Opening a Self-Directed IRA And Understanding Prohibited Transactions

Welcome everyone to the Directed IRA webinar and a special Directed IRA podcast episode. This is Matt Sorensen. I'll be your tour guide today. I'm an attorney, CEO at Directed IRA, and I'm joined by the great and fabulous Lindsey Marcino. Let's show her on camera there. All right, there we go. Look at that, so cinematic. And Lindsey's going to be helping with some questions. She's been in the space for 10+ years? 13.

13?

Wow. So, but She's a pro, super knowledgeable. So between the two of us, we're going to try and get through a lot of content, but also your questions. So if you have questions, we like to say use the chat and Q&A, but nobody follows rules. So we'll be checking both. Please keep in mind though, that this webinar will be recorded. So if you've missed any piece of this, you got something else going on, or you want to rewatch this and relive the great moments, the hits, it's going to be recorded and posted to directedira.com/webinars. All right, well, let's jump into this. Now I want to level set for everybody that before we dig into prohibited transactions, to make sure you understand what a self-directed IRA is. This is your IRA account. This could be traditional IRA, Roth IRA, even a health savings account, solo 401(k). There's lots of different account types. This is an IRA that can own real estate, crypto, a private company, a small business, a note. You can lend people money, okay? Your IRA can own a stock or a mutual fund, which is what you're doing with your broker-dealer IRA. But a self-directed IRA can own these private, sometimes called alternative assets. So once you start getting into that and you do that with an amazing company like Directed IRA, and there's, you know, maybe 20 other companies that do this, you just need to know the number one company, Directed IRA. And, but when you're doing this, the number one thing you need to know is something called the prohibited transaction rules. And that's our focus for today's webinar is making you a master of the prohibited transaction rules. So you don't screw up your account. Okay? Because if you mess this up, it can cause problems with your account. The nice thing is it's not that complicated. And most of you don't really actually need to worry about this, but some of you do. Some of you like to get creative and structure things and some deals that might come across where this is a rule you need to know. Now, I always tell people, learning the prohibited transaction rules is not rocket science. It's more like learning a board game. You just need to know the rules. And then once you learn the rules, it's the same thing over and over and over again. So don't feel like you need to, like, you know, master this to a complex level. Just know about what you do and understand the rules are going to apply in your situation, the types of things that you're investing in. Okay. Now we do have a slide deck too. I think we'll share that here, or at least it'll be posted on the webinar page at DirectArea.com/webinar once the recording goes up. This is helpful because we do have a lot of detailed information on these slides, uh, and I've wrote a book on this. We have tons of resources on our website as well, uh, so we just want to make sure you have enough educational resources if you want to dive deeper on this. Also, if you've got like that CPA or the lawyer or financial advisor that's like, we want to do what with your IRA? And you want to give them some ammo with like some tax code citations and cases, we have that here for you too. So So, and for any of you CPAs or attorneys on here, you know, we gave those for you guys as well. Okay, enough commentary. Anything we else need to say on Q&A or questions, Lindsay, if they're joining in?

Yeah, drop it in the chat, guys. We have Michelle who's joining us live as well. So Michelle will drop her calendar link in the chat just in case you guys want to set up a call with her, pick her brain one-on-one. It's completely free to book a call with us. So do so. And if you do decide to open up an account, we've also got an awesome promo this week. So ask Michelle about that. We'll also share with you guys promo code is here shortly, but make sure that you drop that in the chat. Check the chat for her link, uh, and book a call today.

Yeah. All right, well, let's dig in here. So the first thing when we're talking about the prohibited transaction rules you need to understand is this isn't about what your IRA can invest in. This is about who your account can transact with. If we think about what your IRA can invest in, there are only 3 things that are on the 'you can't invest in this' list. So let's go to the slides here. I got those on the list here. The first is collectible items. Your IRA cannot invest in a collectible. Now, this would include like an art collection or a stamp collection, coin collection, certain precious metals like American Eagle coins, like gold, silver, platinum, palladium. Those are actually excluded from this rule. So you can own like an American Eagle coin, for example, in your IRA. But otherwise, like the Krugerrand or the collectible coin, the I don't know, the, the, I don't know, pneumatic? What's the word? Numismatic? I don't know.

Yeah, something like that.

