Phase 2 - Real Estate 101 (How to or one big idea)

Webinar - Incorporating Real Estate Into Your Financial Plan

Tyler Stewert
August 24, 2021
Webinar - Incorporating Real Estate Into Your Financial Plan

Chris Bixby, Senior Wealth Advisor at Mariner Wealth Advisors, joined us for a webinar to discuss incorporating real estate into your financial plan.

Chris is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Certified Advisor for Senior Living, Retired Income Certified Professional® and an Enrolled Agent with the IRS.

Chris has a particular focus on tax, estate and retirement planning. He helps families manage tax and estate tax ramifications related to achieving their financial goals. He has more than two decades of industry experience.

Links

Click here to download the slides from this presentation.

*If you'd like to learn more about how ReAllocate + Mariner Wealth Advisors can help you build a roadmap for your real estate investments head to — BuildMyRoadmap.com.*

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Transcript

Tyler Stewart:
All opinions expressed by Adam, Tyler and podcast guest are solely their own opinions and do not reflect the opinion of RealCrowd. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. To gain a better understanding of the risks associated with commercial real estate investing, please consult your advisors.

Tyler Stewart:
Welcome, this is Tyler with RealCrowd. We have a special presentation for you today with Chris Bixby of Mariner Wealth Advisors. If you're listening to this presentation on a podcast, please note that slides of the presentation are available for download and you'll find a link in the show notes. Today, Chris will go over incorporating real estate into your financial plan. He'll talk about real estate risk tax considerations using retirement accounts and much more.

Tyler Stewart:
We've gotten to know Chris and some of you have gotten to know Chris as well through our sister company ReAllocate and ReAllocate's partnership with Mariner Wealth Advisors. As a reminder, ReAllocate is a registered investment advisor that quantifies the risk of real estate investments so that you and your advisor can match your risk profile with the underlying risk of real estate investments. If you'd like to learn more about ReAllocate and our partnership with Mariner Wealth Advisors, please head to buildmyroadmap.com, that's buildmyroadmap.com. With that, here's Chris.

Chris Bixby:
Well, thank you Tyler. So as Tyler said, my name is Chris Bixby. I'm the Senior Wealth Advisor at Mariner Wealth Advisors. My background is I've been in the industry for over 20 years. I'm a certified financial planner and also pertinent to this conversation, I'm an enrolled agent with the IRS. And that's very important just because what we do from a financial perspective is going to flow through the tax return at some point in time. And so that just backgrounds it allows me to really understand the impact of the financial decisions that we are making.

Chris Bixby:
Mariner Wealth Advisors is a company that has been around since 2006. Really focusing centrally on the client and the client's unique needs from a financial planning perspective. We bring trusts and estate services, tax services, a full range of investment products from private investments to general stocks, bonds, mutual funds to real estate, all under one platform to truly help our clients achieve their goals and their financial objectives. I just like to show this slide here very quickly not to do a big, long commercial. But just to say that so many times when you talk to people in the financial industry, they're very focused on one area of your wealth.

Chris Bixby:
And so really being able to bring the value add of services in all areas of your financial wealth allows us to truly serve the full needs of the client from a fiduciary perspective, as opposed to being focused on just what products and services we can sell. And with offices all across the country, we do have the ability of really servicing all clients and all manner of clients. But really, what we're here for today is to talk about real estate as it fits within the context of your financial plan. And I would like to really say that real estate is something that many times the investment community tends to overlook.

Chris Bixby:
And when we think about real estate, we have to understand that real estate offers inherent diversification to the stock market of equities and the bond markets when we think about debt and leverage. And so using real estate to bring into a portfolio really helps us to identify and modulate the risk. Now, before I go any further, I think it's behooves us to talk about a couple areas of real estate and some terms that you should become comfortable and familiar with because sometimes when people think real estate, they just lump it all into one bucket and they just think all real estate is the same. And it doesn't matter if it's a piece of land that we're going to build a warehouse on to an existing property that's already fully occupied and being rented out.

Chris Bixby:
Those are both real estate, yet in their context appear to be very, very different. And the returns and expectations are going to be different, the risk inherent is going to be different. And so there's four risk terms that I think we should be comfortable with. And the first is core. Core real estate typically, and there's a whole bunch of metrics and Tyler and the RealCrowd and ReAllocate people came really get further into this. And we look at this as well as we look at it from a risk perspective. But generally, a core property is going to be one, a property that is already fully occupied, and has strong cash flow.

Chris Bixby:
But this property is really being purchased as an investment in order to keep and retain the cash flows that are inherent in this property. It has very low leverage typically, it is also typically less volatile and very conservative. And frankly, it fits into the realm of being a part of the bond and very conservative portion of your portfolio. Moving up a level of risk, and therefore also a level of return is what we call core plus. Typically, again, this is fairly fully occupied property. But it needs some improvements, it needs some rehabbing, it needs something done to it that will increase the cash flow. And so there's a little bit more initial investment into that property. But higher cash flow as a result of that investment.

