In this episode, RealCrowd Co-Founder & CEO, Adam Hooper, discusses the ins and outs of self directed IRA investing with leading expert, Mat Sorensen.
Mat Sorensen is a partner at KKOS Lawyers in its Phoenix, AZ office. KKOS Lawyers assists clients nationwide from its offices in Arizona, Utah, and California. Mat’s practice has a particular emphasis on self directed retirement plan law. Mat has assisted over 1,000 clients with self directed retirement plan investments and has established IRA/LLCs, partnerships, private offerings, corporations, and other investment structures with self directed IRAs and 401(k)s. In addition to his legal practice, Mat also serves as an instructor for the Retirement Industry Trust Association’s (“RITA”) Self Directed IRA Professional certification program. RITA is the premier national association representing the self directed retirement plan industry.
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Adam Hooper – Hey Tyler.
Tyler Stewart – Hey Adam. How are you today?
Adam Hooper – Good. Welcome RealCrowd listeners to the RealCrowd podcast number two. Tyler, what are we talking about today?
Tyler Stewart – Well today Adam, we have an expert on Self Directed IRA Investing, Mat Sorensen. Mat is going to walk investors through how to get the most out of their retirement accounts.
Adam Hooper – Great. So Mat is the guy who literally wrote the book on Self Directed IRA Investing.
Tyler Stewart – Yeah, it’s a great book by Mat.
Adam Hooper – Available on Amazon. Five-star reviews. We’ll talk about that a little bit here in the podcast. And Mat’s an attorney at KKOS Lawyers in his Phoenix, Arizona office. Emphasis on self-directed retirement plan law. Great guy. Good background, the real estate industry. Used to own a title insurance company. Just an absolute expert in all things self-directed. So Tyler, what are some key takeaways you think from the podcast today?
Tyler Stewart – Yeah, a couple takeaways I had were one, how to maximize your tax strategy using a retirement account combined with private real estate investing. Mat offered a lot of good information on this point. Point number two, was the comparison between 1031 Exchanges and SD IRAs. We have investors who utilize both and Mat did a good job of going over the benefits and the disadvantages of both.
Adam Hooper – Yeah, I think one of the biggest things to me too is his emphasis on creating the right team when you’re looking at going self-directed with your retirement plans. His big point was don’t try to skimp $200 going it alone and not talking to an attorney or an accountant. Make sure you get everything set up right the first time and hopefully you’ll be good-to-go for all future investments through your self-directed plans.
Tyler Stewart – That’s right. Do it right the first time and also know your investing goals before you select that self-directed IRA custodian. Different custodians have access to different product types and it’s good for investors to first know the investments they’re looking for, and then identify those custodians who can give them access to those product types.
Adam Hooper – Right, and we touch a little bit on UBIT and UDFI, the two big scary four-letter acronyms that come up in the self-directed world. So, there should be a lot of great information in there today.
Tyler Stewart – Yeah, over the years we’ve gotten a lot of questions from investors looking for more information on self-directed IRA investing and I can’t think of a better person to deliver that information than Mat Sorensen. So it’s going to be fun to get this information out there in front of our listeners and I look forward to the fall of questions we get from investors. This is a topic we could do many episodes on and we probably will.
Adam Hooper – Great. With that, let’s get to it.
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Adam Hooper – Alright, well we’re joined here today by Mat Sorensen, partner at KKOS Lawyers in Phoenix. How are you doing today Mat?
Mat Sorensen – I’m awesome. Great to be on. Appreciate you having me.
Adam Hooper – Good. Well, we’re glad, glad to have you on today and this is a hot topic. A lot of investors ask us questions about this all the time and as an expert in the self-directed IRA space, we’re thrilled to have you on. Hope we can get some good information for our listeners.
Mat Sorensen – Yeah, I think this is probably one of the most cutting-edge strategies out there. It’s grown tremendously over the last 10 years. I mean if you think about it this way, there’s 25 trillion dollars in retirement accounts in the United States. And for people listening, I mean you might have your own little sliver of this 25 trillion, and you never knew your could invest in real estate. You thought you could just buy stocks, bonds and mutual funds, but the financial services industry has been telling you that cause that’s what they sell. But you’re not just limited to that. You can get off that beaten path of you know, picking a mutual fund, which let’s be honest, tell me a mutual fund you want to buy right now. You don’t know. You know? But there might be people that are like, oh I know what real estate deal I want to do. Or I know where I can find better returns on real estate. And that’s what I’ve spent a lot of my time doing and why I love the topic cause it’s just really empowering to people to be like, I didn’t even know I could do this and…
Adam Hooper – Right. I have a lot of money or I know people that have a lot of money in retirement accounts and think of that 25 trillion. There’s no place of investible capital larger than that. There’s no other place. It’s all in everyday Americans’ retirement account sittin’ out there to be invested. Good. Well, so let’s just jump right in. What is a self-directed IRA?