Something like that. You know, these collectible coins. I don't know. Um, I want to say the nerdy coin collector thing. I don't know what that is, but there's value in that. People collect them. My grandpa did it. You can't own that in your IRA. All right. Um, life insurance. I'm trying to walk it back out of that one. I pissed somebody off that collects coins. I'm sorry. Uh, life insurance. Your IRA can't own life insurance. 401(k)s actually can. IRAs can't. Nobody came here to learn about that. And then S corporation stock. So IRAs can own C corporations. When you— your IRA buys stock in a publicly traded company, that's a C corporation. Your IRA can own that. It can own a small business C corporation. Your IRA can own LLCs or limited partnerships, which is what it's doing if it invests in a small business or a private fund or doing an IRA LLC. Your IRA can own those. It's just S corporations. IRAs don't qualify as an S corporation shareholder. It's really an S corporation rule. S corporations must be owned by individuals. An IRA is not an individual, so it doesn't qualify. All right. That's it. Everything else is fair game. Your IRA can own the duplex down the street. It can invest in a private fund. It can invest in a small business in your community. It can invest in the next greatest startup that can happen out of Silicon Valley, whatever. You could private lend it to other real estate investors or other business owners. All these things are assets your IRA can own, even crypto and precious metals. Okay, those are all things that your self-directed IRA can own. All right, so since the world is your oyster and you can invest anything you want, we're really not here to teach you about what your IRA can or can't own. What you need to know is the prohibited transaction rule, which is about Who can the account transact with? So for example, if my IRA is buying a duplex down the street, who's selling the duplex to my IRA? For example, the first person that is restricted here that you couldn't transact with is yourself. So you can't sell the real estate you personally own, that duplex down the street, to your IRA. That would cause this thing called the prohibited transaction. Now, that's a quick example here. We're going to break down the rules on how that works, but it's all about who Who's the account transacting with? And that's the first level here of what is a prohibited transaction. All right, so the first thing here is you don't want to have a prohibited transaction. Prohibited transactions are bad. You end up losing your account. It gets distributed and your account's subject to penalties. So don't have a prohibited transaction because you lose your account and all the tax benefits and privileges of it. Now in today's webinar, we're going to go over 3 types of prohibited transactions. There's 3 different varieties that this could hit, and you have to actually learn each, all 3 of them, because sometimes you'll say, well, this isn't one type, but it is the other. So we're going to go over each of these. There's per se, extension of credit, and self-dealing. These are the 3 different varieties of prohibited transaction. All right, so let's go to the first type, which is a per se prohibited transaction. Now you have what is called a per se prohibited transaction when you have 3 things occur: an IRA transact with a disqualified person. Well, the whole reason to have a retirement account here is we've already got one, we have an IRA. If I'm going to make money, I've got to transact it. So it's really about, is the other person in the transaction a disqualified person? Right? I'm going to have an IRA go invest in something. If I buy real estate, it's going to have a tenant in it. If I invest in a startup, someone already owns it or is going to run it. So we're looking at who else is involved in this transaction and is there a disqualified person? So I gave the example earlier, my IRA is buying a duplex. Who's the seller of that property? It's my father. My father is a disqualified person to my IRA. Or I'm a disqualified person to my IRA personally. So that would cause a per se prohibited transaction. So the question becomes, well, who is a disqualified person under the rules? Well, here's the list. Okay. Anyone here in red is a disqualified person your IRA cannot transact with. And it starts with you. You're disqualified to your own IRA, your spouse, your kids, your parents, your son-in-law. Your daughter-in-law, for any of you in Utah, all your spouses, okay? They are all disqualified persons under the rules. Now, if you look there in green on the list in the diagram here, those are people that your IRA can transact with. These are family members that are actually not disqualified. So for example, my brother or sister. So let's say that my sister's doing a fix and flip property. She's a real estate investor. And she needs a loan for $100 grand to fund the rehab. And I'm like, I could lend my sister $100 grand on the rehab. I'll get a note. She'll pay me 12% interest and 2 points for the loan, and I'm going to put a lien on the property to make sure she pays back my IRA. That would be totally fine. Okay. My IRA is lending her money. That's a transaction, but she's not a disqualified person. So it's okay. Obviously, there could be some third-party investor. I don't have to worry about these rules if it's just some unrelated third party that I don't even know who the hell they are until we met for this deal. So, but a lot of people will say, well, family's disqualified, or you'll read online, you go on to ChatGPT and you say, who's a disqualified person in my IRA? Family members. Not really. It depends on who in the family they are. Okay. So remember anyone in green there, brothers, sisters, aunts, uncles, cousins, they're all fair game. The red ones, that means stop. Do not transact with them. I tried to do red and green. Keep it simple here. So that's who is disqualified now. Transaction can be a lot of things. So let's say, and I'm just going to give real estate examples because they're the easiest, but it could be like a company or stock. Another common one we'll get is, hey Matt, I own these shares in this company. I've got options at this company I work for, and they're pretty valuable now. They've gone up in value and they're in my name, but I want to have my Roth IRA buy them. How do I get my Roth IRA to buy them? Well, that would be a prohibited transaction. You can't do that because that would require your Roth IRA to buy them from you personally, which would be a transaction. And now you've just engaged in a prohibited transaction. That would be a per se prohibited transaction. So no matter what the asset type is, just remember any transactions, buying or selling, even leasing. So let's go back to the example. Let's say that, let's say that my IRA just buys real estate, some third party. And I'll get this question every once in a while. Hey, Matt, my kid's going off to college and I want to buy a rental property in the college town. It's a pretty good little rental market and my kid will stay there as the tenant. Well, that's a per se prohibited transaction too. And they'll say, well, and here's why it's prohibited, by the way. This is your IRA that owns it. It's leasing the property, so it's collecting rent from your son. And really, you're probably paying for it anyways. But you know what I mean? So like, even if you were giving the money to your son and they're paying it, they're on the list of a disqualified person. Okay. So that would cause a per se prohibited transaction because they're paying rent. Then I'll have clients say, well, Matt, what if they stay there and they don't pay? It's not a per se prohibited transaction, huh? Correct. It's not. There's no transaction. They're staying there for free. But there is something called self-dealing. See, this is why you got to learn all the rules. So we'll get to what is a self-dealing prohibited transaction. Here in a second. So just because I don't have a per se prohibited transaction doesn't mean I'm in the clear. I got to make sure I get these through these other two varieties, extension of credit and self-dealing, before I know I'm totally in the clear on the prohibited transaction rules. Okay. Now, one question that typically comes up right now is, well, Matt, when is a company a disqualified person? What if I have an LLC that owns a piece of real estate and I want to sell that property to my IRA. Well, the way a company is disqualified is if 50% or more of the ownership of the company is owned by disqualified persons. And this is actually 50% of the capital, the ownership, or management of the company. Either of those three is over 50% of disqualified people. That's you, your spouse, your kids, your parents, right? Any of the individuals if they own 50% or more of that LLC, corporation, whatever the company is, the company is now disqualified. So if it's just me that owns an LLC 100%, or me and my spouse that owns an LLC, between the two of us we own 100% of it, that company will be disqualified to my IRA. But let's say instead though that me, Lindsay, and Angel here, the three of us, let's say the three of us set up an LLC We bought a fix-and-flip property and we each own one-third. We all just work together. We're not family or anything like that. And let's say we want to sell the property now. And I'm like, hey, I actually think that'd be a great rental property for my IRA. Could my IRA be the buyer of that fix-and-flip property? Yes, it could. It's not a per se prohibited transaction. I only own a third, 66% of the ownership, Angel and and Lindsey is non-disqualified people, okay? Now, if I change the facts and let's say it was me, my spouse, and Lindsey that each owned a third of the LLC, now me and my spouse total our ownership, each a third, we're 66%. We've gone over 50%. So now the LLC becomes disqualified, okay? So for LLCs or corporations or entities, that entity becomes disqualified based on this 50% rule. All right. Okay. Let's see if there's any questions at this point on who's a disqualified person that we want to bring up or not, or just prohibited transactions. We still got to hit extension of credit and self-dealing, prohibited transactions. Yeah.

