Due Diligence

Estimated reading time: 5 minutes

Due diligence is a step by step process to help protect your IRA from investment fraud and to determine if it is the right investment for your IRA. Investment is the application of money in order to gain profitable returns, as interest, income or appreciation in value. All investments have risk and there is a constant battle between risk and reward. The more you know about the investment the better you will be able to judge whether the risks are balanced by the reward and whether investment fraud could be possible. That is why at Quest Trust Company we recommend that you invest in things you know. We believe you should be more cautious when you are investing your IRA funds because they are intended for retirement. We had a client who invested all his retirement funds in a big investment that was guaranteed to payoff big, but his widow found that it was a Ponzi scheme and she was left with only social security for retirement.

The reason investment fraud succeeds is because people are lured into emotional decisions by the con artist without first completing their due diligence. Due diligence is what forces you to uncover the facts about the investment and make a rational decision. Con artists spend much time and energy preparing strategy and learning techniques designed to convince you to buy on faith without investigating. They study the characteristics of affinity groups to create a sense of trust and common bond. They have well-rehearsed answers to common questions.  They target small individual, non-accredited investors because individual investors rarely do their due diligence; whereas, institutions nearly always do. That makes small investors easier prey.

Investigators and prosecutors cannot protect you from investment fraud. Even with secured, regulated investments you should always assume that fraud is a possibility. The front-line of defense against investment fraud is an educated and skeptical investor. You must protect yourself and your IRA. That is why due diligence is necessary.

The Due Diligence process begins with broad general questions and narrows down to specific questions about the investment depending on the type.  At any point during the process you find that the investment has too great a risk for the amount of return or has a high probably of fraud, then you can stop the process and move on to another investment. Don’t commit to the investment until you have all the pertinent details.

 The first general question is does the investment offer make good business common sense? If it is too good to be true it usually is. Above market returns only make business sense if a competitive advantage exists that you can exploit but other potential competitors cannot.

Below are two questions to help you address the business common sense test for any investment: 

  • How exactly does this investment strategy create above market returns? What is the competitive advantage?

Ask yourself if the answer you are given is complete, thorough, and makes business sense. Is the answer is glib, laced with jargon and techno-babble, or is it simple and straightforward? Do you understand the competitive advantage well enough to explain exactly how it works to someone else? If you can’t explain it then you don’t understand it.

  • What are the barriers that will lock out competitors so that additional capital and supply doesn’t force returns down to market level?

There must be a legitimate business reason that returns will remain excessive. Again, does the answer pass the common sense test or does the explanation sound like something from the Top 10 Warning Signs of Investment Fraud?

1. It promises “guaranteed” returns;

2. It promises high returns for little or no risk;

3. It’s being pitched by a leader in your community or a fellow group member, such as ethnic, racial, religious, or other groups;

4. It involves a reverse merger stock or your money has to be sent overseas;

5. It involves “break-through” technology;

6. It’s tied to a current natural disaster;

7. It’s unregistered, or it’s being pitched by an unregistered adviser or salesperson;

8. It lacks documentation, such as prospectuses, offering statements, or financial reports;

9. It’s difficult to understand; and/or

10. The pitch comes with high-pressure sales tactics that push you to purchase immediately.

       Fully exploring these two questions should eliminate most investment fraud right from the beginning. In order for an investment to pay you above market rates of return it must have a competitive advantage and barriers to competition. If it doesn’t then it can’t pass the business common sense test for legitimately offering above market rates of return.

      Be wary of over friendly and charming promoters who respond to your questions with techno-babble terminology or disdain for the question.

       Serious questions are a symptom of a serious buyer and honest salespeople know it, welcome it, and respect it. They have nothing to hide so they will attempt to simplify their answers so you can understand the investment and make an informed decision.

      What you want is a professional sales environment where a rational, fully informed decision can be made. You want to ask your questions and get straightforward answers. Never allow trust, friendship or emotion to get in the way of that task. It’s your money and investing is serious business.

 When you don’t understand an investment it doesn’t mean you are dumb: it just means the investment doesn’t make sense. Never settle for anything less than a complete and detailed understanding that allows you to make a fully informed investment decision. Drill them until you get the answers you deserve.

The next general question: How can I lose Money? All investments have risk.

 To discover the risk of loss ask the promoter the following questions and don’t be surprised if you have to press hard to get a thorough answer:

        (1) What are all the conditions under which this investment will lose money?

(2) What is the worst market environment for this investment strategy?

(3) What assumptions or correlations must remain valid for profits to continue?

