Month: July 2022

It is getting increasingly popular for individuals to use self-directed IRAs to invest in alternative investments—that is, investments in things other than stocks, bonds, CDs and the like.

The single most popular alternative investment for self-directed IRAs is real estate.

With real estate values continuing to climb, you may be thinking about establishing your own self-directed IRA to purchase residential rental property, commercial property, or other real estate investments.

But before you do so, you should be aware of some potential downsides of using self-directed IRAs for real estate. These aren’t necessarily dealbreakers, but they can be big obstacles.

Debt Financing

First, it is more difficult to get debt financing for real estate held in a self-directed IRA.

You, the self-directed IRA owner, are not allowed to lend any money to your self-directed IRA. Your close relatives are also barred from making loans. Nor can you personally guarantee a loan taken out by your self-directed IRA.

Instead, your self-directed IRA must obtain a non-recourse loan. With a non-recourse loan, the lender’s sole recourse in the event of default is to foreclose on the property. Such loans are more difficult to obtain than regular loans. Typically, the lenders that make these loans require your self-directed IRA to furnish a 30 percent to 50 percent down payment.

Unrelated Business Income Tax

If you obtain such debt financing, your self-directed IRA could become subject to the unrelated business income tax. This is a tax imposed on tax-exempt entities, including IRAs, that earn money from businesses unrelated to their tax-exempt purposes.

The unrelated business income tax is based on the percentage of the property that is debt-financed. For example, if your self-directed IRA buys a rental property worth $500,000 with $250,000 of non-recourse financing, 50 percent of the rental income from the property is subject to the unrelated business income tax.

The unrelated business income tax most often poses a problem when your self-directed IRA sells debt-financed real property. It pays the unrelated business income tax on any profit at capital gains rates. If the property has substantially increased in value, the tax could be large.

Key point. Your self-directed IRA can avoid paying the tax if the debt on the property is paid off more than 12 months before the sale.

RMDs

Finally, if you’re at or near 72 years of age, you need to consider how holding real estate in a traditional IRA will impact the requirement that you take annual required minimum distributions (RMDs). (No RMDs are required for Roth IRAs.).

Once you hit the RMD age, you must distribute a percentage of your IRA’s value to yourself each year, based on your life expectancy, or face an enormous 50 percent penalty.

If all or most of the assets in your traditional IRA consist of real estate, the property may not generate enough cash to pay your RMD. This is not an unsolvable problem, but it is a problem.

If you have questions about self-directed IRAs or RMDs, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• July 5, 2022

Do you own or advise a corporation, limited liability company (LLC), limited partnership, limited liability partnership, limited liability limited partnership, or business trust?

Or are you planning to form one of these entities?

If so, be alert. There’s a new federal filing requirement coming.

Back in 2021, Congress passed a new law called the Corporate Transparency Act (CTA) that requires corporations, LLCs, and other business entities to provide information about their owners to the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN), which is a unit separate from the IRS.

The CTA is part of a government crackdown on corruption, money laundering, terrorist financing, tax fraud, and other illicit activity. It targets the use of anonymous shell companies that facilitate the flow and sheltering of illicit money in the United States.

Businesses subject to the law will have to file a “beneficial owner report” with FinCEN, including each beneficial owner’s full legal name, date of birth, and residential street address, as well as an identifying number from a legal document such as a driver’s license or passport. FinCEN will include the information in a database for use by law enforcement, national security and intelligence agencies, and federal regulators that enforce anti-money-laundering laws. The database will not be publicly accessible.

Violations of the CTA can result in a $500-a-day penalty (up to $10,000) and up to two years’ imprisonment.

The CTA did not take effect immediately. Rather, Congress gave the FinCEN time to write regulations governing how the CTA should be applied and to give businesses a heads-up about the new law. FinCEN has now issued its proposed regulations, and they take a fairly hard line on how the law will be applied.

Here are four things the new regulations make clear.

1. The filing requirement may begin soon. The CTA goes into effect when the proposed regulations become final, which is expected to occur sometime between mid- and late 2022. As soon as it goes into effect,

• new corporations, LLCs, and other entities will have to comply with the filing requirement within 14 days of being formed, and
• existing entities will have one year to comply.

2. Millions of small businesses are affected. The reporting requirements will apply to almost every small business that is not a sole proprietorship or general partnership, including corporations, LLCs, limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships—over 30 million in all.

Larger companies with over 20 full-time employees and $5 million in gross receipts are exempt.

3. There will be many beneficial owners. The proposed regulations make it clear that a company can have multiple beneficial owners, and it may not always be easy to identify them all. There are two broad categories of beneficial owners:

• any individual who owns 25 percent or more of the company, and
• any individual who, directly or indirectly, exercises substantial control over the company.

4. Law and accounting firms are not exempt. Neither the CTA nor the proposed regulations contain any exemption for legal or accounting firms, except for the relatively few public accounting firms registered under Section 102 of the Sarbanes-Oxley Act of 2002. Thus, any law or accounting firm that is a professional corporation or an LLC will have to file a beneficial owner report unless it has more than 20 employees and $5 million in annual income.

If you have questions about the CTA and its effect on you, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• July 1, 2022