So we've got a couple of questions. Russ is asking, can a Roth LLC— so I'm assuming that's a Roth IRA LLC— Can my Roth IRA LLC own a vehicle that I use for business?

Ooh, great question. Good question. The prohibited transaction rules for your Roth IRA or Roth 401(k) apply to any LLC it owns as well. So if you have an IRA LLC, checkbook IRA, all those prohibited transaction rules apply to the LLC. So if it buys a vehicle, you can't use it. Now, we have had clients do like Turo or things like that where they've had an LLC that owns a a vehicle for that, that they lease out on Turo. So that wouldn't be prohibited if you're renting it out to third parties, um, but if you're personally using it, that would cause a prohibited transaction. Now let's think about this. If you're like, well, the Roth bought it but I'm using it, there's no per se prohibited transaction because I didn't transact, right? Now if I paid my IRA LLC for it, that would be a transaction. But why is this a prohibited transaction? Well, this is self-dealing. Let's actually jump to self-dealing and we'll come back to extension of credit because it's a good question. A self-dealing prohibited transaction occurs whenever you have a disqualified person benefit from an IRA's investment. That's the easiest way to think about it. Does it— did a disqualified person benefit because my IRA made an investment. And here with your IRA LLC that bought a car that you use, well, you're a disqualified person. You're benefiting because you're using assets your IRA owned. All right, so that would cause a self-dealing prohibited transaction. The other one is like the vacation rental property. Let's say that your IRA or your IRA LLC— the rules are the same here, and this could be Roth, traditional, SEP, doesn't matter the account type— let's say that it owns an Airbnb property. And you're like, well, no one's going to stay there for a week. Why don't I just go stay there with my family? You know, I'm not going to pay rent. That I know that would be prohibited, but I'm just going to use it because it's just going to sit there vacant, Matt. There's no, there's no harm, no foul. Well, you've benefited from using the property, so that would actually cause a self-dealing prohibited transaction because you're a disqualified person. So now, a question a lot of people raise after I give that example Sorry, I've been teaching this for a long time. Is, what if my brother stays there, Matt? What if my brother stays there because— and they don't pay any rent? He's not a disqualified person. Can we do that? Sure, your brother can stay there. I don't care. I guess— I mean, it's not— they're not disqualified, so they could have self-dealing in their favor, I guess, you know, if you want to. Um, like, what if my brother stays there and he invites me over? Okay, now we're back to your benefiting from use of the asset or benefit from the investment. Okay, another example of self-dealing, and self-dealing is kind of tricky because it's subjective. The first variety of per se is IRA transacts disqualified person. It's like very objective. Like we know who's a disqualified person. A transaction is pretty much anytime money's going in and out of the account. To somebody or some company, that's going to be a transaction. And obviously we have an IRA, otherwise we wouldn't be talking about this. So it's really objective to like figure out per se. Self-dealing, though, is subjective because did a disqualified person benefit? You know, it can be very subjective, but use of assets is going to be pretty clear, whether that's a car you buy from an IRA LLC or the Airbnb that you actually stay in. That's going to be clear you're benefiting because you're having use of the assets the account owned. Another way you can get self-dealing is if you get compensation because the IRA invested. So for example, let's say that your IRA goes and buys the duplex, okay, the rental, the single-family rental, whatever, doesn't matter. It buys a piece of real estate as an investment asset. And let's say you happen to be a real estate agent, so you receive the commission on the purchase of the asset. You get a 3% buyer's agent commission. The property was $300,000, so you got a $9,000 commission to you personally as the agent. Well, you benefited because the IRA made a transaction. You personally, a disqualified, benefited by getting that commission. So that would cause a self-dealing prohibited transaction as well. So now, self-dealing, remember, this is, um, you're benefiting, whether it's compensation, use of assets, but it has the same ramification of The account becomes distributed. Your account's subject to penalties and interest. If you're under 59 and a half, you have an early withdrawal penalty. If it's a Roth account and you haven't had it for 5 years, you're under 59 and a half, all that growth you've had in is now taxable and subject to penalty. And also any of the investments you made after the prohibited transaction that you didn't have to pay tax on are now subject to tax as well. So it's kind of like Not good, obviously, to have a prohibited transaction, no matter the type here.

It's also not worth it to try and think that you're being really sneaky. That's also called potentially tax evasion. So let's not do that. Let's not try to be sneaky. If you're trying to think of a loophole, the IRS has probably thought of the loophole and closed the loophole. But call us and ask us those questions. That's what we're here for.