(4) What crazy, impossible to imagine situations would result in losses if they actually occurred no matter how remote the possibility of their occurrence?

     Until you uncover the risk inherent in the investment strategy then you don’t understand the deal. If the risk doesn’t appear, then the investment is probably not legitimate or you don’t understand it. Also be wary of guarantees. Guarantees are frequently marketing tactics designed to make you accept claims at face value, invoke trust, and make your decision easy so that you don’t look deeper into the issues.

 The next general question: What are the track records, backgrounds, and histories of the person and company soliciting the investment including information about officers, directors and other key personnel? Research and verify all information about the company and claims by the company. Review recent financial statements for the company and verify addresses.

 With these general questions answered and passed you are ready to investigate the particular investment and its appropriateness for an IRA depending on the type of investment:


MAJOR CHANGE in interpretation of 60 day rollover rule

Estimated reading time: 5 minutes


The Tax Court ruled in the case of Bobrow v. Commissioner, T.C. Memo 2014-21, that the one-time per 12 calendar month 60-day rollover rule applies to ALL of the taxpayer’s IRAs, and not to each IRA separately. This is in direct conflict with information contained in IRS Publication 590 and in Proposed Regulation 1.408-4(b)(4)(ii).

UPDATE: In IRS Announcement 2014-15, the IRS has indicated that it will withdraw Proposed Regulation 1.408-4(b)(4)(ii) and will interpret the 60-day rollover rule in accordance with Bobrow. However, in order to give IRA custodians and trustees time to update their administrative procedures and their IRA disclosure documents, the IRS has announced that it will delay the application of the Bobrow interpretation of the 60-day rollover rule until January 1, 2015.
A summary of the ruling is below:

Bobrow, TC Memo 2014-21

The Tax Court has ruled that Code Sec. 408(d)(3)(B)’s one-rollover-per-year rule applies to allof a taxpayer’s IRAs, not to each of his IRAs separately.

Facts. Alvan and Elisa Bobrow, husband and wife, were a married couple who filed a joint federal income tax return. On Apr. 14, 2008, he requested and received two distributions from his traditional IRA in the combined amount of $65,064. On June 6, 2008, he requested and received a $65,064 distribution from his rollover IRA. On June 10, 2008, Alvan transferred $65,064 from his individual account to his traditional IRA. On July 31, 2008, Elisa requested and received a $65,064 distribution from her traditional IRA. On Aug. 4, 2008, they transferred $65,064 from their joint account to Alvan’s rollover IRA. On Sept. 30, 2008, Elisa transferred $40,000 from Taxpayers’ joint account to her traditional IRA.

The taxpayers did not report any of the distributions as income. They claimed that they implemented tax-free rollovers of all of the distributions. IRS asserted that the June 6 distribution to Alvan and the July 31 distribution to Elisa were taxable.

Background. Generally, Code Sec. 408(d)(1) provides that any amount distributed from an IRA is includible in gross income by the distributee. However, Code Sec. 408(d)(3)(A) allows a payee or distributee of an IRA distribution to exclude from gross income any amount paid or distributed from an IRA if the entire amount is subsequently paid (i.e., rolled over) into a qualifying IRA, individual retirement annuity, or retirement plan not later than the 60th day after the day on which the payee or distributee receives the distribution.

Code Sec. 408(d)(3)(B) limits a taxpayer from performing more than one nontaxable rollover in a one-year period with regard to IRAs and individual retirement annuities. Specifically, Code Sec. 408(d)(3)(B) provides: “This paragraph [regarding tax-free rollovers] does not apply to any amount described in subparagraph (A)(i) received by an individual from an individual retirement account or individual retirement annuity if at any time during the 1-year period ending on the day of such receipt such individual received any other amount described in that subparagraph from an individual retirement account or an individual retirement annuity which was not includible in his gross income because of the application of this paragraph.”

The reference to “any amount described in subparagraph (A)(i)” refers to any amount characterized as a nontaxable rollover contribution by virtue of that amount’s being repaid into a qualified plan within 60 days of distribution from an IRA. The one-year limitation period begins on the date on which a taxpayer withdraws funds from an IRA. (Code Sec. 408(d)(3)(B))

June 6 distribution to husband failed the one-rollover-per-year rule. The Tax Court ruled in favor of IRS, that the June 6 distribution was taxable because Alvan failed the one-rollover-per-year rule.

