that can come up unexpectedly.
The same rule would apply to your IRA. You want to have working capital if you will available when you’re doing certain types of transactions. Now it’s… where those things most commonly come up are with buying a whole real estate or buying flip because things come up that weren’t expected. You need to keep in a little bit more cash into that transaction. And so you just want to kind of have those things in mind. Now there are ways. Again, like I said, they structure a deal to where that you can kind of manage that to some degree. But just at a basic concept, I think it’s really important what you brought up is you want to make sure you have some working capital based on the type of transactions that you’re doing in that account.
Joe: All right. So let’s say you have $50 grand. Let’s say you have $25 grand in a self-directed IRA and you want to buy a rental property. And then you use $20 grand to buy a property that is worth $40. So you use $40 grand of your own cash, $20 grand of your own cash and $20 grand of your IRA’s cash to buy the property. Well, you still have $5,000 left in there. You get rent of $1,000 a month. So if the IRA is 50% owner of the partnership of this property, 50% of the rent has to go into the IRA, right?
Joe: And 50% of the expenses have to be paid by the IRA, correct?
Joe: Okay, so if you have to write a check or for utility bills let’s say, and you have a $50 water bill, does the IRA have to write a check? So do you have to send two checks in to pay the water bill? Half of it from your IRA and half of it from your own business account?
Edwin: Yes and no. It depends on how you hold that asset.
Edwin: When you’re partnering, then yes. If the IRA has direct title along with yourself or your business, the other partner let’s call it, then those checks have to be cut separately. One way that clients will kind of clean that up a little bit, particularly if it’s like a rental property or something like that is that they will… There are a couple of things that they do. One thing is that if there’s a property manager on that property. The property manager can collect rents, pay expenses and that proceeds back. That’s one way to clean it up.
Another way to clean that up is to use an entity like an LLC. In other words, you can set up a brand. It has to be a brand-new LLC solely owned by the partners in that transaction. And what happens is instead of the IRA purchasing the real estate directly, the IRA purchases an interest in that LLC. Now the money is in the LLC bank account. Now the LLC is the one taking title to the property. And so there’s IRA LLC property; now the LLC writes one check. The LLC writes… So all the income and the expenses run through that LLC. So now you’re dealing with one checking account versus two, or three or four, or whatever… however many partners you have in that transaction.
Joe: Right. And this may sound complicated and some of you guys may be thinking, “What a hassle that’s not worth.” Well, yes, it may be a hassle, but it’s certainly worth it if it’s going to help you save thousands and thousands of dollars in taxes every month or every year. You know what I am saying? This is stuff that’s really important to understand. And I am hoping that by asking some of these maybe more difficult questions that it’s not scaring anybody off, because there are companies like yours, Edwin, that help people navigate through these kinds of difficult issues. And Alex, feel free please to interact if you’ve got more questions along this line.
Joe: I wanted to ask a few more questions about wholesaling and self-directed IRAs.
Alex: Good question.
Joe: Can you talk about that, Edwin?
Edwin: Yeah, so wholesaling is a terrific strategy inside of IRAs particularly for people who are just getting started with an IRA perhaps because as to your point if they have… And I’ll give you a scenario. I’ll give you a specific client that we did this with. He started off the IRA with a $500 contribution. And so people will often say, “What can you do with $500 in the self-directed IRA?” Well, you actually have a lot of options believe it or not, and one of them is wholesale. What he did on his very first transaction was that he found an opportunity. He talked to a motivated seller. And instead of himself writing that option to purchase, he had his Roth IRA do it.
Joe: Option is the key, right? Like a contract. No, but…
Edwin: Yes, that’s the key in the transaction, and that’s exactly what he used. He used an option to control the transaction. He only needed $100,000 of financial consideration to make that option legally binding. And so then what he did then was he took that option and assigned that contact to an investor who’s a rehabber, who purchases properties, fix them up, and sells them. And so when he did that deal, he assigned that option for $8,600 so… I’m sorry; it was $8,700. But he had $100 to combine the account. So he had an $8,600 profit, but $8,600 went back to his Roth IRA, that deposited in the account. So he went from $500 to like $9,100 bucks within 30 days.