Yeah, and we can help educate you, of course. If you want to get crazy and have super complicated questions, you need to call a lawyer and have attorney-client you know, conversation about your interesting ideas. Um, so, well, let's hit a couple that we know are like— as, um, Lindsay said, uh, these are— could be loopholes, but the IRS has closed out. For example, there's something called a stepped transaction, which is something where you say, hey, Matt, um, I really want to get this money out of my IRA, and I was just going to lend it to myself or my business. But that— but I'm a disqualified person, so that'd be a prohibited transaction. So what if I lend it to my sister, um, and then my sister will just give me the money, or she'll lend it to me? Would that be prohibited? Yeah, that'd be prohibited because that's called what the IRS calls a step transaction. Anytime you put an artificial step in the middle of a transaction to get around a tax rule, whether it's prohibited transaction or frankly anything else, the IRS blows through that. So they would really look at that as if your IRA lent money to your sister and your sister just gave it to you personally, they're going to see that there's no economic substance to your sister being in the transaction and that the ultimate intent was you got money from your IRA without taking a distribution. That's going to be a prohibited transaction. So don't try to put artificial steps in the process to get around a prohibited transaction rule. It will never work. I was, I probably charged clients hundreds of thousands of dollars as a lawyer for clients to find a way to get around the prohibited transaction rules. Now there's ways they apply and don't, and it's, you can definitely get a lot of advice on what you can and can't do. And sometimes there's gray areas, but this type of stuff of like just putting somebody in the middle of the deal to get around the rule never works. All right. So don't try to do the deal with your sister or brother. Another one that I don't love, and this is where you start getting the gray area, is let's say you're like, hey, hey, Lindsay, you've got an IRA with $100,000 in it. I've got an IRA with $100,000 in it. Why don't— why doesn't my IRA lend you $100,000 and then your IRA lends me $100,000? Neither of us have to take a distribution from our retirement account. We won't pay taxes or penalty. That's a no-go either. Don't be doing that. Yeah, sorry. Um, because now we're basically saying, well, the only reason my— the only reason my IRA would lend to Lindsey is because Lindsey was personally going to give me money. So I'm personally benefiting because my IRA lent her money. We're back to self-dealing here. All right. So I know some people get creative with these ideas, but in the end, if you're getting personal benefit because your IRA invested, it's just going to be prohibited. The benefit that should happen from your IRA's investment is your IRA grows in value. That's what you're focused on, and you can benefit that way. That's the whole point of this thing. But you can't personally benefit now in your personal name. All right. And that's the, the big distinction. So if you're like super focused on just making great investments and building wealth in your retirement account, as you should be, and most of you here, of course, is just think about growing the retirement account balance and how to make good investments. Don't think about how you get to make money now or how you get a benefit because your IRA did something now. Okay, another one we'll get, and I'll just throw out, you know, examples here, and we'll start taking some other questions too. We still got to hit extension of credit and some— we'll hit statute of limitations, how does the IRS discover prohibited transactions. We're gonna hit those topics too. But another one that's kind of common that's a little bit of a gray area too is people say, well, Matt, I want to get one of these golden visas in Europe. I know Portugal is a popular place, and if I invest at least you know, $250 grand into Europe, I can get a visa. I can get one of these golden visas in my personal name, and I can go live in Europe full-time if I want. Well, isn't that self-dealing? If my retirement account makes an investment into Europe for $250 grand, and the only reason I was doing that was to personally get a visa so I could personally live in Europe full-time, isn't that self-dealing? Probably is. Maybe there's a lawyer that thinks it's not. It sounds like self-dealing to me if that was the intent. Um, now maybe you already made the investment and had nothing to do with you getting the visa, and now you're getting around to it, like, oh, maybe I'll go live in Europe for a year, and the IRS can't tie those two things together. Could you get, get around that? Possibly. Could that, could that work? Yes. But the presumption from the IRS is the only reason you did that was to go get the Golden Visa, and so you're benefiting from your IRA's investment. Okay, we could go on and on with examples here, but let's see if there's any other questions on self-dealing. We'll still hit extension of credit here.

Yeah, so just some just kind of general questions regarding prohibited investments and disqualified parties. Wayne has a good one that I'll take. Wayne says, as long as you're not purchasing from a disqualified person, your Roth can make the investment. So almost. So you want to remember, Wayne, not only do you have to look at the disqualified parties, but you also want to look at the prohibited investments as well. So just keep in mind, you can't do the life insurance contracts, the collectibles. Or the S corp shares, that already is in play. And but if those three are not your concern or not what you're considering, plus there's no disqualified parties, then the answer is likely yes. Unfortunately, the IRS doesn't have an all-inclusive list of all the investments you can make. They only list the ones you can't make. So we presume fair game for the rest, which is actually nice.

In some ways, that's the problem. There's like, like crypto, for example. Like, there's nothing in the tax code that says your IRAs can can buy crypto or not. But it only— IRS just tells you what you can't do, right? They don't tell you, you know, they just say the speed limit or what you can do. That's what the law is all about. So like, well, what does this mean? I can— I walk on the sidewalk? There's no law that says I can. Well, shit, there's just a lot says you can't walk in the road, okay? Or like jaywalk or run across the street. So, so this is just how the tax code is built too with prohibited transaction. There's not green lights of what you can do. There's just red lights of what you can't do. And then when it's a gray area, you know, that like the caution light or the yellow light, and I gotta look around, I don't know, just, and then you determine if it's good enough to—

Exactly. So it's really nice that we can just presume everything else is, is fair game. It's a lengthy list of what you can actually do. So don't get too hung up on the assets you can't buy or the disqualified parties you can't transact with. There are endless numbers of different types of investments that you can invest in, and there are millions and billions of other people outside your family members that you can invest in. You can transact with and invest with. So don't get hung up on the 6 or 7 that you can't invest with, or 8 or 9 if you're in Utah and have multiple spouses. But other than that, you're fair game. I just slid that one in. I stole that one from Matt. The only other comment that I wanted to share here is from Anita. This is actually a good one. I haven't heard this one before, so I thought it was kind of unique. Anita asks, what are the rules for prohibited transactions disqualified parties if you're over the age of 59 and a half. The rules don't change. So the rules will always stay the same regardless of your age when it comes to prohibited transactions and disqualified parties.

Yeah, great, great question though. The rules don't change, but the penalty is different.

There you go.