Mat Sorensen – The best way to describe it is it’s a retirement account that can invest in any investment allowed by law. So, there’s very few restrictions on what you can and can’t invest in, but real estate’s always been something for example you’ve always been able to invest in. A lot of people just didn’t know about it. Startup companies, you can invest in with your retirement account. You can buy precious metals. These are a lot of alternative investments people can buy with a self-directed IRA. So a self-directed IRA is really just an IRA that can invest in any investment allowed by law.
Adam Hooper – Good.
Mat Sorensen – Now some brokers like TD Ameritrade will say we have self-directed IRAs. What they mean by that is you can pick what stocks to buy. That’s it. That’s what the deem self-direct. So be careful. Sometimes it’s misused, but a truly self-directed account is one that can invest in any investment allowed by law.
Adam Hooper – So, self-directed from their menu. Rather than truly self-directed, yeah. Okay, so since we’re on the real estate world here, tell me a little about your prior real estate experience before you got into the self-directed IRA game. I know you had some investment experience of your own and there was maybe a title insurance company that you were involved with. Can you tell us a little bit about the background?
Mat Sorensen – Yeah, I mean our law firm KKOS Lawyers, we have an office in Phoenix where I’m at. One in Utah, one in Southern California. We’ve always been a real estate law firm, had a lot of real estate clients and back in 2006, I had some of my first clients basically buying real estate with retirement accounts. I had always been a real estate investor myself. I own a number of rentals. I have my own little rental real estate portfolio. I have a real estate development, some commercial properties. I’ve owned a title company. You know, there was specific to investment transactions. So I worked a lot just from a professional side as a lawyer. I worked in the real estate side just personally. I also invest my own self-directed retirement account into real estate. I kind of got into it in about 2006, where I really started focusing on self-directed accounts in real estate.
Adam Hooper – And so that’s obviously a very specific niche of law. What drew you to the self-directed space? Was it because like you said a lot of your early clients were doing it? Was there something specific that kind of drew you in to that area of law?
Mat Sorensen – Well, I was trying, I went where the money was at. You know, I got some good advice that said go focus your legal practice, your business where the money’s at. And both, as I said earlier, a lot of Americans’ wealth is in their retirement accounts. People just didn’t know how to use it. We had a lot of successful real estate clients who were making a lot of money in real estate and they would come to us and say, well we’re frustrated with paying so much in tax. Give us better tax strategies. So one of the best strategies out there was, alright, let’s see how we can use your retirement account to buy real estate and sell real estate for profit, rather than you buying real estate or your company you personally own buying real estate and selling for profit and you pay tax. Let’s think of how we can use your retirement account to buy real estate and sell it for profit. So I could use even Roth IRA for example, you can buy real estate. You know, buy a property for $100,000 and sell it for $150,000. That $50,000 gain goes back into your Roth IRA totally tax-free. So for a lot of our clients, that was kind of eye-opening that this was available. They were doing 1031 Exchanges and other tax deferral strategies. But those were just deferring the gain.
Adam Hooper – Right.
Mat Sorensen – And the 1031, you had to buy in a certain time and they end up buying crap they don’t want and so they get frustrated on their replacement property. So, but there’s no rules on that with a self-directed IRA. So it was kind of a very underutilized tool. What I realized is, there wasn’t a lot of written about it. There was not a lot of professional articles on it. There wasn’t a great book on it, so I kind of got out there and decided I’m going to make a practice focused entirely on this and become a national expert on it. That was my goal 10 years ago. Right now I have the number one best-selling book in the industry on the subject. It’s the Self Directed IRA Handbook. You can find it on Amazon. I speak around the country on this topic of using self-directed accounts in real estate.
Adam Hooper – You’d mentioned the 1031 challenges. Obviously, that does pose a challenge. Certainly when you’re talking about what we see mostly in the ya know online marketplace investing platforms where it’s hard to do like kind of exchange when your ownership is units in an LLC, right? You get into some challenges around the structure, which makes it more difficult for doing 1031 Exchanges when you don’t own that whole property outright. So that can be another challenge. Obviously, I am not a lawyer. But something to be cognizant of when you’re looking at these investments and how you might get into some other tax strategies, which we’ll touch on a little bit. Investing through your self-directed IRAs and solo 401ks. You can have some of those tax benefits and still not have those challenges with the structure that we see in a lot of these entities.
Mat Sorensen – Yeah, very true. That was what some clients were realizing. They were doing some of those strategies and realizing those frustrations and then frankly, even the Roth IRA was just wait, I can do this tax-free? I mean I have clients with ten million and plus Roth IRAs. You know? Putting $5,500 bucks into a Roth IRA. So they’re making money on doing good investment transactions. They built those accounts up by investing smart. They’re sophisticated real estate investors or they may be a tech investor or someone that has a specialty. But they’re basically investing what they know, what they have more comfort and belief in.
Adam Hooper – Good. So now ya know, let’s talk a bit about the key advantages of going self-directed. You know, obviously you had mentioned before actual control over what you invest in and maybe a more broad menu of asset classes to choose from, but as you’re talking to investors that are looking at doing this. If you were to talk three or four key advantages that you see when you’re looking at self-directed?