The Bobrows asserted that the Code Sec. 408(d)(3)(B) limitation is specific to each IRA maintained by a taxpayer and does not apply across all of a taxpayer’s IRAs. Therefore, they argued, Code Sec. 408(d)(3)(B) did not bar nontaxable treatment of the distributions made from Alvan’s traditional IRA and his rollover IRA. The taxpayers did not cite any supporting case law or statutes that would support their position.

The Court said that the plain language of Code Sec. 408(d)(3)(B) limits the frequency with which a taxpayer may elect to make a nontaxable rollover contribution. By its terms, the one-year limitation laid out in Code Sec. 408(d)(3)(B) is not specific to any single IRA maintained by an individual but instead applies to all IRAs maintained by a taxpayer. In support of this theory, the Court emphasized the word “an” in each place that it appears in Code Sec. 408(d)(3)(B).

The Court then explained its rationale for concluding that the June 6 distribution, rather than the Apr. 14 distribution, was taxable. When Alvan withdrew funds from his rollover IRA on June 6, the taxable treatment of his April 14 withdrawal from his traditional IRA was still unresolved since he had not yet repaid those funds. However, by recontributing funds on June 10 to his traditional IRA, he satisfied the requirements of Code Sec. 408(d)(3)(A) for a nontaxable rollover contribution, and the April 14 distribution was therefore not includible in the taxpayers’ gross income. Thus, Alvan had already received a nontaxable distribution from his traditional IRA on April 14 when he received a subsequent distribution from his rollover IRA on June 6.
Finally, the Court took note that Alvan received two distributions on April 14. It said that it would be inappropriate to read the Code Sec. 408(d)(3)(B) limitation on multiple distributions so narrowly as to disqualify one of the April 14 distributions as nontaxable under Code Sec. 408(d)(3)(A). So, it treated the amounts distributed on April 14 as one distribution for purposes of Code Sec. 408(d)(3)(A).
The July 31 distribution to wife was repaid too late. IRS put forth two arguments as to why the July 31, 2008, distribution was ineligible for nontaxable rollover treatment: (1) the funds were not returned to a retirement account maintained for Elisa’s benefit, and (2) repayment of funds was not made within 60 days.

As to argument (1), IRS asserted that because she distributed the funds first to the taxpayers’ joint account and the taxpayers thereafter transferred $65,064 from their joint account to husband’s rollover IRA, the July 31 distribution was paid into an IRA set up for Alvan’s benefit and not into an IRA set up for Elisa’s benefit. The Court disagreed with that argument: it said that money is fungible, and the use of funds distributed from an IRA during the 60-day period is irrelevant to the determination of whether the distribution was a nontaxable rollover contribution.

The Court did agree with IRS’s second argument. Partial repayment was not made until Sept. 30. Sixty days after July 31 was Sept. 29


H. Quincy Long is a Certified IRA Services Professional (CISP) and an attorney. He is also President of Quest Trust Company, Inc. (www.QuestTrust.com), a self-directed IRA Custodian with offices in Houston, Dallas, and Austin, Texas, and clients Nation-wide. He may be reached by email at Quincy@QuestTrust.com. Nothing in this article is intended as tax, legal or investment advice.

© Copyright 2013 H. Quincy Long. All rights reserved.

Wealth Building Options for Your IRA

Estimated reading time: 8 minutes

In my last article on Option Strategies for Your IRA, I discussed option basics. In this article I will expand on the uses of options and how these strategies might be used to turn small amounts of cash into tremendous wealth in your IRA.

Simple Options. The most basic type of option is simply to have an option to purchase a piece of property for a specified price within a certain period of time. This is much better than a loan because it is similar to zero percent interest financing. For example, if a Health Savings Account (HSA) has a five year option to buy a piece of property for $50,000.00, then the HSA does not owe any more for the property at the end of the five years than it did at the beginning, yet the HSA effectively controls the property. This amounts to a five year, zero percent interest loan, but with no unrelated business income tax (UBIT)! You could even structure the option to have monthly or yearly renewal fees, so that it feels similar to a regular seller-financed loan for the property owner. With options all the burdens of owning the property, such as property taxes, insurance, and maintenance, continue to be on the property owner, thereby reducing your IRA’s risk!