So if you think about like, if I have a prohibited transaction, I'm 45, I am 45, right? My account gets distributed. I'm under 59 and a half. So I have a 10% early withdrawal penalty. If this is my Roth account, any of the earnings are now subject to tax. So it's like nasty, right? But let's say I'm 62 and even— and I've had a Roth IRA for 5 years and I end up having an account— my account has a prohibited transaction. Well, I just— that just asks— it's just the account's distributed. No tax, no penalty, because I'm over 59 and a half. I don't have a Roth IRA anymore. That sucks. Whatever was in that account is fully distributed. And so I have had clients over the years, and this was Attorney Matt when I used to consult clients. I don't do that now, but like, uh, hardly I do that. But when I'm like, if, if I'm advising a client who's over 59 and a half, and I do have many that have large Roth account, we're always thinking about, all right, if this— there is some gray area in a transaction, let's say, what is the risk? The risk is you don't have a Roth IRA anymore. Now, one thing that's really, really important to understand is the consequence of a prohibited transaction. For IRAs, if you have— let's say you have a million-dollar IRA, Roth, traditional, doesn't matter— but you engage in a $10,000 prohibited transaction, well, the IRS distributes the whole million-dollar account. It doesn't matter there's only $10,000 involved. For IRA rules, one prohibited transaction in the account, the The consequence is distribution of the entire account back to January 1st of the year when the prohibited transaction occurred. And so it can be very risky if you're in a gray area here. Let's say, where is it prohibited? Is it not? I don't know. Maybe we can hit some gray area questions. But so a strategy would be is separate that investment. If you've got the million-dollar account or the larger account and you have a $50,000 investment that might be a Gray area. You'd want to put that $50,000 into a new IRA. Let's say it's a Roth IRA and it would make its own investment. That way, if something happened in that and that was deemed a prohibited transaction, only that account that made the $50,000 investment that doesn't have anything else in it is distributed. Your other IRAs, your other Roth IRA with us or other account at Schwab or wherever, those are not affected. So it's only the account involved in the prohibited transaction that gets distributed. But it is the whole thing. So not that everybody needs to do that, and 99.9% of you don't need to know that, but if you have a lot of creative structures and strategies where you can run into gray areas, a little more advanced, that is a kind of a higher account, more advanced strategy to separate out your accounts to limit the risk of a prohibited transaction. Because it is like the death penalty. And I've even been involved in lobbying Congress, and there was a, there was a bill called the IRA Preservation Act that was introduced in the House about 6 or 7 years ago. Where we were trying to change that rule so that the penalty was only on the amount involved, not on the entire account. Which, the amount involved, by the way, is if you have a 401k, even a solo 401k, the consequence of a prohibited transaction there is, um, only the amount involved is subject to penalty, and it's a 10— it's a 15% excise tax, and you have to correct the prohibited transaction. So solo 401(k)s, any of you self-directing those, or just any 401(k)s that are employer-based plans that are self-directing, um, it's a— there's no death penalty on the whole account. The consequence is just on the amount involved. Okay, sorry, that was a little legalese for a while. Anyone still listening? Is there anyone on still? Did everyone leave?

No, you lost everybody, Matt, with all your tax attorney chatter. No, that was very helpful, and it's also awesome to hear just about the lobbying that you're doing as well. So thanks for pushing that on, on your end.

We lost, but you know, whatever, we'll try again another time, right?

Um, no, I think everybody's asking some really awesome questions. There's some really advanced and specific ones too, so way to go, guys. It looks like we've got a really good audience here today, or super engaged. So just keep in mind too that if you've got some super specific questions, book a call with Michelle. She'll drop her calendar in the chat here in just a second. I just found out she's working Thursday and Friday, guys, so book her for the holidays if you've got nothing else going on. You're home with the kids or just trying to escape for a little bit and take a little quiet time, take a meeting with Michelle, learn some more about self-directing. And she's also got an awesome promo for you guys too. I'm going to give it to you right now, so make sure you write this down, guys. It is BF250. BF250. It's going to get you $250 off. It's our Black Friday special, gets you $250 off the account establishment. So make sure you put that when you book a call with her, add that promo code to the, uh, to the actual booking itself so that we know you're one of those from the webinar.

Yeah, and this will only go until Cyber Monday. So that promo code is like, we don't do it that high ever. So if you're going to use it, use it now. You got till Monday, till Cyber Monday.

Matt told us to do BF200. We slipped in the 250, so don't tell him. Okay.

Yeah, well, I just heard, but too late now. Damn it. Okay. All right, well, let's come back to extension of credit-privileged transaction because I kind of skipped over that. Um, this one's a little easier to understand, and we'll give a good case example of it too. So an extension of credit, credit-prohibited transaction occurs whenever there is an extension of credit between a plan, which means IRA, and a disqualified person. All right, so for example, let's say your IRA is buying real estate and you have $100,000 in your IRA, but the property is $300,000. Well, you can get a loan actually to buy that property. So the bank will lend $200 grand on it, but you can't guarantee the loan. You can't be the guarantor or have your credit ran on that. Okay. That would cause this extension of credit prohibited transaction because now I've provided my personal credit and I'm a disqualified person to benefit my IRA in the investment. So when I'm getting loans for purposes of an IRA, when I'm buying assets or even improving assets or whatever it may be, I can get a loan, but it needs to be something called a non-recourse loan. And there's 7 or 8 banks that really specialize in these and will do loans to single-family rentals. You know, it doesn't have to be some big apartment or commercial property. In fact, most of the time it's just on single-family rentals where they will lend you money to your IRA or your IRA-owned LLC. They will lend it money to go acquire real estate. Now, these need to be income-producing properties because there's debt service that needs to be met. And they'll do this like kind of like a— they'll have a debt service coverage ratio, you know, that it needs to meet, which frankly, you'll want to meet that. Otherwise, it's a bad rental property anyways. They want to make sure that the rents that you should be able to collect on this will cover the debt service. Also, these loans are going to require about 30% down, sometimes up to 40%, depending on the property or the lender. The reason for that is under these non-recourse loans, in the event of default, the bank can't come after you because you didn't guarantee the loan. They can't come after your IRA either because that violates IRA rules. The only thing they can do is foreclose on the asset they lent on so they can foreclose and take that property back. But if your IRA has other assets or money in it, they can't come after your IRA, nor can they come after you personally. So their only recourse is on the asset itself that they've lent on. All right. And that is a non-recourse loan. Lots of banks out there do it. If you go to On Directed on our website, there's a number of lenders on there. It's under the resource directory, I believe. Yes. Go to directed.com and you get to the resource directory from our home page. You'll see a number of banks that you can contact there. Also, for any of you that are creative real estate investors, you're acquiring properties subject to or with seller financing or whatever that is. That's fine too. You can acquire properties that way, that your IRA or Roth IRA or IRA LLC is the buyer on that and you take it subject to the existing loan. And then usually you'll be using an IRA LLC for this and the LLC is, you know, will be agreeing. So this is your IRA LLC XYZ Investments LLC will agree to make those payments or they'll agree to make them to the seller of the property. But you can't guarantee the seller that the LLC or your IRA will make those payments. Okay? That would cause this extension of credit. Now, there is a big case on this about 10 years ago called Peake and Fleck versus Commissioner. This was two guys that used Roth IRAs, actually, and they formed a new company. This new company, the sole purpose of this new company, it was owned 50/50 between their Roth IRAs, was to purchase an existing small business. So they bought this existing small business, but when they cut the deal from the person that owned this business before them, they said, hey, we don't have all the money to buy you out of the business. I think the business was like a million bucks, couple million bucks to buy it. Like, here's $500 grand that we have between our Roth IRAs. We'll pay you the rest over time. And so there's a seller finance note from the seller of the business saying, hey, I'm going to sell you this business for $3 grand. I'm just giving— I don't know the exact numbers here, but We're going to sell this business for $3 grand. Sorry, $3 million. Slight detail. Selling this business for $3 million, but I'm going to take $500,000 from you now, which the Roth IRA is put into the new company and the new company paid the seller $500,000. But you're going to owe me $2.5 million that you'll pay me over the next 5 to 10 years. All right. Now, that was all fine. You can do that. However, the seller said, But I really want to make sure you guys pay me back. So I want you to guarantee these notes personally, that you will personally guarantee that you will pay me back this extra couple million dollars. Plus, I'm going to put liens on your homes as collateral to make sure you really pay me back because I don't trust you. I'm not just going to take your word for it. Now, that is what caused an extension of credit prohibited transaction because they agreed to personally guarantee the seller finance note, and they use their personal homes, their personal assets, as collateral for the loan that was really for their Roth IRAs. Now, Peake and Fleck, bless them, they tried to fight this out in tax court, as they should. There are some arguments they made here that there was a company involved in the middle, and they tried to work around this with the tax court. They lost. All right, and, um, and the tax court basically said your IRA benefited and received credit extended from you personally when you personally guaranteed the note and used your personal assets as collateral. Now, here's what happened in this case. Their IRAs got distributed. These were Roth IRAs. The IRS didn't realize this until they'd already sold the business and made a couple million bucks. So what happened is the IRS audits them later and says, oh my gosh, you made over— they each made over $1 million of profit in their Roth IRAs from buying this business. Improving it and selling it for a profit. But they came in, unwound the transaction, realized that they had guaranteed the debt to acquire it, caused a prohibited transaction. And what happens is, is the prohibited transaction goes back to when they guaranteed the loans in the first place. So the IRS said you didn't have Roth IRAs when you owned this business. So any of the profits you're making in the business, those are actually taxable now. And when you both sold it and there was a couple million of profit, each of your IRAs got $1 million of profit, that's subject to capital gains tax now because you don't have Roth IRAs anymore. You had a prohibited transaction. All right. So that's another angle of the consequences here is if you have transactions and investments where you're making money, which is the point here, those things actually become taxable now because you don't even have an IRA at the point you engage in a prohibited transaction. So that's extension of credit. Hopefully that example and case is helpful. Bottom line takeaway is don't guarantee debt or pledge personal assets as collateral when your IRA is getting a loan. Work with a bank lender that understands these loans. Don't call your friend the loan officer that does loans for LLCs all the time if they don't understand IRA and non-recourse loan rules. Also, if you're doing creative deals with seller financing or subject to, also just make sure you're not personally guaranteeing that. Um, that will also cause a extension of credit-privileged transaction, just like it did for peak and fleck. How are we doing on questions now?

