Tax-Free Real Estate Investments

I'm going to summarize the book The Insider's Guide to Tax-Free Real Estate Investments by Diane Kennedy and Dolf De Roos by section.

Section 1

Basically this is the introduction to why the current retirement plans won't exactly make you rich easily. We all (should) know there are the the basic retirement plans such as 401(k), IRA, and Roth IRA. This books describes these plans and some new plans that have a tax advantage that go along with them. It also mentions the Alternative Minimum Tax (AMT), which is a tax between 26% and 28% of your adjusted gross income. To help avoid this tax, this book introduces the Solo 401(k) and the Solo Roth 401(k) retirement plans.

Section 2

This section talks about the different kinds of income including Earned Income, Portfolio Income, and Passive Income. The book mentions "The Jump Start Program" which consists of the following steps:

1. Create a business, and maximize your business income with tax loopholes.
2. Maximize your tax-free benefits with tax loopholes by discovering your hidden business deductions.
3. Once you have minimized your taxes from your business, pay your taxes.
4. Invest in real estate, and maximize your real estate investments with real estate loopholes.
5. Maximize your cash flow with real estate loopholes.
6. Buy a house, and maximize your home investments with home loopholes.
7. Get money out of your house! Maximize your cash flow with home loopholes.

Something else worth noting here is the two-out-of-five-year rule which says once you have lived in your home for at least two years out of the preceding five years, you can sell the property and take the first $250,000 in gain tax free (or $500,000, if you're a married couple filing a joint tax return).

Two Ways that Tax-Deferred Plans Can Get You

1. If your tax bracket is low now but will be higher later, you've traded a low tax for a high tax.
2. If the income you're deferring is considered long term capital gains (from the sale of assets held over 1 year), you've traded capital gains income tax (maximum of 15%) for ordinary income (maximum 35% tax rate).

This section of the book describes the differences between several different plans, the most important of which were listed earlier in my summary(Solo 401(k) and the Solo Roth 401(k)). I also wanted just to mention the Education (Coverdell) IRA where you can contribute a maximum of $2,000 per year for each beneficiary.
There are three basic rules for the two pension plans which I mentioned above (Solo 401(k) and the Solo Roth 401(k)):

1. You and your spouse are the only full time employees allowed.
2. You have to draw a salary from the business.
3. You have to contribute the right kind of income.

For these types of plans you must receive income through either a Sole Proprietorship or a (S or C) Corporation. The book describes in more details the above mentioned pension plans and then lets the reader know why they beat the other plans. The Solo Roth 401(k) has no income limitation, you can put away a significant amount into a Roth fund (for 2006 $15,000 per year or $20,000 if you're over 50), you can use your tax free Roth funds to invest in things you couldn't before like S Corporation stock or life insurance policies, you can borrow up to $50,000 or 50% of your plan's value, there is no mandatory distribution requirement for your Solo Roth 401(k).

Section 3

This section describes things you can and can't do/invest in with your Solo Roth 401(k).

You must find a custodian to hold your pension assets and administer your pension funds so that you stay within compliance with the IRS. These are the questions you should ask and the answers you should get:

• Will the custodian allow you to invest in real estate and businesses? Yes.
• Is your proposed custodian government regulated? Yes.
• How much malpractice insurance does your proposed custodian have? Enough. This is important because the IRS is very unforgiving.
• Who are your proposed custodian's auditors? What does their last audited financial statement show? Ask for a copy and make sure that the auditors did not include any comments of concern.
• Does your proposed custodian offer ongoing client education? Yes.
• Ask about standard operating procedures and time requirements for new account setup, transfers, purchases, sales, funding, distributions, IRS reporting, statement productions, and phone contacts.
• How much are your proposed custodian's fees? Preferably a flat fee.

Avoid Prohibited Transactions

• The sale, exchange, or lease of any property between a plan and a disqualified person.
• The furnishing of goods, services, or facilities between a plan and a disqualified person.
• Using any portion of your pension fund as security for a loan of a disqualified person.
• Use of income or assets of a plan by a disqualified person for his or her own profit.

Disqualified Persons

Direct line relatives (parents, grandparents, or children) are disqualified persons.

Prohibited Investments

• Collectibles such as art, rugs, antiques, metal, gems, stamps, coins, alcoholic beverages, or other tangible personal property
• Life Insurance

Section 4

The problem with being self directed is that you must have a plan administrator to purchase and sell your investments and since they are not available 24/7/365, this may slow down your response time to some investments. There is, however, a way around this by using a IRA or Tax-Free LLC. This method allows you to use your pension plan in conjunction with your LLC. The LLC is important because it limits your liability to that which has been invested into it and it also allows you to personally manage your funds faster. The LLC usually should be set up in the state in which the investment such as property is. It is very important how you set up the LLC, because otherwise you could suffer a hefty fine or two. I won't go into it, but the most important thing is to set up the Tax-Free LLC where you are the only manager (no salary) and your pension plan is the only member. The LLC is then funded by your pension plan and you can act as the manager to direct the funds into the investments we discussed above. But be very careful when signing checks to make sure you sign it as the manager of the LLC and not with your personal signature! It is also still very important to let your plan administrator know what you're doing. You will be held responsible for making prohibited investments, not your plan administrator. Many more important details for this section need to be read in the actual book as it would take too long to summarize them here.

Section 5

This section is about leveraging the money you have in your pension fund or LLC. Essentially it says that if you don't have enough money to buy a property (investment) out right, then a bank can loan you a money. Typically they want you to put at least 30% down and they will loan you 70%. This is called a 70% non recourse loan. One downside of leverage in an IRA LLC is that you are subject to a Unrelated Debt Financing Income Tax(UDFI) and Unrelated Business Income Tax(UBIT) tax on the percentage of the profit made from the portion of the investment funds that was loaned to you.

Section 6-7

The rest of these short sections discuss what type of investment is a good investment, what types of property to buy, etc. I won't go into this details, because it doesn't exactly relate to why I read this book.

All in all, this book was very informative and up-to-date, which is more than I can say for a lot of books I read. This field is constantly changing which makes it hard to keep up with all the information. Hopefully now you'll know enough to at least ask pertinent questions to accountants, plan administrators, etc. Read the rest of the book and leave a comment if you like.