Chris Bixby:
Value add takes it a step further and says there's some major improvements to be made. And really, this type of property is not typically going to be held for cash flow purposes. It's really what, years ago, we talked about people flipping properties, that's kind of this value add, you go in, you do some major improvement and you turn around and you sell it pretty quickly. And really, focus is no longer on income, it's really about the capital appreciation due to a quick turnover in the real estate. And then there's opportunistic, and this is the most aggressive part of the real estate market, but also the potential versus the highest type of returns.

Chris Bixby:
It requires significant capital expenditure, it has no cash flow to begin with typically, it is highly levered, meaning a lot of debt is being used in this type of transaction. And again, a lot of times we're talking about there is dirt, and there's going to be something built on it that will later either be turned into an income-producing property or more than likely sold to someone who is looking for that income production. Okay? And so again, when we think about real estate, it's important for us to understand that real estate has very, very different risk parameters depending on the type of real estate that we have.

Chris Bixby:
And just like we do in the traditional investment market when we talk about investors and their risk appetite and what level of equities to fixed income or bonds they should have. When we talk to real estate investors, we need to pay the same type of attention to risk and say, "Well, how much risk can they afford to take? How much risk is appropriate for them to take? What type of income do they need from their portfolio and construct a real estate portfolio that fits within the parameters of those risk return and income constraints that we have talked about?" Okay?

Chris Bixby:
So that's one term that we need to be aware of is that portfolios have risk and real estate portfolios also have risk and need to be measured to be consistent with your financial situation. When we take a risk in the real estate market though, we also think about different levels and different types of risk. First of all, there's just a general market risk, right? There's the risk that the economy changes. I live up here in the Seattle area, the Seattle real estate market has been very hot for a number of years as a result of some very large employers that everybody knows about, right? The Amazon, Microsoft, Boeing for many years.

Chris Bixby:
Those companies and their commitment to this geographic area have created a geographic economy that is very strong for the market. Should those employers decide to move out and move away from Seattle, their employees go with them, it would cause devastation to the real estate market potentially, right? And so the economy as a whole and the economy geographically, interest rates, as interest rates go up and the cost of debt becomes higher, that creates drag on the income or the return that real estate portfolio can generate, inflation. As inflation goes up, our money is worth less and while that may see an increase in rents, but that is also going to be a risk that is affiliated with real estate statistically.

Chris Bixby:
Also, the asset level risk. There's an asset level risk and I've alluded to this that if I'm buying malls as an example, there's a very different level of risk involved in buying malls than there is with buying housing or buying Grade A office space. Each one of those risk depending on the type of the investment, the asset that we are investing in is going to present its own level of risk, idiosyncratic risk. Idiosyncratic risk is a funny word, but it's a word I like a lot and idiosyncratic basically means unique. It is the unique risk that is due to that particular investment.

Chris Bixby:
I've mentioned the market risks of and I mentioned Seattle, of being in Seattle, and I said Grade A office space. Not all Grade A office space in Seattle is created equal. The idiosyncratic risk of this Grade A office space in Seattle is going to be different than the idiosyncratic risk of any other Grade A office space in Seattle. And so each investment itself has to be looked at for the validity of its own structure. And then real estate also has liquidity risk. And this becomes very important in the terms of financial planning as people need cash flow and need money to spend for different things and that is just that real estate as a general rule can be less liquid than say stocks, bonds, or cash.

Chris Bixby:
Why? Well, that's because there is a readily tradable market for bonds, stocks and cash. And as a general rule, you can get your money out, I'll be at sometimes at a discount. But you have that inherent liquidity in those markets that is many times unavailable in the real estate side. So someone needing money very, very quickly and having no other sources to get their money from could create some financial challenges due to the inherent liquidity risk of real estate. Another level of risk is replacements and this one very simply is what else is available in the market?

Chris Bixby:
I buy a Grade A office space in Seattle 20 years ago, and I'm the only Grade A office space available, I have cornered the market until a bunch more towers go up and build more Grade A office space. And as more competition enters a lucrative market, then it dilutes potentially the value because there are more replacements. And then the risk that is inherent in the niche of real estate which is the structural credit or leverage risks that come around using debt that is used to finance the properties and many times the debt that has to be refinanced based on the covenants that are inherent.

Chris Bixby:
So again, there's risk in real estate and understanding the various levels of risk and the levers of risk that happen within real estate are very important when constructing any financial plan. Now, I want to get into real estate and the tax considerations, okay? And as we talk about real estate and the tax considerations, many times with real estate, we're going to see low tax in the early years. And that's because much of the income is going to be offset by depreciation. And that offset of depreciation is going to say it's not a non cash expense, it's the value of our investment that we're writing off over time and that's going up against the income that we're receiving.