He went full tax attorney on us, guys. What a treat. So we do have some questions, but they're not necessarily applicable to this particular segment. So we can still hit some of them, though, because they're really good. Wayne's got another good one. Wayne says, as a realtor, can the commission benefit be rolled into the purchase of the home, which benefits the IRA by lowering the cost basis and no payout to me?

Yes. Love that. Great, great idea. And that's what I would do. Just reduce the purchase price if you're the buyer by that 3%. Either do it in the offer from the beginning. That's probably the cleanest way to do it. Just say, hey, you know, I'm the agent, but I'm not taking the commission. Let's just reduce the purchase price by that 3% or have it credited back in closing. Maybe your broker takes a little bit of a fee, but otherwise would go to the agent that can just be part of the proceeds to purchase. So your IRA can benefit, that's the other thing, your IRA can benefit from your IRA making an investment. That's okay. You just can't.

There you go. All right, we've got a few more. Let's see, how about, ooh, okay, this is a good one. Terry has a good question about fixing prohibited transactions. Terry says, "If you take it out and realize it's prohibited, can you repay it back?" So if you take money out and do a transaction, make an investment, can you repay it back as like a whoopsie? Or how do you return it back as a refund? Or is it a second contribution or, what happens?

Okay, let's say you had a transaction where you got money from your IRA, okay? And you're like, oh damn it, I just watched this webinar, apparently that's prohibited. Okay, um, this is attorney-client privilege, okay? I'm not going to use the real name here. Um, first what I would do is this: you kind of want to talk to a lawyer. Do not call your IRA custodian on this. Do not call if the Directed IRA or whoever your IRA custodian is and say, hey, I did this, is that prohibited? 'Cause if they say yes, they're going to distribute your account, all right? So you need to go talk to a lawyer and have attorney-client privilege conversation about this. Maybe you trust your CPA, but by the way, your CPA's information is subject to audit and the IRS could interrogate them or request any of the records. But if you talk to an attorney, it's attorney-client privilege, the IRS can't get any of that info. So have a professional conversation with an attorney about it. And, uh, and, and what, what you're going to find in that conversation is, and I'll just kind of outline this, I've done, by the way, I did continuing education, just, I did a, um, for lawyers and financial advisors, um, I did a course on prohibited transactions and self-directed retirement accounts that was for continuing education credit. I've been to other of those events with lawyers. It's a small niche industry of people who play in this, and the consensus of other professionals Once an IRA is engaged in a prohibited transaction, you have a few options. One, report it as a prohibited transaction. Just let your custodian know, eh, I engaged in a prohibited transaction. You're going to have to distribute my account. Okay? And that's going to go on your tax return. You're going to put that on your 1040. Okay? That is one approach. Okay? That's frankly what the IRS is expecting you to do. The second approach might be like, hmm, I might have some forgiveness here with the IRS. I'm going to fix it. All right. Now, there's no official procedure on this for IRAs. There actually is for 401(k)s in some instances. But you can take an approach to try to fix the transaction and put your account back in the position it would have been if you didn't engage in a prohibited transaction. You're subject to audit. And frankly, now it depends on who's the IRS agent you get and then the tax court judge you get later if the IRS agent didn't like what you did. So it's not saying there's— you've washed yourself clean of it. Your IRA custodian can't bless it or anything like that. This is an attorney-client privilege conversation with your lawyer to say, ah, I did that, but I fixed it. I got my account back into the same position it was. Now, there's a lot of exceptions to the prohibited transaction rules. Um, that's the nice thing about the tax code is it giveth and it taketh away, but here it giveth right back with exceptions. So yes, we can do self-directed IRAs and invest in real estate, but There are some prohibited transaction rules that you can screw up, but there are also some exceptions to it. So no way we could get through this today. I'm already trying not to make this boring and have Lindsay joke that I'm doing Tax Attorney Matt today. So we'll avoid the exceptions. But as the geeky tax lawyer that did talk to clients for years about this and actually did advice, and my law firm still does this at KQS Lawyers. So, so there's a team still that can help you and there's other attorneys out there that are smart on this too. Um, but, uh, there are sometimes exceptions you can rely on. So, but don't talk to your IRA custodian about it. Best person is an attorney because that's attorney-client privileged. And you may have ways where it's actually not prohibited because there's an exception, or there is a way to get your account back in the same position. And then you're going to have to worry about what's my audit risk on this. All right. Um, again, more of a professional conversation, not really for me at Directed IRA to say, but it is helpful, um, to know how are prohibited transactions discovered or alleged. All right, so here's how prohibited transactions are discovered or alleged. It's a common question I'll get. This is actually— is interesting, I think.