Mat Sorensen – Well I think people that are realizing a few things, first is that’s where the money’s at. So a lot of people come to me and they’re like alright, I’m investing and they may have an expertise in business or in real estate or some special field and they didn’t realize that this retirement account from their old 401k from a prior employer that’s got $500 grand in could be deployed into these things they have an expertise in. So the first thing I like clients to understand about self-directives is invest in what you know, or what you can learn and come to know and understand. Because a lot of people get a mutual fund and they don’t understand what the heck it means. Nobody reads those things. We don’t know what in the heck they are.
Adam Hooper – Right.
Mat Sorensen – But we just want to be in the market. So we buy that crap. And so, but with real estate it’s something you can actually understand. You know? I have clients that invest in… I have clients that have been inventors, clients that have been software developers, clients that have been real estate investors, medical device clients. I mean a whole gamut of clients that have expertise in areas. We figure out, how can I invest your retirement account into those things you know?
Adam Hooper – Right.
Mat Sorensen – Wise investments where you have an expertise and a competitive advantage. So that’s the first thing. I want them to invest in what they know, where they can kind of get a competitive advantage over the typical mutual fund. Pick a random stock type standard retirement account type investment strategy. There’s the tax benefits, obviously I’d mentioned earlier. You buy an investment and you sell it for a profit. You don’t have to pay capital gains tax on the gain. If it’s a Roth account, you know it’s tax-free until you retire. If it’s a traditional retirement account, it’s just tax-deferred. But it builds up in your account. You’re not paying taxes. You go, the account builds up and you pay tax later when I’m out of retirement. So, those are the main advantages. I think being able to invest in what you know, the tax benefits. There’s really no other way to make money on investments better than in a retirement account. There’s no other beneficial avenue than a retirement account. This can be your self-directed IRA or a self-directed 401.
Adam Hooper – Yeah, and so what kind of accounts can be converted to a self-directed?
Mat Sorensen – Yeah, good question. So if I have a Roth IRA, I could convert that to a self-directed Roth IRA. If I have a traditional IRA, I could make it a traditional self-directed IRA. A self-directed IRA is just kind of an industry term. When I say a self-directed IRA, it’s really just a traditional IRA or a Roth IRA or a SEP IRA. All those type of IRA accounts you can make self-directed. Let’s say you’re at Merrill Lynch for example who’s not self-directed, and you have a traditional IRA there. You could roll that money from Merrill Lynch to a custodian who allows you to self-direct, and you just have a traditional self-directed IRA. It’s just the custodian is someone who lets you actually self-direct. So that’s the distinction there, but you could have IRAs. You can rollover a prior employer’s 401k to a self-directed IRA. So, really the only place people get stuck is if they have a 401k and they’re still working there. You typically can’t roll out of your current employer’s 401k, so you’d get stuck. Everyone else though, you have an IRA somewhere else, you’re going to be able to get it to a self-directed IRA. Or if you have a prior 401k with an employer, you could get that to a self-directed IRA.
Adam Hooper – Okay. So basically, most of these retirement accounts are the terminology self-directed. It’s still a traditional Roth or SEP. But the ability to make your own investment decisions is what determines whether that custodian will allow you to make those investment decisions essentially.
Mat Sorensen – Yeah and you just got to make sure you get to a custodian that lets you self-direct. And there’s 30 of them out there in the industry now, so there’s quite a lot of options. You know, you just have to move the account. That’s a tax-neutral thing. You’re not paying taxes, you’re changing custodian.
Adam Hooper – And so when investors are looking at potential custodians, what are some of the things they should look out for? Or questions that they should ask of those custodians when they’re looking at a handful of different groups?
Mat Sorensen – I would look for referrals from other professionals in the area. Even me, I’ve worked in the area. I’ve worked with every company in the industry. Most of them all find my book to give to their employees. I’ve probably spoken at most of their offices over the years and so I’m pretty familiar with all of them. There’s pros and cons to others, but depending on what you’re looking to invest in, some custodians may be better than others. Some of them have a better expertise in private equity than they do in real estate. Some of them have a better fee structure for real estate versus private equity or LLCs or different things. So, depending on what you’re looking to do, you may want a different custodian. Some of them do what are called Solo 401ks. That’s a really popular self-directed account for someone who’s self-employed where they can operate it like a 401k or an IRA. So it depends on what you want. You could ya know, look into that. I would get a referral from a professional in the area like us or maybe a CPA or another attorney.
Adam Hooper – So depending on what investment class that the investors are looking for, you say there might be some custodians that are better suited for that. Obviously again, we’re talking about real estate today, but what other types of investments? You mentioned startups, venture or some other asset classes, real estate probably being the primary for self-directed. What are some of the other asset classes that people look at when they’re getting into this avenue?
Mat Sorensen – Let me just say on the custodian, just add one other point on that in terms of looking for them. I would go to ritaus.org. That’s the Retirement Industry Trust Association. That’s the national association for self-directed IRA custodians. Ritaus.org.
Adam Hooper – It’s ritaus.org, correct?