Chris Bixby:
And so we may be receiving one level of cash flow, but reporting it from a taxable perspective as a different than lower number. So that offset of depreciation can be very valuable from a tax planning mechanism. There is a problem though, and that is that there is net income and if that net income comes to you, it is taxable as ordinary income. Unlike dividends from stocks and stock portfolios which can be seen as qualified dividends, meaning they are taxed at capital gains tax rate, dividends that come from real estate investment trusts or profits that are distributing from a syndicate or a limited liability company or partnership, all of that income is always going to be taxed as ordinary income.

Chris Bixby:
Meaning, your highest tax rate. Now, I just mentioned the terms REIT and LLC and I'm sure that all of you are somewhat familiar with those terms. Just to recap though very quickly, a REIT trades more like a security, it's a corporation that you buy the stock, okay? And because you're buying the stock, any income that's going to come to you is actually going to still be ordinary income even though it comes in the form of dividends, because it comes from the income of the REIT which again, over 90% of the income has to be distributed to the shareholders, it is ordinary income.

Chris Bixby:
Should the REIT experience a loss, that loss is not going to be a deductible loss from you. However, you are going to get that loss as a return of capital. Okay? And a return of capital just means the company is saying, "Hey, you're giving back part of your original investment and so it nets out to a tax zero for you. But essentially, you're not going to get the full benefit of the loss." An LLC on the other hand, as a partnership typically, is going to have much more tax flexibility. You're going to be able to many times in certain conditions, depending on the tax client and their tax status and their involvement in the real estate, but they're going to have some ability to deduct the losses or at least deduct the losses against other income within their portfolio.

Chris Bixby:
So there is more tax flexibility with an LLC. However, when you are invested in some syndicate partnership, you're going to end up getting not a typical 1099 tax form which is very easy to deal with on your tax return, you're going to get a form called a K-1 which is a partnership distribution form. And that form is much more complex, your tax preparer is typically going to charge you significantly more to prepare that, you are now responsible for tracking some of your own internal basis of the K-1. And so it's a little more complicated from a tax perspective even though it has more tax flexibility and one more consideration of that K-1 is if you have property in a particular state, and that state charges an income tax.

Chris Bixby:
If you receive a K-1, you're going to be required to file income taxes in the states in which the properties are located. That is not true typically have a REIT. And I say typically, there are some states that have changed some rules regarding REITs that are talking about changing rules regarding REIT. And they may charge a tax at the root level, but those will not flow through to the individual investor as a general rule. So again, when we talk about tax perspective, any income received from a REIT or an LLC through a K-1, you're going to end up claiming that as ordinary taxable income.

Chris Bixby:
Now, what happens at the time of sale? Well, at the time of sale, we have a fairly complicated maneuver to deal with and that's specifically with the LLC. And that is that we have two levels of gain. And let me just give an example here. Let's just say that we made an investment for a half a million dollars into a real estate project. And I'm not going to say whether you bought it personally, it's through a syndicate, doesn't really matter, we're just going to ignore that and say that you invested a half of a million dollars and you kept that investment for a 10-year-period.

Chris Bixby:
Along the line, depreciation has been taken against this property, reducing the value from a half million dollars to roughly $250,000. And that is your return of capital in the form of tax deductions offsetting the income. Now you go to sell that property and that property goes back from being worth a half million dollars, it's increased in value and we'll just say again, I'm just throwing out numbers here, we'll just say it went up to $650,000. So, it's very much underperformed it appears. So over that period of time.

Chris Bixby:
You now have two different levels of gain. The first level of gain is from the basis which was 500,000, but because of depreciation has been lowered to $250,000, that gain from 250,000 to $500,000 is going to be considered recapture gain. And under the IRS rules, that recapture gain is going to be taxed as ordinary income, which if you think about it kind of makes sense. That depreciation expense every year was reducing your ordinary income. And so this is going to be added back to ordinary income.

Chris Bixby:
So you will be taxed $250,000 as recapture income at the maximum capital gains of … The maximum ordinary income rates that you pay up to a maximum of 25% statutorily. So that just means a lot of ordinary income for most people in the year that they sell a piece of real estate. Now, the gain from $500,000 of your original investment up to the $650,000 sale price, that $150,000 of gain will be considered capital gains in nature. So I've seen this mistake done many times where someone goes ahead and, "Hey, I just sold the property, and all of the gain from the property is going to be considered capital gains." And the IRS comes back and knocking and saying, "Hey no, you have some recapture gain that you still have to pay taxes on."

Chris Bixby:
So real estate tax considerations say that at the time of sale, you're going to have to be very careful. You're going to have some multiple tax calculations to make and some higher gains than just the capital gains tax rate. Now, one thing to say, and I've seen people try to do this particularly on individual real estate that they own is they'll buy a piece of real estate and say, "I don't want that recapture tax, therefore, I will not depreciate the property. The mortgage interest is offsetting most of my income, so I just won't take the depreciation to create the losses."