Just you?

Yeah, just me. I think is the, the IRS does not have a department that audits or is responsible for IRAs.

Well, don't give them ideas.

Yeah. So like, there's no IRA department that audits IRAs. There's actually a department for employer plans like 401(k)s that actually audits 401(k) plans. Obviously, there's an individual, you know, department that audits individuals' returns. There's a business department that audits business returns, and there's an estate department that audits estate and trust tax returns. Okay, so there's different departments that will audit different things. There's no department for IRAs, for better or worse. So the way IRA prohibited transactions come about is your IRA is invested in a company and that company return got audited. Okay. Like, I've read every prohibited transaction case out there. The vast majority of prohibited transactions come from a business return got audited and the IRA was invested in that business. Peake and Fleck, perfect example. They had a company, they had a corporate tax return. Actually, there was actually a C corporation that they did because it was an operating business that could have had UBIT, but their Roth IRAs own 50/50 of it. And that 1120, the tax return that a corporation files, got audited. And then they started digging into the business that they bought and all the nature of the transaction. So that's how that one got discovered. The other one is your IRA custodian sees that you committed a prohibited transaction, whether that's us or any other IRA custodian, or you call them up and tell them you did it. And then we will issue a 1099. And I believe it's like code 5 on the 1099. I don't know. There's like a code we have to code it that says it was prohibited. But basically your entire account gets distributed. Okay, so that's second way it happens. The third is if your IRA is, is like on your 1040, there's like a number of cases where There's a guy that owns some real estate in his IRA LLC, and he was taking all the expenses on schedule— on his— on Schedule C, actually. It might have been Schedule E, but he's putting on his personal return. He was trying to write off the property on his personal return and claim the income in his IRA. He was just doing a dumb thing. That's not what you do. So he kind of like exposed what he was doing to the IRS on his personal return. And so they audited it. 401(k)s, when you have a solo 401(k) with more than $250K of assets, you have to file a tax return for the solo 401(k). So we have thousands of clients that have solo 401(k) accounts that they self-direct. Your solo 401(k) return, this is called a 5500 return, could get audited. So it's a low likelihood on smaller 401(k)s, but it's possible. So that's the 3 areas where you'll typically see a prohibited transaction. Um, and again, the most likely is there's some company return or your IRA is involved in a transaction and someone got audited in that and they see an IRA and kind of dig deeper. So, all right, now let's talk about the statute of limitations here. Um, so there's an actual case on this. I'm just waiting for Lindsay to make fun of me again. All right, I mean, if any of you want to read this, I think it's fascinating. Deason versus Commissioner. And actually I was like excited when this case came out because I'm like, I, I couldn't figure out what the statute of limitations was. And I was advising clients for so long guessing. I had the guess right. But like, now there's a good case on it. So the statute of limitations is basically 3 years. So, but it's 3 years from the time you filed your personal return. So for example, let's say like right now we're in November of 2025. Okay, so your 2024 return was due by now, right? You had to file that even with extensions until October 15th. Okay, so, so '24 is at play to be audited. '23 is at play to be audited. 2022 is at play to be audited. Okay, so those are the 3 years you would be subject to audit right now. What does that mean? That means '22 is being audited. The IRS is always auditing the last year possible because they're always behind. So, um, but 2021 and 2020, they're only auditable if there's an exception met here, which I'll get into here in a second. But for the general purposes, even the IRS's Internal Revenue Agent Manual for IRS agents says to only audit up to 3 years for prohibited transactions. Okay, now the IRS under statute can go up to 6 years to audit for a prohibited transaction, where they get an additional 3 for a total of 6. Now this, they can only do this if under, if they allege a prohibited transaction and your adjusted gross income because of the prohibited transaction on your 1040, on your personal return, would go up 25%, meaning it was significant enough, then they let the IRS go back an additional 3 years to a total of 6. But this is only if the Assistant Secretary of the Treasury agrees and authorizes additional 3 years for a total of 6. I have never heard of that happening. I've never seen a case where they went past 3 years. I don't even know who this Assistant Secretary in the Treasury is that authorizes this. And I don't know that that person knows either. So bottom line, worry about 3 years. Now, if you're committing tax fraud or doing something totally fraudulent, there's an unlimited statute of limitations, and that's the tax code in general. But what I really worry about, if you typically, if you made a mistake or something, Um, is you've really got a 3-year window for statute limitations on a prohibited transaction. Okay, I thought that was interesting.

That was fascinating. I actually did not know that. So in my 13 years, I never— Lindsay learned something today of limitations. I got schooled today, guys. Um, I think the whole prohibited transaction area is so fascinating though because your average investor doesn't realize that this is a thing. So you guys already have a leg up. There's not a lot of people that realize that prohibited transactions and disqualified parties take place when it comes to dealing with your IRAs. And that's because a lot of people are used to your traditional kind of IRA where you're buying Google or you're buying a mutual fund. You don't have to worry about the owner of Google, right, being your, your father, hopefully. Um, so yeah, it's just fascinating.