Mat Sorensen – Correct, exactly. And that’s got all the companies in the industry. They’re members and they have the membership list, contact list. That’s the best place to go to just get the big list. As to investments, it can be anything. I mean real estate is the most common. I’d say private equity. I have a lot of clients that will set up LLCs and they’ll combine multiple accounts to buy a specific real estate investment. Or they’ll find some personal funds and retirement plan funds into an LLC that buys an investment. Those are kind of special LLC structures. You got to be careful on how to do it, but that’s a cool structure. We’ve had clients buy seriously Selena Gomez tickets and sell them. And Superbowl tickets. Race horses.
Adam Hooper – Wow.
Mat Sorensen – Diamonds. Precious metals. Lots of weird things that ya know, you’re just like, why would you do that? But some of these clients have an expertise. The only thing you can’t invest in, there’s only very few restrictions on what you can’t buy with a retirement account. That is you can’t buy a collectible item. So like, a stamp collection or art. You know, when retirement accounts first came out, you could buy art. A lot of people were abusing that rule. They’d buy art and put it in their office and they’d hang it in their home. The IRS was kind of like, this is really not an investment. This is more a personal benefit use. People were buying like wine collections. Wine collections turned into bottle collections. So there was like this abuse and the IRS said you know, we got to shut down collectible items. They said collectible items you cannot buy with your retirement account. But that’s really it. I mean S corporation stock is another restriction. Retirement accounts just don’t qualify under S corporation rules to be shareholders. IRAs can own LLCs with limited partnership, C corps, trusts. There’s lots of things that retirement accounts, like deeds of trust, things like that, retirement accounts can own. But I think real estate whether it’s in a crowd-funded deal, a partnership deal, directly the retirement account owning just like a single-family rental. A retirement account lending money on another person’s real estate, kind of like playing banker. The retirement account is basically the lender with a secured note against the property. Those are going to be the most popular. Private equity would be second, which could be startup companies, venture capital type stuff. That’s gotten pretty popular. That was Mitt Romney if you recall in the Presidential cycle the last go-around. I can’t believe it’s been that long ago. Ya know, he had a 100 million dollar IRA and he was all written up in the Wall Street Journal. How does he have a 100 million dollar IRA? Well, he’s investing in private equity stuff essentially. He wasn’t just buying in regular stocks and mutual funds. He had an expertise and startups and turnaround companies. That’s what he put his retirement account into. But that’s the most popular. Precious metals has gotten popular also as the stock market’s gone up and down. People kind of get worried about paper assets. They want like hard assets such as precious metals I guess. So there’s been a rise in that too.
Adam Hooper – Well, now this is maybe venturing a little bit into the self-directed 201 course, but one of the things that we get questions about frequently and is an issue, specifically when you’re looking at investing in real estate is UBIT. Can you take a few minutes to go over maybe kind of high level. What is UBIT? What causes that? And as we’re looking at some of these different investment opportunities, what are the things an investor needs to look out to to try to avoid that or how do they mitigate any challenges that might pose?
Mat Sorensen – UBIT, there’s really two rules you got to know about a self-directed retirement accounts. The first is UBIT, and UBIT for real estate investors, it can apply in two different ways. First is if the retirement account receives business income. The retirement accounts are designed to receive investment income. Like rental income, capital gain income, interest income. If your retirement account’s getting that, you’re not falling into this UBIT directly.
Adam Hooper – And UBIT again just stands for?
Mat Sorensen – Unrelated Business Income Tax.
Adam Hooper – Okay.
Mat Sorensen – Very exciting. But UBIT is for real estate will apply if your IRA’s invested in like a real estate development, where it’s more business income being generated as opposed to investment income. So if you’re getting business income, like your IRAs owns an LLC that’s doing a real estate development, that’s going to push through business income. Or if it’s doing new construction, that’s more business income and that can cause UBIT for the IRA. Congress wanted your retirement accounts to get income, estimate income like rental income, capital gain income, interest income, loyalty income, dividend income. That stuff’s all exempt. That’s the first rule on UBIT is get investment income. The next part to that though, for someone investing in real estate, which is actually more important is there’s a portion of UBIT called UDFI. Another four-letter acronym there. UDFI, Unrelated Debt Financed Income. Now what UDFI is, it’s a part of UBIT. UDFI is essentially a tax that says, if your retirement account’s investment its cash investment is leveraged with debt or it invests in a company that owns an asset like real estate that’s leveraged with debt, the IRS taxes a portion of the profits attributable to the debt. That’s a freakin’ complicated explanation of it. I’ll give you an example of the best way to understand it. Let’s say my IRA buys real estate for 100 grand. The IRA puts in $40,000. I get a loan for $60,000. Now when I get a loan, there’s a rule that says I can’t sign for the loan. It has to be something called a nonrecourse loan. So I can’t guarantee the loan. The retirement account gets it. There’s some banks that offers these. They’re called nonrecourse loans. But for someone else in the deal, sign for the loan. That’s fine. It’s my IRA, I can’t be signin’. But I buy the $100,000 property. $40,000 from the IRA. $60,000 comes in from a loan. Now when the IRS looks at that, they’re going to look at that and say okay, 40% of this deal is retirement plan money. So 40% of the profits go back to your retirement account. You don’t pay tax. The other 60% of this deal is debt. This was never retirement plan money. Your retirement account’s getting the benefit of this debt that was not retirement account money. So we’re going to tax 60% of the profits that relates to 60% of the deal as being debt. So they tax that. If I made a $10,000 profit, let’s say sell the property, make 10 grand or I had cash flow rental income after expenses of 10 grand, then what they’re going to do is $4,000 goes back to my retirement account, no tax. The other $6,000 though is subject to this UDFI UBIT tax. The IRA having to end up to file its own tax return in paying that tax. What you’ll actually fall into is if your IRA is investing in real estate that’s leveraged with debt. It’s not the end of the world. I have a lot of clients that still do it because you’re getting the benefit of the leverage. Tax really on leveraged real estate really isn’t too bad. But that’s the basics of, I can get into more detail as needed. But that’s the basics of it.