Chris Bixby:
The IRS has a rule that says all expenses and deduction allowed or allowable must be taken. And depreciation is an expense allowed or allowable and must be taken every single year in which the property is a rental property. So don't believe that just by getting rid of by not claiming the depreciation that you get out of the tax, the IRS says, "Nope, you took depreciation, whether you took it or not, you will pay the recapture tax." Now, when we sell the property, is there anything that we can do about that? And the answer is, "Yeah, we could defer the taxes." And there's a few different ways of doing it, but basically, we'll talk about two primary ones here, and the primary one is what's called a 1031 exchange, okay? And this exchange basically says that I'm going to take the proceeds from the sale and I'm going to make sure that I reinvest it in real estate.

Chris Bixby:
So typically speaking, this is not going to happen from a big syndicate investment. Sometimes it'll happen through a REIT, into what's called an UPREIT, but typically we're talking about someone who owns a house that's a rental, a building that's a rental who owns individually or with a small group of people a piece of property and has sold this investment and wants to reinvest in real estate. Okay? Now again, mistakes that we see happen is people just say, "I sold this piece of real estate, I took the cash, and then I went out and bought a new piece of real estate and therefore, that's the 1031 exchange and it's not taxable." And that is unfortunately, incorrect.

Chris Bixby:
In order to qualify as an exchange, you must use what's called a Qualified Intermediary. Meaning, you have to go through some hoops, the money does not come to you at the time of sale, the money goes and is deposited with the Qualified Intermediary. There are some deadlines as far as dates when you have to identify replacement property, when you have to close on replacement property, and the funds then disbursed from the Qualified Intermediary into the new property. So just watch out for that, we can defer the taxes on that property that we sold as long as we properly use a Qualified Intermediary and reinvest the proceeds.

Chris Bixby:
Now, some people ask me from time to time, "Chris, do I have to reinvest all of it?" And the answer is no, you could just reinvest 50% of it and then 50% of your gains will be excluded and deferred until the sale of the second property. And again, remember, this does not typically work with LLCs with large syndicate type of investment properties and it doesn't work typically with most REITs, so this is more for individual type of holdings. Another option though which is a little more available, it does not require as Qualified Intermediary, has a little bit more time around it is something called an Opportunity Zone.

Chris Bixby:
Now, what are the benefits of an opportunity zone and I have a graphic up here. And basically, the first thing is you defer your taxes, and you defer your taxes typically for a period of five years. Meaning that any gain that would have been affiliated with that investment is now going to be paid in five years allowing you to manage and plan for your taxes further. Now, note that this does not allow me at the end of five years to roll it into something else. Okay, it just differs it for that one period of five years. Then if I hold it for the entire period to get the deferral, then at that point, I'm also going to get what's called a step up in basis, meaning that my investment amount will be "increased" meaning, I'll pay less taxes on the gain of the new opportunity zone investment.

Chris Bixby:
And if I hold it for 10 years, then we will eliminate the capital gains on the new property's investment. Again, the old property, the money which we rolled into the opportunity zone, that gain will be taxable in five years, it's the gain on the new property. So when we look at an opportunity zone, we're looking at a long-term hold. We also want to make sure that the investor, that the management company is qualified and knows what they're doing because opportunity zones have some very specific investment metrics and timelines that have to be met in order to qualify as an opportunity zone. And if they don't qualify as an opportunity zone and miss their metrics, then unfortunately, that gain becomes taxable immediately.

Chris Bixby:
Now, one of the reasons I mentioned opportunity zones is because opportunity zones create a wonderful opportunity for certain types of people. And that opportunity is for people who already own syndicate type partnerships. And I have one sold and maybe have two or three sold in one year creating an excessive tax burden, then they can take some of the proceeds and invest in an opportunity zone instead and minimize or reduce the amount of taxes that they're going to pay on money that was already going to be reinvested in real estate. The second opportunity though comes from people who may not be in real estate at the moment.

Chris Bixby:
And up here in Seattle with a lot of clients who are tech workers, a lot of Microsoft and Amazon and a lot of Facebook and Google, all of those people up here have a lot of stock, they were granted stock many years ago for some of them or that stock has appreciated rapidly in value. And they're at a point where they're trying to diversify too much of their wealth is concentrated. And if you recall back to that first chart and we talked about risks, concentration of risk in any one area of real estate increases your risk, concentration of risk in one stock of a company increases your risk.

Chris Bixby:
And so we like to diversify, to spread out that risk over various investment categories, various investment real estate projects, as well as various investment stocks and bonds. So what we do with these people is we work on a program of reducing their risk over time. We don't want to just sell everything and incur a huge amount of capital gains in one year, especially if it's already a good company. And so typically, we'll set some program where we're going to sell stock over the next four or five years. And we're going to tear these things in so we'll sell approximately, maybe we'll just say 20% every year so that we're still going to be left with about a 20% concentration in the stock at the end.