Actually, you're hoping it is your father.

Yeah, you are hoping.

Yes, then you wouldn't need an IRA if you're preparing for retirement.

Exactly. Yeah. Um, we do have a lot more questions coming through. I've got a really good one in regards to IRA LLCs. And this one's from Gloria, and Gloria asks, can you elaborate on the pros and cons of using a checkbook self-directed IRA when investing in tax liens and deeds specifically? But I think the pros and cons of just using it in general would be awesome.

Yeah, I love the IRA LLC. Some people call it a checkbook IRA. I actually use that myself for real estate investments that I do with my self-directed retirement account. So The most common application is real estate investors. You're, you're buying a property. It's a buy and hold rental. It's a rehab that you're going to hold or flip or you're doing tax deeds or tax liens. The reason that the primary reason someone uses an IRA LLC is it's just easier to do deals. So whether I'm buying a property that's a rent that I'm going to rent or I'm going to rehab, you just think of the logistics of it. If my IRA owns the property, right, there's a lot of back and forth with me and my IRA custodian. Hey, did you send the money? Hey, did they— you got to sign the contract. Hey, you got to pay this person that went and worked on the property. It's kind of a pain in the butt for you and us. But you can use this IRLC structure instead, or rather than from your IRA owning the real estate or the tax lien or deed here. I'll come back to that in a second. Your IRA owns an LLC. The LLC has a bank account, you're the manager of it, and now you just transact in the LLC's name. So let's say you called the LLC ABC Investments LLC. The contract to purchase is in the name of ABC Investments LLC. You don't need us to approve anything or sign anything or send a wire. You have a bank account in the name of the LLC. You can authorize the wires as manager of the LLC. And so it puts you in a lot more control to just manage the investments. If your IRA is just investing into a private fund or a startup and it's buying shares or units in something, you don't need the IRA LLC. Because we're just going to process the paperwork. Your IRA is going to go subscribe and own these shares, and it's going to get distributions or a payout at some time in the future. There's not a lot of maintenance or things you got to do to make the deal happen. You're not dealing with a title or escrow company. It's pretty straightforward and simple. Now, on tax liens and tax deeds, what I've just seen over time is that's a volume game, right? And some of those may pan out, some of them may not. Some of them might turn into a property you actually end up acquiring. Which sometimes is your endgame goal there. So because of all that maintenance and back and forth and volume, you just want to have an LLC. That's what I would do if I was to— I haven't done tax liens or tax deeds, but this is where you can— if someone's like, what the hell is he talking about? You can go buy people's property tax liens from the county. If they don't pay their property taxes, you can go buy the lien from the county. And if they don't pay that back in a certain amount of time, you can foreclose and take the property and wipe out mortgages too, even. And so there's some— it's very state to state, and there's even some nuances within the counties within states. But the general gist is, is you can own that lien right, which has some interest, and that they have to— the, the, the owner of the property will have to pay. And also there's some foreclosure rights as well. Now, there are some rights of prior lienholders and mortgage holders and stuff as well there. But that's just a quick summary there. So if someone's doing that, I've always seen as a volume play. Endgame is you want to acquire the property anyway. You'll be far better off just having an LLC where you're managing all those transactions, especially when you're going to tax lien auctions or anything like that.

When you're live at the auction, you want to be able to sign contracts and write checks and handle everything right then and there. If you don't have the IRA LLC in place and you have to reach out to us to do so, Now we're super quick. We can move really quickly. Not every custodian can though. So be extra cautious, especially with timing on those things. If you're at an auction, the LLC could benefit you for that purpose.

Yeah. And a lot of them make you bring a cashier's check, right? And so like getting a cashier's check out of your IRA from us, it's not simple. And I, if you're calling, if you're trying to do that, I'm just going to just do an IRA LLC. You'll thank me later. I know it's a little cost to get that set up. It's like $1,200 for an IRA LLC. Their IRA owns 100%, but your time and your life cycle of making these investments. If you're trying to grow this account over 10, 20 years, I don't know your time period of trying to grow this. You will— it'll be well worth it for you. And we want to work with you. Don't— we want to hear from you. It's not about that. Don't, don't, don't feel that. But it's— guys, I use it, okay? I'm in the office. I know everything. I can tell people what to do. I use the iRealEstate for my own account.

Yeah, IRA LLCs are awesome. So go to kkoslawyers.com if you want to learn a little bit more, and or when you book your phone call with Michelle, she can also go over a lot of the basics with you, um, to tee it up to get you set up properly for that. Um, on that note, don't forget to book a call with her. I just checked her calendar and she's completely booked for today. So sorry guys, if you're trying to get in for today, she's fully booked, but she does have some availability tomorrow, and then she's got even less availability on Thursday and Friday. So it looks like you're getting full, Michelle. Sorry about that, but glad, glad you're working, uh, the entire week. So thank you for doing that.

This is her decision, okay? This is not me. Don't be like, Matt's a terrible boss.

No, no, we— he absolutely allows us to have days off, just not Michelle. So no, I'm just kidding. Michelle's allowed days off too, but she volunteered, so we appreciate you, Michelle. Um, again, don't forget that promo code, guys, BF250. That's Black Friday 250, $250 off. So add that to your notes when you book the call with her, and there's a little spot you can add some notes for your call as well. That'll make sure you get $250 Awesome.

Okay, well, remember, this is recorded, so you can come back to this. You'll get a notification on it the next day or two. It'll be up at directhire.com/webinar. Make sure you're signed up for our newsletter. If you're not getting our newsletter, make sure you're signed up for that. You can do that at directhire.com. You'll get notices of all the other upcoming webinars that we have. You'll get reminders of recordings of webinars and all the content we're putting out every week, just trying to give you more education so you can take control of your retirement. It's a pleasure to be your IRA custodian. For any of you that are clients, we do appreciate your business. And for any of you that are prospects and thinking about, you know, self-directing your IRA and what's— who's the right IRA custodian, you finally found that. You're here. Just join the team already. We want to help you. Um, and so now's a great time. Take advantage of that promo. Thanks everybody. Stay calm. Self-Direct On.