Adam Hooper – Got it.
Mat Sorensen – You bring in the debt with a self-directed IRA, it causes this UDFI tax. Now one note I’ll make is Solo 401ks, a lot of people who are self-employed can do a Solo 401k as opposed to an IRA. Cause if you’re self-employed, you can set up your own 401k for the benefit of yourself. And Solo 401ks are exempt from that leveraged UDFI tax. There’s a weird exemption in the rules for 401ks that get that exemption.
Adam Hooper – So if I’m an investor, and again just kind of looking at a Real World example. A lot of the properties that are on ya know, certainly our platform and many others out there, and just real estate in general is often levered. If I invest into a deal that has that leverage, who’s actually doing that work? Who are the checks and balances of calculating what percentage is coming from the leverage and what the tax is? Is that the custodian’s job? Is that the real estate manager’s or does that fall to the responsibility of the individual investor and their accountants?
Mat Sorensen – It’s the account holder’s. A lot of IRA account holders don’t even know this. You know? But it’s their responsibility. The custodians, in all of their documents, they’re going to provide information and disclaimers that says hey, if you have UBIT or UDFI tax, that’s your responsibility to report it and file the tax return and pay any tax. We’re not doing it. So, it’s that account holder’s responsibility. What happens is the IRA files a 990E tax return. It’s separate from the account owner’s personal return. IRA ends up filing its own separate tax return, which IRAs usually don’t do. You’d only do this… Your IRA would only do this if it runs into the tax. But it’s the account owner’s responsibility and they’d need to hire a lawyer or a CPA that’s familiar with that type of return.
Adam Hooper – Okay.
Mat Sorensen – The taxes paid from the IRA, if there is any tax due.
Adam Hooper – Got it. And so now as it relates… So obviously again specifically to real estate, what are some of the investments that if someone was looking to avoid having to deal with the UDFI and UBIT issues, as you mentioned, purchasing assets debt-free? We had one fund on RealCrowd that was actually a debt-free income fund, so you’d be able to avoid it if you’re buying properties all cash. What about debt investments or trustee investments? You mentioned those?
Mat Sorensen – Yep. That would be good too. So if it’s a real estate project as you’d mentioned, that’s got no debt in it. That’s going to be clean. No UDFI tax. It’s going to be straight rental income not leveraged. Or if it’s a debt fund where the income being generated is interest income, and it’s an equity position essentially in the fund that is, and the fund is getting debt out lending others money, that would be clean too. You’d receive interest income as the IRA. No UBIT or UDFI tax. But I’d say too, a lot of people still invest in a leverage deal. I mean if it’s, if the deal is good, don’t be shy on the issue of leverage. A lot of my clients have even large accounts. I have one client that has… I just did a 990-T for him. He’s got a million dollar plus commercial property in his IRA that’s leveraged with debt. He maybe pays about 14 grand a year in UBIT tax. But he’s cash flowing. I shouldn’t say cash flowing. He’s got cash-positive money accumulated in his retirement account of over $150,000 a year on this commercial property.
Adam Hooper – Right.
Mat Sorensen – So but don’t be too shy. Don’t freak out on it. I want people to know about it.
Adam Hooper – Sure.
Mat Sorensen – So that you can calculate that into what to invest into. And then I know some people are like, you know what, crap, it’s my retirement account, I don’t even want to think about taxes and then maybe avoid it, but that might be a bad decision. You could otherwise be passing up what could otherwise be a good deal.
Adam Hooper – Yeah, and leverage that is one of the benefits of real estate right? To increase those returns is the ability to lever these things. So as long as investors again are aware of the UDFI and how to go about that process with their tax team. That’s important, right?
Mat Sorensen – Yeah, and just take it into your decision process on the front end, ya know? Unfortunately, a lot of people figure it out on the back end, like they didn’t talk to a competent lawyer or CPA before they made an investment. They later found out about it years later and they’re like ah crap, I didn’t know this. And maybe I wouldn’t have invested in it if I did. Then they got to go backwards to possibly to correct things. So it’s good to know this on the front end and that’s why I’m glad you’re doing this podcast with me.