Alex: How many times can you do this before it’s considered doing a business? And now you are subject to the famous UBIT and all that wonderful stuff which is the Unrelated Business Income Tax.
Edwin: Yeah, that question comes up every time I do this.
Alex: Yeah, of course.
Edwin: And it’s a great question. Here’s my answer to that. You’ll get different answers from different people. Some people say you can do one a year; some people say you can do twenty years; some people will say you can do 10-year or 5-year. You’ll get different numbers. Here’s the reality of the issue. UBIT is a tax, or if people are not aware of what we’re talking about. UBIT is a tax and it was created to kind of equal the playing field or level the playing field by the government, not for profit, versus for profit businesses. Because it’s not for profits, they don’t have to pay taxes and have an unfair competitive edge over for profit businesses. But it applies to any kind of tax shelter or tax protected entity like an IRA. That’s where that kind of comes from.
The issue is this is really the question. The question is, “Is it an investment activity that you are doing in your IRA or is it a business activity?” Investment activities are never taxed, business activities are always taxed. So that’s the distinction. If you’re doing an investment activity, and it’s not a business, there is no number of transactions. It’s unlimited. If it’s a business activity, one business will trigger tax. So the question is, is wholesaling or buying and selling an option an investment activity, or a business activity. My opinion is it’s an investment activity.
If you buy options on stocks in the stock market, nobody ever is concerned about UBIT on that, all we did was change up the type of asset. It’s no longer stock; it’s a piece of real estate. The instrument, the mechanics of it operate identically. And so my opinion is unless there’s something that comes out in the future, that’s an investment activity. So as long as you’re conducting investments inside your IRA, then it is not subject to UBIT. There’s no tax. You don’t have to worry about it. So that $8,600 in that particular case went back to the account, no taxable event, 100% tax free profit, he now has $9100 in that account to go and reinvest.
Joe: So is it a grey area or is it, because you did say it’s your opinion, is the IRS intentionally not clear on that or how do you know, okay, “I’ve already done five deals, maybe I shouldn’t do anymore for a little while,” or something like that.
Edwin: Well, people make their own judgments about those things, but in terms of a gray area… I don’t know that it’s a grey area; it’s not a grey area. Where I think it’s gotten confusing for people is that investing is an activity which is investing. But what happened was that many people started years and years ago. They set these things up as businesses, as formal business operations. And so when they are doing something as a business, why do we do things as a business? Well, because there are tax benefits. We get write-offs; we can take deductions. And there’s all kind of advantages and asset protection that come by owning a business outside the IRA.
And so then when people start looking at doing some of the same activities that they’ve organized outside the IRA, then their immediate thought process because that’s how they’re looking at it is, “Well, this is a business.” Well, no, not necessarily. I’ll give you another example outside the real estate world, Forex traders. They trade derivative type of instruments. Now that’s considered an investment activity that’s not subject to UBIT. However, there are traders who set their trading up as a business outside their IRA, because they have the ability to take deductions and write off expenses and those kinds of things. They don’t have the liability concern that maybe real estate investors have but they have these other things that they want to do and accomplish. So they go out of their way to organize their trading activities as a business. It doesn’t matter that they do that when it comes to the IRA. It’s an investment activity.
Joe: Now, if you are doing wholesaling in your IRA, I’d imagine then, if you don’t want to make a business activity, you probably should not pay for your marketing from the money inside your IRA. Is that correct?
Joe: So really, the only money that can come out of your IRA when you’re doing a wholesale deal is maybe the honest money for the deal, is that right?
Edwin: Any direct expense of investments is paid for by the IRA. Now marketing is not really a direct expense, because you can send out as an example, 1,000 letters. You might get a response; you might not get a response. You get a response; you might buy it in your business name; you might buy it in the IRA. That is not a direct expense of an investment. But real estate taxes due to the accounting on a piece of real estate that your IRA owns, that is a direct expense of the investment. That’s going to be paid from the IRA. Does that distinction make sense?
Joe: Yes. So if you have any closing costs as part of the deal that you’re paying for, that will probably be paid for by the IRA.
Joe: Now why do you say do it in an option? I’m assuming you are contrasting that with double closing. Is it more important then to assign an option agreement to do it as an assignment fee or does it matter?