Chris Bixby:
And then at the fifth year, we will go ahead and end up with the gain from the opportunity zone. So what we did is we sold two years worth of stock in year one, invested half of it in the opportunity zone, getting a real estate diversification for it. And that way, paying tax on only half of the gain this year, increasing taxes throughout the year and then in the fifth year, that final tax that was deferred, meaning, we spread out the benefit of the taxes over five year periods, but we received an upfront slug of money that allows us to further diversify their portfolio and invest in real estate.

Chris Bixby:
So again, when we take a look at the opportunity zones, they're not for everybody, but they are for the particular and specific investor to be able to invest appropriately that real estate investment may actually be very beneficial by using it through an opportunity zone rather than through a traditional investment. So again, as we get the sales, then it gives us several options as far as deferring those taxes. Now, what about real estate and funding sources? Okay. Now, as a general rule, non-IRA funds are going to be used for investment in real estate.

Chris Bixby:
A good part of it is that when you get cash, you can just take and spend the cash. So it's easy from a distribution of cash flow's perspective because you don't have to worry about the cash, but it's also potentially tax inefficient. Remember, I mentioned before that any distributions from real estate as a general rule are going to be ordinary income because they're coming from the rent. And so that ordinary income treatment may be tax efficient, inefficient excuse me, unless you need to spend the money. So for someone building wealth that just wants to reinvest the money, doesn't want to pay taxes on it now, a non-IRA investment in real estate may not be very tax efficient.

Chris Bixby:
So we like to look at IRA as being the way of investing the money, some when we are in that accumulation mode. And one benefit of using IRAs is of course, it's the bulk of many people's assets. A lot of people have invested money in IRAs over the years, 401(k)s rolled it over and things like that. And so it's the bulk of their investable wealth, and they would like to buy real estate. And the benefit is that that cash flow is tax deferred. And so that's really good from a reduction of taxes on an ongoing basis.

Chris Bixby:
Here's the problem. When we use IRAs, we have something called Unintentional Business Taxable Income, UBTI. This comes into a fairly complex topic of tax law. And I'm not going to be able to do this justice. I've actually taught for CPAs and attorneys a one and a half hour session on this topic and here, I'm going to spend about four minutes on this topic. It comes into because of a confluence of tax laws. And basically, it comes down to a real estate is not considered an investment under tax law, it is considered a trade or a business. And trades or businesses are seen a little bit differently. And while you are allowed to invest in it, it is a trade or a business, it's not a direct investment under tax law.

Chris Bixby:
Now, that's good for certain tax purposes. But for IRAs, it's bad because most of those real estate companies and businesses borrow money to fund operation. They use leverage to increase their performance, but I already have a rule that says they're not allowed to borrow money. So our IRAs cannot borrow money. So what happens? Well, because it's a real estate trader business that has borrowed money as a general rule, and IRAs cannot use leverage, then the proportion of the debt to the total investment is now taxable income even though the money is inside an IRA.

Chris Bixby:
Now, that's a very complex statement. So let me give an example. Mark purchased a real estate valued at a half a million dollars. In order to fund the purchase, he uses $200,000, that's his cash out, but debt financing was used. Now, by the way, Mark could do this individually by setting up a self-directed IRA, and I'm going to discuss self directed IRAs here in a little bit if he finds a bank that will lend him the money through a self-directed IRA, he could do that.

Chris Bixby:
If he put $200,000 in the syndicate, and they had used the leverage, so that his proportional unit value was a half million dollars $300,000 through debt, we're at the same equation here. He has 40% is his money, but 60% is the bank's money. So at the end of the year, if the property has net income after depreciation, so it's reducing the income and the net income is $20,000, then now 60% of his income even though it's inside of his IRA is considered Unintentional Business Taxable Income, UBTI and that number is $12,000, he has to claim $12,000 of income from his IRA and go ahead and pay the tax on it.

Chris Bixby:
Now, this is not a distribution from the IRA. So it's not subject to penalty, but it is going to be considered ordinary and taxable income even though it was inside of his IRA. Bad news? He didn't actually receive any cash. The cash has to stay inside of the IRA. If he pulls out the money from the IRA to pay the tax, that distribution is considered a distribution from the IRA. It is also taxable income and if they're under the age of 59 and a half, it's going to be subject to a 10% penalty. So while we do like to go ahead and invest real estate within an IRA, we have to be very careful that we actually ended up with that, we might end up with UBTI, that we fully understand how much leverage is inherent in the property that we are investing, and what type of income it might be getting.

Chris Bixby:
Now, we can avoid this by using REITs. So if you're looking at doing with dealing with a higher level of higher risk types of investment that's going to have more leverage, and therefore UBTI is more prevalent, then using a REIT might be more acceptable. If you're going to be using some sort of core type of income product where it's really low leverage, high income, then UBTI may not be that much of an issue for you and using a syndicate inside of an IRA is still fully acceptable. So I'm not going to say that there's one right or wrong way it's going to depend on the facts and the circumstances, but what we need to be aware of is UBTI is very important consideration when putting money inside, of putting real estate inside of an IRA.