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Adam Hooper – Yeah, and you brought up a good point there. What is the team I guess, or what is the roster for someone that’s looking for getting into converting to self-directed? Who should they be consulting with? Obviously we talked about a custodian. You briefly mentioned accountant, attorney. What is that process look like to convert? And who should be involved in that decision making process?
Mat Sorensen – Yeah. So most self-directed investors, I hate to say it are do-it-yourselfers. Self-directed accounts attract people who like to do it by themselves. And unfortunately, sometimes you can hurt yourself doing that. Because when you get into self-directed accounts, you’re going to have to talk to a custodian. What most people do unfortunately is they get a custodian because they have to for a self-directed IRA and then they rely on their custodian for all the questions. Well, the custodian a lot of times the person you’re talking to is someone that may have worked there for six months and you know, makes 14 bucks an hour and they don’t have expertise. They’re not a professional that can advise you. And they’re not supposed to either. They don’t want them.
Adam Hooper – Right. I was going to say, they’re probably not allowed to provide tax or legal advice, right?
Mat Sorensen – Yeah, but you can rely on them. They say well I want to do this. Can I do this? And they’re like yeah, you can do it, but… That might cause UBIT tax, but you can do it with your IRA and so they’re also they want you to set up an account.
Adam Hooper – Sure.
Mat Sorensen – So independent advice, I would talk to a lawyer or a CPA that has expertise in this area. I’m not the only one, but get some advice on the front end about specifically what you’re trying to do. I think a lot of people get on the web too, and they just start Googling stuff and like sometimes you get a lot of bad information and sometimes you get a lot of information that has nothing to do with what you’re specifically trying to do. But if you just do a consult with me for example, we can do it in 30 minutes. I can just talk about what your specifically wanting to do, your specific situation. We can get rid of everything else that doesn’t matter to what you’re trying to do. If you’re wanting to buy real estate, I don’t need to talk to you about precious metal storage rules, ya know? Or the plan asset rule for private equity. So I can just focus on what you need to know. And that’s all you need. You know? You might need me to set up an LLC maybe, or structure a partnership deal, or structure a transaction of what you’re doing. But we’re just going to advise you. I don’t have an interest. I’m not making money if you invest in something or not. That’s the other thing, a lot of people rely on someone who’s selling them the investment just to say how it works and how it doesn’t. Then they don’t talk to their own professional to figure out how it actually works for their situation.
Adam Hooper – Yeah.
Mat Sorensen – I would just seek out at least a lawyer or CPA that’s competent in the area. You’re going to have to have a custodian, but don’t rely on them for your question. They try to be educational in nature, but you’re really going to be talking to someone that has no business helping you or giving you this type of high-level advice. For a lot of people, I mean this is money they’ve saved. This is their hard-earned money.
Adam Hooper – Right.
Mat Sorensen – They’ve been socking away for years, right? Don’t just go on the cheap and be like, well I can save 200 bucks. I got a $300,000 retirement account, but I can save a couple hundred bucks and avoid calling the lawyer.
Adam Hooper – And so we’ll talk about structure here in a second. But can you run us through real quick process. So I’m an investor. I now know I’ve got an asset that I want to invest in. I need to convert a traditional account to a self-directed. How does one go about that and what does that process look like? Just kind of high level?
Mat Sorensen – Yeah. So step one essentially is find a self-directed IRA custodian. Roll over your account, your existing account and you would presume that would of been an account you could roll over. If it’s again a 401k or somewhere you still work, and you’re under the retirement age of 59-and-a-half, you can’t move it. But otherwise, if you have an existing IRA or 401k, you could rollover. So step one is getting a self-directed account. Step two would be rolling the funds over to the self-directed account. Step three would be getting professional advice on the specific investments you’re planning to make, which would involve a lawyer or CPA. You could put that on the front end too, if you’re not sure whether you’re going to self-direct at all. Then the next step, step four I guess, would be getting investment document(s), making an investment decision. Whether it’s a contract or investment subscription documents, whatever it may be. Getting the actual investment documents, which need to be reviewed too and make sure you understand them. You made need a professional to help with that. You may not. You know, there’s a lot of people are experienced. What I try to tell clients about self-directed accounts and retirement accounts, especially if they’ve never done it before is, it’s kind of like playing a board game for the first time, where a lot of times you just sit down and you’re like playing a new board game, you don’t read the rule book or you don’t have someone sitting next to you that’s like you can’t do that, you can’t do that, you got to move it this way. You’re going to be so frustrated, ya know? And if, you know, like you’ve been… You’ve sat there and you’ve had some friend that’s playing some game with you. They’ve never played before and they’re asking you a million questions. Why can’t I do that? Why can’t I do that? Ans they’re moving the piece in the wrong places. Well that’s what it is with a self-directed account. You need to know how it works. It doesn’t just work like you intuitively think it would. Unfortunately, it’s based on the tax rules which have no logic created in them.