Edwin: No, you can do it either way. It doesn’t matter either way. That was just how he happened to do that particular transaction, which is why I used that as an example.
Joe: Okay. Hey, Alex, have you ever wholesaled a deal in an IRA?
Alex: IRA? No, I haven’t.
Joe: I haven’t either. But I’m definitely interested in doing it someday.
Alex: Well, just because… The thing is I was trying to make sure I had enough money. Actually, I’d only have a self-directed IRA, so I need to talk to Mr. Edwin here and figure that out because… And even my lenders. I mean, try to get the money from the bank into the IRA somehow so that they can start doing this and realizing the tax benefits, because lending out of your IRA is definitely tax-free as opposed to doing these flips like this. So we definitely need to talk when this is over.
Joe: Well, yeah. And so one of the things that you talk a lot about, Edwin, is how to use other people’s money to fund your deals. And there are a lot of people out there who have money in retirement accounts, and maybe they don’t know about self-directed IRAs, or maybe they’ve heard of them and they want to invest in real estate, and you have deals that you are looking for lenders on. Can you talk a little bit about how to use other people’s money, private investors, self-directed IRAs, all that good stuff?
Edwin: Yeah. So it’s a great concept and it’s a great strategy, and I’m a big advocate of this. I’m an entrepreneur; I’m a business owner. And as business owners, Joe, that one of our biggest challenges is funding our business, sometimes funding the operations or funding an expansion of a business or being able to get into an investment. The banks aren’t really that corporative with us. In fact, the way I always like to say it is, “If you don’t need money, that’s when you can go to the bank for a loan.” And that’s typically how it works at least from the business side.
And so… But the great thing about IRAs is this, and this is the huge opportunity that exists for investors today. It’s never been a better time, because there is currently, as of the end of last quarter, $20 trillion. That’s trillion with a T, okay? $20 trillion inside of retirement accounts right now. That’s the size of the pie, if you will, that exists today. I’ll venture a gas, and say that’s probably more money than anybody listening right now could probably put to use in the next couple of years.
And so, the cool thing about it is that virtually, everybody you know has a retirement account of some kind. They are not familiar with self-directing, but they do have a retirement account because they have a job. And by the time they are 35 to 40 years old, they have accumulated through various jobs and contributing to those companies sponsored plans anywhere between $100,000 and $200,000 on average already saved. They’ve gone through multiple cycles on the stock market. They had the same experience I did when I was young and they are looking for alternatives. They are looking for ways to make more consistent predictable type of returns.
And so there’s a strong interest in saying, “Hey, I want a diversified way from this stock market,” but they don’t necessarily know what the alternatives are. Note investing is one of my favorite types of investment inside the IRA, because it’s truly 100% passive to the IRA. Alex kind of mentioned that. And the IRA can loan on virtually anything. And so you have a real estate project you want to do; you have a real estate investment you want to make; you can borrow the money from someone else’s IRA and depending on how much money you are looking for. So Alex, you mentioned like $120,000 for a deal at the beginning of the call.
Well, you only need potentially one person to fund that transaction. If you’re looking for a million dollars in capital, five to ten people can provide it. You are not talking about a lot of people and the people are all around you. We actually have services and things that we offer for clients who want to start using other people’s IRA to kind of train them, support them, help them, to go out and raise private money. I will give you a quick example. I just have a gentleman who just started working with us in the last 30 days, and he’s up in the Chicago area. And he heard about the self-directed IRAs and we met. And he said, “Well, I’ve got this real estate investment I want to do and it’s down in Florida. And I need to raise some money and I don’t know anything about this.” So long story short, we’re transferring over… We started working together about 30 days ago, and he’s bringing over one account with about $220,000 in it. That’s his first one.
And so he’ll probably raise about a million dollars; that’s what he wants. He wants us to raise about a million dollars and we’ve got a goal of accomplishing that in about 45 months. And so he’s on track to do that. So it’s just being aware of the opportunity, and they are getting a little bit more education on how that works and having somebody to work with to help you to do that.
Joe: All right. So let’s say you are doing your marketing. You find a deal that is worth $300,000; you can buy it for $150,000. It’s a real pretty good deal. The numbers look real good and you want to borrow some money from a private investor. And you have a friend who has $150,000 in a retirement account. Maybe it’s a traditional IRA. And this guy wants to invest in this deal with you. So what is the first step? What do they need to do?