Chris Bixby:
And I said I would talk about self-directed IRAs. And by the way, when I use the term IRAs, I'm talking about traditional IRAs, I'm talking about Roth IRA. Simple IRAs, SEP IRAs, it doesn't matter if it's an IRA, debt is not allowed. You cannot leverage your IRA. You cannot use the IRA as collateral for a loan, it is a disallowed activity. If it is done, your IRA ceases to be an IRA and the income is fully taxable immediately. Okay? Self-directed IRAs have their own inherent dangers. Now, what is a self-directed IRA?

Chris Bixby:
Well, a traditional IRA and traditional I just mean in the way that it is an IRA or a Roth IRA. If I am investing money directly with a sponsor that allows IRA, by the way, some sponsors don't allow IRA investments because they don't want to keep track of and record potential UBTI. That's a traditional IRA investment. A self-directed IRA says, "I am going to set up my own "company" that's going to be bought using … that's going to be funded using the proceeds of my own IRA. And I am going to use that IRA to purchase an individual piece of property, a house, an office building, something like that."

Chris Bixby:
A couple other rules that are dangers that we see, the first rule is the property may not be used by a related party. We see this, unfortunately an awful lot. And that is that someone says, "Oh, I'm just going to use the proceeds of my IRA, make it a self-directed IRA and buy my own house and live in it." You can't do that. "Oh, well, I'll just pay myself rent." You can't do that. "Oh, well, I'll put my business in it." You can't do that. You're a related party. "I'll put my kids in it." You can't do that. They're a related party.

Chris Bixby:
So we have to be very careful that we don't use that, that it's used as an arm's length transaction as a full investment, not to a related party. The other portion we see is distributed income is taxable and potentially penalized. We see people who go ahead and set up a self-directed IRA, invest in a piece of real estate, collect the rent and rather than accumulating the rent inside of that self-directed IRA, take the money to spend it. It's okay to do, except that is a distribution from the IRA. It is taxable. And if you're under the age of 59 and a half, it is potentially penalized as well.

Chris Bixby:
So that's another danger is you've got to be careful about the distributed income from that self-directed IRA. Fourth danger is that improvements and repairs are subject to the annual contribution limit. Let me just give an example. Again, I have a half million dollars that I put inside of a self directed IRA to avoid UBTI. I invest the full $500,000 into a piece of property. There's no cash left inside of the IRA. I am collecting rent, and I collect a year's worth of rent and I'll just say that after expenses and all, there's $10,000 sitting inside of a checking account that is owned by the self-directed IRA. And the roof blows off, and it costs me $20,000.

Chris Bixby:
What am I going to do? Well, I'm going to use the 10,000 that I've accumulated. But now, I personally have to pay for the $10,000 remaining. My contribution limit for the year is we'll just say only $6,000. That first portion is considered a contribution to my IRA, that is part of the annual contribution limit, but the remaining $4,000 that is an excess contribution, it is subject to penalties, and withdrawals, there's a lot of things that go on, and all of a sudden, that's going to cost you more money.

Chris Bixby:
Now, someone might ask the question, "Well, can my spouse contribute in their IRA?" And the answer is not really, because they don't own the self-directed IRA. There are situations where two spouses could individually set up self-directed IRAs and invest, that gets a little more complicated, it is doable, but in this case, it's not direct unless the spouse was owning the self-directed IRA. And then finally, is required minimum distributions.

Chris Bixby:
Once you reach the age of 72 under current law, you are required to take annual distributions based on an age-based factor table. If you own a piece of real estate, and any cash that's self-directed that's available there, it is all accumulated, you put the factor together, and you have a required minimum distribution that has to come out. If all of it is real estate, and there's not enough cash to cover it, then we have a problem because first of all, we're going to be required essentially to do a valuation every year to see what is the property worth so that the IRS is happy with what is the value of the property.

Chris Bixby:
Now, I'm not saying it has to be an extensive valuation, but we have to have some basis for knowing what the property was worth on December 31st of every year, some level of valuation is required. But if we have no cash for the distribution, then we're going to be forced to do something very, very difficult which is split up the ownership out of the self-directed IRA, we're going to require tax work and legal work in order to do it or we're going to be required to borrow money in order to pay for the distribution which of course, brings back the specter of UBTI. So I'm not saying that self-directed IRAs are bad or wrong, they are available under tax law. But very specifically, we have to know the dangers of investing in them and making sure that we're doing these the right way.

Chris Bixby:
By the way, I realized I didn't say one thing about the related party rule and that is that if you already own the real estate, your IRA cannot purchase it from you. Okay? You are a related party to your IRA, therefore, you can't sell yourself the property. And so again, if it's not existing property, it has to be a brand new property, brand new investment for that to work. So again, I have a bunch of disclosures here that will be part of the forms that you get, but basically, hopefully what we got today was an overview of what are the types of things that we begin to think about.