Adam Hooper – Yeah.
Mat Sorensen – So, some things you have to do just because the rules say you do it that way. But it’s not complicated. Once you learn how to play the board game once, you know how to play it. You play it the next time, it’s the same stupid rules. So that’s what it is for self-directed account. Just get the rules down. Make sure you know how to do it for your situation. You don’t need to know everything about it. Just know what you need to know for what your investments you’re trying to make. But get those rules down before you play the game, before you invest. Otherwise, you get heartburn after of like oh crap, why did I do it that way? That’s a key thing is just making sure you get the rules down. In my book, I mentioned that earlier, I think the Self Directed IRA Handbook, I made that to be the rule book for how to self-direct your retirement account. Easy to research topics. It’s got a glossary too. I mean the chapters are broken out into subjects, so you don’t have to read it from start to finish. You can just read the chapter for your specific investment.
Adam Hooper – Yeah.
Mat Sorensen – That’s really critical. Before money leaves the account and you actually make the investment.
Adam Hooper – At what point do people usually get involved with you? Do they have an asset that they’re looking at? Will people proactively set these up as self-directed just in case something comes together? What’s usually the trigger for when you get a call?
Mat Sorensen – Yeah, I would say when they should be calling me is hey, I want to start self-directing and these are the type of investments I want to do. Maybe they have the self-directed account, but they haven’t invested. I just want to have a consult with someone or make sure someone’s otherwise getting educated before they actually make the investment, and like I said, it’s not like you’re going to need that every time. If you’re doing the same thing over and over again, which is what most self-directed investors do. They kind of find a niche and they just keep doing it. You don’t need me all the time. But when you’re starting out the first time, you need me, or you need someone like me.
Adam Hooper – Right, to make sure everything’s set up correctly and properly from go and then you’re not going to have to unwind those issues down the road.
Mat Sorensen – Right, exactly. So I just say, before money leaves your account, or before you sign any documents or get any contracts drawn up, that’s when you want to get a consult from a professional.
Adam Hooper – Okay, and you mentioned briefly before, do you need to set up an LLC or a partnership? Can you talk a little bit about structure and how you see these typically come together? Is that dependent upon the investment that they’re going to make, I’m assuming? Or is that kind of a common structure how you’d prefer to see these set up?
Mat Sorensen – It depends on what you’re doing. If the IRA is investing like a crowd-funded deal, you typically wouldn’t do an LLC, because that company is going to be an LLC or a limited partnership in and of itself. So you’re going to get that liability protection from the company that the retirement account’s investing into. So your individual LLC or IRA could have wouldn’t carry, but some clients, most real estate clients I would say that are just buying rental real estate directly, like you might just buy a single-family rental with your IRA. We don’t want your IRA to be on title directly because it’s a pain in the neck. Your IRA custodian’s on title. Your IRA custodian gets the income. Your IRA custodian has to pay the bills, and you got to be on top of all that making sure they’re doing it, and they charge you fees for all that. Plus there’s no liability protection. Your IRA’s directly on title. So what most real estate clients do is they use an LLC. So instead of your IRA owning the real estate directly, your IRA owns an LLC. The LLC in turn owns the real estate. Now you can be manager of the LLC. There’s restrictions on what you can and can’t do that are based on something called the prohibited transaction rule, which basically means you can’t make or personally benefit. But as manager of the LLC, you can sign contracts for the LLC, manage an LLC checking account, and the IRA will invest its cash into the LLC. LLC owns the property. The LLC bank account will you know, buy the property, receive the income, pay expenses, and so that’s how it works with the LLC. There’s also liability protection of the LLC. Another reason to use the LLC is if you’re going to partner accounts. Maybe like a husband and wife have an account, they want to put together into an LLC to buy a specific property or investment asset. Maybe you’ve got a Roth IRA and a traditional IRA you want to partner together. Maybe it’s you and some friends or you are partners, or whatever it may be coming together on a specific deal. An LLC is a good partnership entity to put together. Whenever IRA gets invested, there’s some specific provisions in the LLC documents that are required. The IRA custodians review those documents before they’ll let the IRA invest into it, so it has to comply with the IRA rules. We’re obviously familiar with those. But there’s a lot of variations of that LLC structure. It just depends on what you’re doing. If you’re buying like raw land, you know there’s not a lot of liability issues. You maybe get a property tax bill once a year. You could just buy that directly in the IRA. If you’re doing note lending, like your IRAs doing, maybe it’s a long-term note, you could possibly avoid the LLC. You don’t need it. You could do that directly out of the IRA. You could have a third-party servicing company that services the note. But I have a lot clients that do kind of short-term hard-money lending out of their IRA. Not typically used in LLC, because they want to have access to the fund. They want to be able to have quick access to write a check if they need to.
Adam Hooper – Sure.
Mat Sorensen – Or receive income, chase people down if they’re a default from the LLC.