Edwin: So the first step in the way that the process works is that when we work with folks who are actively raising money, we assign them to a single point of contact at our company. So they have a self-directed specialist that they work with. And so what happens in that first step is they make an introduction. So the first step is that the person who’s going to put together the investment, be borrowing the money, kind of goes over their business model their investment model with the personnel on our team that they are working with. Then what happens is that they make introductions. It happens in different ways, but sometimes and most often, it’s probably done via e-mail. “Hey, Edwin meet John.”
So then we e-mail, “Hey, John, great to get connected to you. What’s a good time to talk?” We have that conversation. There are certain things that… And this is the trick. This is the rub in the whole process to making it work, is that when you talk to someone who’s never heard about self-directed before; they might never even really be familiar with real estate investing at all. There’s certain question that they have. The problem is they don’t know enough to know what to ask. And that’s what they say and they say, “You know what? I have questions but I don’t know what to ask.” If they don’t get their questions answered, they don’t move forward.
The thing is we’ve been doing this long enough that we know what they need answered. And there are four specific things that they need answered. And so that’s one of the things that we go over. So what happens is then specialized IRA services, as the IRA provider, is the one that is responsible for setting up that account, transferring that money over. And as soon as that money comes over, then it’s available to fund that investment. The investor that the IRA owner is working with typically has the loan docs and that kind of thing. We put that with a direction to invest form which is what we call our paperwork that comes to us and we basically wire the money to wherever they send it to, say they send it to. Typically, the title agencies are closing at a time.
And that’s it. The process isn’t complicated, but if it’s unfamiliar to people then it’s really more an issue of familiarity and learning the process and implementing it and just getting started, talking to people about it and that kind of thing. And we have all kind of support materials and that kind of thing to help people have that conversation, make the introduction, and handle the handoff. The great thing about it is that people don’t have to be experts in the IRA. They only have to be an expert in their investment. That’s what they do and then we handle the IRA platform.
Joe: But I like the fact that you went to get to know that investor as well. I mean you want to know what this guy, if he’s really knows what he’s doing.
Edwin: Absolutely. Because what we want to know, we want to know a few things. One of the things we really want to know and uncover as well is how you are structuring these transactions. Because when we have that conversation with a potential lender or investor that they are going to be working with, the nice thing about that is that we know exactly how to have that conversation because we know what to tell them is going to be needed and expected and how that process is going to flow and time frames and all those things. So it makes a nice easy conversation for someone who’s unfamiliar with self-directing and they just want to know how it’s going to work.
Joe: Okay, all right. So let’s say, like in St. Louis, I have, we sold a lot of rental properties. We wholesale a lot of rental properties. In the past I haven’t really focused on trying to find people who have self-directed IRA money. I just have… I have ties of properties, the numbers are good. We are selling pretty quick. But I’ve been thinking about this like maybe I should be more intentional in finding people who have IRA money, who are looking to make pretty safe 10-12% return on their money through these turnkey properties that we are selling.
So what do you recommend to somebody like me who’s a wholesaler, who is finding these properties maybe doing a little fix up, has property management in place, wanting to sell these kind of turnkey deals, what do you recommend to those investors who are looking for these people who have self-directed IRAs to find them to sell these properties to. Does that make sense?
Edwin: Yeah, makes perfect sense. And it depends… as I’ll use as an example, it kind of depends on how the person is set up and organized. I’ll use this last person real quickly. He has a website, he’s got a Facebook page, he’s got some people connected to him. He doesn’t do a tone of marketing; he doesn’t do a lot of those things. So what we did was we actually shot a couple of videos via Skype and recorded those videos and he basically interviewed me on retirement account investing and how you can use that to invest in real estate.
We focused on the type of real estate transactions he was putting together obviously. And then he posted that video on YouTube, he posted it on his Facebook page, he put it on his website, and he started talking to people about it. They go they watched, it’s a short interview and that’s where these $220,000 client came from. So things like, that, if you already have people like you’ve got marketing whether it’s being e-mails or webinars, or whatever, then a lot of what we do is say we just want to tie into what you are already doing because the reality is whoever you are talking to, like I said, a majority of them, I can probably promise you, half of the time, are ready. They are just not aware of it and how to use it.