Chris Bixby:
Each one of these topics we could go further into the weeds about and they are going to vary depending on your unique financial status, and your unique situation. And so hopefully, at least the day starts to make you conversant and to start to think, "With the real estate that I already have, or the real estate that I'm wanting to get involved in. What is the level of risk? How does that risk fit in with my personal tolerance, my existing other investments and my income and cash flow need not only today, but at some point in the future?

Chris Bixby:
As I decide to make that investment, what type of in real estate should I buy? From a risk perspective? Yes, but also, is it a REIT better? Is it some sort of a syndicate deal? Is it a unique piece of property that I fully owned? And where should I get the funds from? Does this make sense to be inside of my IRA. Does this make sense to be part of my taxable portfolio? Where within my construct does this make the most sense?"

Chris Bixby:
And with that, Tyler, I'm going to say that's a good recap there and I'm going to go ahead and change the presenter, and send this back to you since I think I've taken my allotted time here today. So Tyler, back to you.

Tyler Stewart:
Thank you Chris. That was great stuff. I'm going to take back control here. Okay, one question I did have as you're going through all this material, what are some next steps we can take to learn more about real estate risk and tax considerations, the use of retirement accounts, what can listeners do here in the next week or two to start to move in some of these areas?

Chris Bixby:
Absolutely. And Tyler, that's a wonderful idea and concept because when we think about all of these topics, really, we hit on several different things. We hit on the … It all comes down to one thing which is real estate, but it brings in multidisciplinary type of activity. So when we think about the real estate side, we need to look at the real estate, one from just the actual real estate project itself. And that's where RealCrowd, ReAllocate can really help to have a good partnership with someone who understands the real estate market from a day in and day out basis who can help you to analyze the inherent risk in the value of a particular project.

Chris Bixby:
And so understanding that type of real estate risk, but then also, looking at it from your internal financial planning perspective, and having a wealth manager, a certified financial planner, someone who really understand your personal financial situation and how that interacts with your goals, your dreams, your objectives. The second part is not only having the advice from a planning and risk perspective, but it's also to have a tax professional. You notice that a lot of what I talked about today had to do with taxes and let me just say not all tax preparers are created equal.

Chris Bixby:
Not everybody understands fully the impacts of real estate investment, especially if we're going to get into UBTI issues and basis issues and things like that. So having a strong partnership with someone who understands real estate, who works with clients, who invest in real estate or a wealth manager who has a strong tax background and can help you to navigate how those taxes impact you personally. And certainly, if we're talking about retirement funds, you have to work with a plan sponsor, someone, even if it's a self directed IRA, you still have to have a sponsor to help you just with the legality of it, the types of investment.

Chris Bixby:
So it could be one of the major brokerage companies, somebody like that. But again, someone who can help you to place the investment to make sure as much as possible that we don't run afoul of any issues that the IRS would say, "Hey, this is no longer an IRA, that income was fully taxable two years ago when you mistakenly made that investment." And so again, it's a multidisciplinary approach that you're going to have several different parties at the table, or one party who has the full resources of a firm like Mariner who does have the tax expertise on board, who has the sponsors on board, who works with the ReAllocate and the RealCrowd groups and has real estate understanding and able to do those types of investments. But that's really the team you have to think around you. Do I have the expertise in real estate, the expertise in financial planning, the expertise in taxation, and then the plan sponsor that's going to allow me to fulfill these investments?

Tyler Stewart:
Great. Thanks Chris. And for our listeners out there. If you do have any questions, remember, there is the question box. Go ahead and enter your questions in there, and we'll get to those questions. But before I do, we did promise a special link at the end of the presentation. If you'd like to have Chris and the team at Mariner Wealth Advisors review your portfolio and give a second opinion on your portfolio, you can head to reallocate.com/get-invite, that's get-invite and we'll help you connect with Chris and the team over at Mariner. And then with that, we'll get to questions.

Tyler Stewart:
So Chris, we had a few questions come through. The first question, you touched on it in one of your earlier slides. You mentioned risk appetite, what are ways I can figure out my own risk appetite?

Chris Bixby:
That's a very good topic to spend some time on with a wealth advisor. And I say that because unfortunately, the industry has gotten into a habit of just saying, "Hey, here's a bunch of questions. Do you like to skydive? And how long before you need your money? And on a scale of one to five, how do you feel about your investments?" And that gives you a risk appetite. There's some validity to that. But unfortunately, it's also very much dependent on what's happening in the news and how you feel at that moment. It's very changeable due to facts and circumstances and feeling.

Chris Bixby:
Typically, as we take a look at it at Mariner, we're not as concerned about that risk score, sometimes we'll use that. What we're really looking for is how does this risk affect your ability to achieve your financial goals and objectives? And we're going to use different metrics. Metrics around income when you need it, and how you need it. We're going to look at metrics around the volatility of the portfolio and the downside risk exposure. What happens if this hot investment that was all of a sudden returning 20% every year, all of a sudden blow up? And all of a sudden, you can't get cash out of it? And it takes five or 10 years for it to recover?