Adam Hooper – Good. And so wrappin’ up a final few questions here, timing on all of this right, so you say first step, find a custodian. Roll the funds over. Source, your structure and you put the deal together from that standpoint. What then do you see on a timing standpoint if someone’s looking to move quickly on a deal, or someone’s looking at an opportunity that might be closing soon? Can you run through kind of the timeline that you see for this process?
Mat Sorensen – Yeah. I would say whatever timeline you’re thinking it is, add a week.
Adam Hooper – That’s pretty typical.
Mat Sorensen – Everybody thinks it’s faster and it should be faster. Now opening up the self-directed account is actually pretty fast. You can call a self-directed custodian and they’ll have an account open for you tomorrow. The big lag I think a lot of people mistake is moving the money. Let’s say your money’s at Fidelity and you say Fidelity, I just opened up a self-directed IRA at ABC IRA Inc. I need to move my money in my old 401k at Fidelity to this IRA. Well, that may take Fidelity 10 business days to do that. You would think that they could do it in a day or two and they’d send a wire. Nah.
Adam Hooper – No.
Mat Sorensen – They hate closing out accounts.
Adam Hooper – They’re going to make you wait for it.
Mat Sorensen – They make it take forever. So now sometimes people have better relationships with institutions. They can get it done faster. But I would say plan on at least a week just for the money to get moved. But you can be doing stuff in the meantime. If you’re really trying to move quick into an investment, set up the account first. Start the transfer of funds from where it’s currently at. Then in the meantime, as the money’s being moved, start to get investment documents drawn up or get some consulting on which investment you’re trying to make. That way, once the money hits the account, you’re ready to go and you can invest it.
Adam Hooper – Okay.
Mat Sorensen – But I would say two weeks is a reasonable amount of time if you’re working on all of those things at the same time. If you’re waitin’ for the money to show up before you start talkin’ to people or get documents done, then you add another week too.
Adam Hooper – Great. Well Mat, I think that’s all the questions I have. This is a tremendous overview. Is there anything else that you want to add as it relates to what we talked about here real quick? Anything that we haven’t covered that we should cover?
Mat Sorensen – I’d say the one other issue for self-directed accounts, buying real estate that’s important is what’s called the prohibited transactions rules.
Adam Hooper – Okay.
Mat Sorensen – And that’s essentially a rule that says you can’t make money from your IRA’s investments or transact personally between yourself and your IRA or certain family members in your IRA. For example, if my IRA owns a rental property, I can’t rent it to my daughter or my son. I can’t make commissions or make money from my IRA. My IRA can’t pay me money for providing it service.
Adam Hooper – So if you’re purchasing a rental home and you’re managing that property, your IRA can’t pay you personally a property management fee.
Mat Sorensen – Exactly, exactly.
Adam Hooper – Alright.
Mat Sorensen – You can oversee things and do management but you can’t be paid for it or compensated.
Adam Hooper – Okay.
Mat Sorensen – So and that rule’s designed for people to not take advantage of their retirement account, obviously. And so, but that’s the only other rule that really applies. UBIT and UDFI which we talked about earlier and then that early prohibited transactional. But if your retirement account’s just making investments, your family’s not involved and you’re not making money personally, you don’t even need to worry about the transaction rule. Where it gets really dicey is if you’re involved and your parents are involved and your wife’s account’s involved and you’re personally in the deal too. Then it gets messy and you got to really be careful.
Adam Hooper – You see most of the investments that we see you know, on a platform like RealCrowd, there’s going to be enough of a buffer between the real estate sponsor and the individual investor. That’s probably not going to be too big of a concern, but obviously very good to be aware of for activities that they might be doing outside of some of these online investing platforms.
Mat Sorensen – Exactly. And RealCrowd are in a partnership entity like that or a bigger entity with a private offering type thing. The prohibited transaction was less of a problem. It rarely comes up.
Adam Hooper – Good. Great, well Mat, this is a phenomenal amount of information. We really appreciate it. You mentioned your book, the Self Directed IRA Handbook, an authoritative guide for self-directed retirement plan investors and their advisors. It’s a mouthful. Where can people find that book?
Mat Sorensen – You can get it on my website sdirahandbook.com. I kept it simple. It’s also on Amazon and also I’ve got my Self-Directed IRA Summit coming up on April 22nd. I do it once a year. It’s a full day, just about self-directed IRA and Solo 401k investing. We talk about real estate quite a bit, because as I said, it’s the most popular investment for self-directed investors, but that’s in Southern California at the Hotel Irvine, Saturday, April 22nd. It’s also streamed virtually live cause it’s recorded for all attendees too. So if you can’t attend it in person, you can get the virtual stream. Watch it live or get the later recorded version as well.
Adam Hooper – And they’ll find your blog on your website as well?
Mat Sorensen – Yep and you can go to sdirasummit.com for the summit sdirasummit.com and my blog is at sdirahandbook.com.
Adam Hooper – Perfect. Well Mat, that wraps up the session. Really glad we could have you on. Listeners out there, if you have any questions, please send an email to email@example.com. Any followups that you want us to direct towards Mat or comments for future episodes. Thank you all and I hope you were able to get some good information today.
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