And so what we need to do is help draw the line for people. “Hey do you have a retirement account? You know your balance and how you’ve been investing in real estate? Do you realize that you can use that retirement account to purchase these rental properties from me? You can get into real estate investing right away without putting your job or putting any kind of real time effort.” And so when people, when you draw that line for people they are like, “Wow, that’s really cool. I didn’t realize that.”
Joe: So in a certain sense, in a certain sense, instead of soliciting for private money which you are kind of not allowed to…
Alex: Do not do that.
Joe: Right. You could advertise for a self-directed IRA education and you can train people are at least offer people access to training on how to find out how to invest their IRA money which is what you guys do.
Edwin: Exactly. So everything we do is education, it’s never solicitation. And as an example, I’ll point out a couple of things. One of the ways that that’s very clear that’s it’s not solicitation is that you notice the examples that I’ve used and the transaction that I’ve talked about aren’t anything that are available to anybody right now on this call. These are transactions that have already been done. That’s education, that’s not solicitation. Now you can go out and do a transaction. You can go out and just like what we’ve been talking about. But that transaction that I brought up isn’t available for anybody to buy into our investing.
And so we are very specific in terms of how we provide the education so that people understand how this works, how it can benefit them. Yeah, we don’t solicit. And that’s by the way just as a new answer to this; people aren’t familiar with special self-directed IRA providers. You know the thing that’s unique about us is that we don’t sell investments and we don’t provide investment advice. We provide the IRA services and allow clients to get control over their account and invest in what they want to invest in, so most clients really appreciate that because we are not selling them anything. They feel that they are in control and they can work with the people they want to work with to invest their account.
Joe: Okay good. One of the things that when we are talking about wholesaling, I was thinking about lease options Edwin, and that’s something that I’m starting to personally to focus more on in my business. I want to build a portfolio of properties, but I don’t want to build… I don’t want to have a bunch of really cheap low end rental properties. I’d like to focus more on the medium priced neighborhoods; more of the in St. Louis that would be you know 100, $150,000, in there $150,000 price range okay? Now if I were to go out and buy a bunch of those properties that would obviously take a lot of capital to do that, but I like the idea of lease options and specifically sandwich lease options. I can control these properties without buying them, without owning them, and I can get some cash flow I can get them at a discount. Not a huge discount but I can get them at a good discount and pay them off in five or 10 years with the cash flow etcetera. I don’t want to go to all those details. Can you invest in those kinds of lease option deals through your self-directed IRA?
Edwin: Yeah absolutely.
Joe: Could give an example that of how, if I wanted to buy a property on a lease option and do a sandwich lease option. Well I am going to be staying in the middle, and I am assuming you know what that is. Like a sandwich lease option right?
Joe: How would I do that?
Edwin: You know if you’re thinking about how you do it now, you know this is, and this is, and it’s really a great question Joe because here’s the trick of it. A lot of people make self-directed and retirement can’t work more complicated than it really has to be. When you’re doing that transaction like you’re talking about and your entering that transaction, you have the documents that you’re using like you have the lease and you have an option right? You typically have two different docs. Right, I don’t know how, is that how you do it in the different docs?
Edwin: Yeah so you have two separate documents, okay? Well who is the person that’s controlling the deal through the option and who’s the person leasing it? Well if that’s you or your business, right, you put a name on there. If you’re using you IRA it’s just what we talked about at the beginning, you’re using the IRA name, you’re not using your name, you’re not using your business name, you’re using the IRA name. All the documents are pretty much identical, like I said the key distinction is the titling, who is going to control or own the transaction? Instead of using your business name you’re going to use your IRA name.
Joe: You could use you could create a new LLC that the IRA owns right?
Edwin: Well we could do that too, you could create a new LLC that the IRA owns to do that and it will be on that LLC name.
Joe: You could have one LLC that owns multiple properties that the IRA owns, correct?
Joe: Okay, simple.
Edwin: Yeah, it’s very simple.
Joe: If I am putting down $1,000 option deposit to the seller on the A to B side, that money would come from the IRA?