Chris Bixby:
What does that do to your financial situation? So while a test of just your overall risk appetite might be beneficial as a starter, really in my mind, we have to build it into your financial situation and say, "What is the worst case scenario? What is the downside exposure?" Number one, "Can we risk that money? Can we take that downside exposure at the worst case scenario?" And then two, "Does this help us achieve our goals and objectives?" We see this sometimes it means asking people to take more risk where they're so afraid of taking risks that they want to invest in core real estate only, and they're in their 30's. And they need to accumulate assets, and they're not saving enough money.

Chris Bixby:
And there's nothing wrong with core real estate, but at the same time, they have the time horizon to see higher returns if they invest more aggressively, and to achieve their goals and objectives by investing more aggressively. We'll see sometimes older clients who say, "I just want to invest in CDs at the bank." And they're losing money every year due to the effects of taxes and inflation, and they're not keeping up and they're not going to run out of money, some measured extra risk is actually going to help them be more likely to achieve their goals and objectives. And so, there's not necessarily a definitive way. But take a look at the downside risk exposure and say, "If my portfolio lost 5%, 10%, 20%, how would I want to feel? And two, what would it do to me financially?" And that will start the set kind of the risk appetite conversation.

Tyler Stewart:
Very good. And we got a question on depreciation and carryover loss. The question is, "If I cannot take advantage of depreciation and have to carry over the loss, what will happen to the loss carry over at the recapture time?"

Chris Bixby:
Yeah, okay. So great concept. So any of the losses that have not been able to be taken or offset against other sources of passive income, real estate is considered passive income, even though it's an active trader business. No one said the IRS ever made sense in that regard, but if I have accumulated losses due to my real estate activity that have not been able to claim at the time of sale, as we figure out the game, the first thing that we do is to the basis of the game, we add back any unclaimed losses.

Chris Bixby:
So essentially, what that is going to do is it's going to reduce the recapture amount which again, makes sense. Those losses would have been ordinary income deduction, so it gets back added on top, reducing the amount of recapture so we will get full benefit of those losses at some point, if not in the current year, at the time of the sale.

Tyler Stewart:
Great. And then we have a couple questions on self-directed IRAs. "Can you use your funds and a non-self directed IRA to pay for improvements for a property held in a self-directed IRA?"

Chris Bixby:
Yeah, so let me just make sure I'm answering this clearly and understanding it. So let me just say you have a self-directed IRA that owns a piece of real estate. The self-directed IRA does not have cash in it. You have a separate IRA, just a traditional invested IRA that does have cash. At this point, the self-directed IRA roof blows off, we need cash, can we take money out of our IRA to pay for the roof? The answer is sort of, okay?

Chris Bixby:
Technically yes, and the end result, the answer is going to be yes. But we actually have to take one step. And that is we need to roll the money from the regular IRA into the self-directed IRA as a direct rollover. And you actually have the 60-day rollover window which means you take cash out of your IRA, as long as within 60 days you put it back inside of the IRA, then you're going to be fine with that. If you don't do it, that way, you're going to end up with unintended tax consequences. And that is that it's going to be considered a distribution from one IRA, meaning, it's taxable income.

Chris Bixby:
So you just have to take it from the regular IRA type of invested IRA into the self-directed IRA to pay the cash. Now that assumes that we are both having regular traditional IRAs and not Roth IRA. If we are going from one traditional to a Roth, we added a whole nother level of conversion and things like that. So we have to be careful. So it can't go from a Roth to a traditional, to a self-directed IRA, but yes, from a traditional invested IRA, being rolled into a self-directed IRA, that can be done.

Tyler Stewart:
Awesome. And we're coming up on the end of our time here. I'll do one more question. And then I did see a question come through. Some listeners wanted to see that link to ReAllocate again. So I'll share that link again, but we'll get through this question first. "Is there an issue with UBTI if you're investing into a deal that does not use leverage?"

Chris Bixby:
No, and that's the whole point, right? It is leverage that causes UBTI. There are a couple other things that could end up being UBTI, but that's very much beyond the scope, and typically not involved in any type of real estate investment. But no, it is leverage that causes UBTI 99% of the time. So let's just say for practical purposes, no.

Tyler Stewart:
Great, thank you Chris. And then here's the link again if you'd like to have Chris and the team at Mariner Wealth Advisors help to give you a second opinion on your portfolio, head to reallocate.com/get-invite, that's get-invite, and we'll help you connect with the team at Mariner. Chris, thank you so much for joining us today.

Chris Bixby:
Thank you. It was my pleasure.

Tyler Stewart:
Awesome, and listeners. Thank you for joining as well. I'll leave this link up here for another few moments and have a great rest of your day.

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