Joe: Cool. And the good reason probably why to have the LLC owned by the IRA is because then if there were some expenses that you had to pay, if there was a month of vacancies or whatever, the IRA could pay that through the LLC not from your other business checking account.
Joe: I think this is what I am saying that does make sense.
Joe: Okay so Edwin how, if somebody wants to start an IRA what do they do?
Edwin: First way to do is to go to www.SpecializedIRAServices.com we have, we just published a new book it’s absolutely free. They could sign up for that online we offer an introductory free consultation as part of that package as well. The 800 number is right there on website, they can always just call in the office. and you know they hit option one when they’re dialing and they’ll get connected to a service director specialist and there’re there to answer all their questions about self-directed accounts, investments you know all those types of things.
Joe: Okay. Good, SpecializedIRAServices.com?
Joe: Go ahead Alex.
Alex: I was going to say, let’s say I have got a lender that’s been lending to me for a long time and they’ve got plenty of money to be able to do this and they want to start realizing the tax benefits but they don’t have a self-directed IRA. What’s the best way for them to go about getting one established, getting it funded so that it has enough to do actually do deals and start realizing those benefits? How will they do that?
Edwin: What, well the short answer is that they should call and schedule a consultation with one of our specialists because you know, and the reason why I say that is because every situ…you know I love to sit here and say that there’s a cookie-cutter approach to all these. One of the reasons why we’ve been so successful with helping clients really move forward quickly is because it’s not cookie cutter, it’s very customized and that’s why we do the consultations Because just to give you an example I have, I had a client who said no I want to, he said how much can I contribute, and I said well how much do you want to contribute. And he says well I have a more than $100,000 I would like get in a self, in some self-directed account right now. And I said okay, so we did the consultation, took a look at it and we were able to get in about $120,000 in his particular case this year.
But it’s based on the, his circumstances and situation, you know these types of things, so that’s why I say it’s a very customized approach what we do to help to really understand what the client wants to achieve, what their goals and objectives are, what their situation is, so that we can make the best recommendations and really help them move forward the way that they want to on their timeframe.
Alex: I understand that, well I’ll have some people be giving you a call and for sure they’ll be definitely interested in that.
Joe: Good and I am looking at your website right now Edwin, the book is called The Field Guide to Financial Success, with this book you can transform your retirement, transform you family legacy, transform your business and your investing, and real simple it sounds like so…
Joe: I mean obviously there are 100 different scenarios, 100 different answers to each of those different scenarios, and so it’s important if you are interested in learning more about creating a self-directed IRA for yourself, and or partnering with other investors who have, or not yet have their own self-directed IRAs. You probably need to talk to a good expert who’s in that field and I have, I am not getting anything by recommending Edwin to you guys, I just know he’s a good guy, he’s honest. Known him from the mastermind, excuse me, and he’s definitely a guy that I think I am glad that we’ve had you on this podcast Edwin so people can get more information, and know where to go to get trustworthy information on that, because we’ve just barely scratched the surface and we were probably asking all kinds of questions all over the board, and maybe we should have kept it more simple but, this has been really good, I appreciate it Edwin.
Edwin: Joe I appreciate it, and Alex it was, thanks for joining us.
Joe: Good guys, so SpecializedIRAServices.com, Edwin would be more than happy to help you guys, this is Edwin Kelly and it’s been a good podcast. Guys don’t forget to go to RealEstateInvestingMastery.com to get our Fast Cash Survival Kit. We didn’t even talk about that at the beginning of the podcast. Go to RealEstateInvestingMastery.com, check out the show notes of this episode; you can even get a transcript of this episode. If you’re driving and weren’t able to write down the website, or the contact information for Edwin, we’ll have all of that in the show notes, so go to RealEstateInvestingMastery.com. Thanks, Edwin. Thanks, Alex.
Edwin: Thanks guys.
Alex: Thanks Edwin.
Edwin: All right. See you guys. Just take care. Buh-bye.
What are you thinking?
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This was an excellent podcast. Joe and Alex asked questions that we spot on about how to invest in a self-directed IRA and Edwin Kelley came up with some gems for answers. I am currently trying to do my first-ever IRA deal and I already learned some things that will help me greatly.
Awesome to hear Gary! Thank you for the comment