Fix Up and Sell Options. Many investors are familiar with the typical buy, rehab and resell strategy for real estate. Suppose you created a deal in your Roth IRA where the repairs to be done are the consideration for the option? You and the property owner would agree on a specific list of repairs to be done, and the money for the repairs would come from your IRA. The option price would be based on the value of the property in its current condition. When the repairs are done the value of the property will have substantially increased, but your IRA has an option to purchase the property at the lower price. The value of your Roth IRA’s option is equal to the difference between the current, after repair fair market value and the original option price. As discussed in the prior article, your Roth IRA may, among other choices, 1) exercise its option and purchase the property, 2) assign the option for a fee to a retail buyer and let him purchase the property directly from the property owner, or 3) allow the property owner to sell directly to a retail buyer at a higher price while paying your Roth IRA a substantial fee to cancel the option!

Options on Ugly Property. What do you do if you locate a property that you think could probably be sold for a profit, but it is such a trashy piece of property or has so little equity that you are nervous about your IRA taking title to it? The solution is simple: have your IRA purchase an option from the property owner, stick a sign on the property, and try to find a buyer for the property which will give your IRA a profit. Options under these circumstances can often be purchased with very little money from your IRA. Even if your IRA ends up not exercising its option sometimes, overall this can be an incredibly powerful wealth building strategy.


Options on Partial Interests. What if there were several heirs owning a property you wanted your IRA to buy, but the heirs did not get along or did not agree to a certain price? Rather than giving up, have your IRA buy an option to purchase each heir’s interest separately.

The price would not have to be equal to each heir. Once you have negotiated options with all the heirs, you could add up the price and see if your IRA could market the property for a profit.

Low Ball Offers and the Right to Cancel. Suppose you want to make a low ball offer on a piece of property. The seller wants too much for the property, and you think he won’t get his price. On the other hand, he has to sell by a certain date for whatever reason (foreclosure, closing on a new house, moving out of town, etc.). Tell the seller this: “If you sell my daughter’s Coverdell Education Savings Account (ESA) an option to purchase the property for my price, I will give you the right to cancel the option within the next 30 days if you return the option fee plus $2,500.00. That way, if you find someone to pay you more than you would get from me who can close quickly enough you can sell the property to them and cancel the option, but you know you have a guaranteed sale if you can’t sell it to someone else on time.” How’s that for overcoming objections to a low ball offer? Your daughter’s ESA either gets the property at a bargain price or the seller pays her ESA not to buy!

Long Term Options. Long term options can be particularly powerful within an IRA, especially if your retirement is not imminent. Although many options used by IRAs are for shorter time periods, a long term option can turn out to be a fantastic investment. For example, in Houston, Texas there is an area called the Heights. This is close to downtown and many urban professionals are purchasing property in the area to avoid the horrible commute. Old properties are being purchased by individuals and developers who knock the houses down and build new homes on the lots. It is an area in transition. Prices have skyrocketed. Wouldn’t it be great if your IRA had 5 or 10 year options on several pieces of property in a redeveloping area such as the Heights or in the growth path of a city? Even if the option was to purchase the property for full fair market value or higher in today’s market, the longer term of the option may allow for a natural increase in the fair market value of the property

Rights of First Refusal. Another technique that can be used either alone or in conjunction with an option is a right of first refusal. A right of first refusal by itself is not an option to buy. It only means that the seller agrees not to sell the property to anyone else before first offering it to the holder of the right of first refusal. This is commonly used in business transactions, and can be used in real estate as well. Sales price and other terms are not typically negotiated in a pure right of first refusal, since it is only the right to buy the property at whatever price and on whatever terms the owner wants to sell.
When combined with a long term option, this strategy can pay off even if the option price is as high or higher than the current fair market value. For example, what if your IRA has an option to purchase a property in a growth path area for $100,000.00, and the option has a right of first refusal clause in it. In other words, any time the property owner wants to sell the property to a third party he would have to offer it to your IRA under the same terms. If the property owner wants to sell the property to a third party for $80,000.00, your IRA will also have the option to purchase it for that price because your IRA’s option has a right of first refusal clause. But suppose $80,000 is at or near the current fair market price and so exercising the option is not a good deal for your IRA. Assuming your option agreement is structured in a way that the option does not expire merely because of a transfer of ownership, the new owner of the property will have to take the property subject to that option. This of course limits his ability to sell the property in the future for more than your option price. Also, if a notice of option is filed in the real property records the buyer’s lender may require that the option be released. What is the value of your option under these circumstances, even though it is at a higher price than the current fair market value? The answer is however much the owner and buyer are willing to pay your IRA to cancel the option if that’s what you want!

Options and Shared Appreciation Mortgages. Has your IRA ever made a hard money loan and you thought, “I’d sure like my IRA to have a piece of that property! What a great deal!” Here is an interesting concept: loan the money to the investor at a low interest rate in exchange for an option to purchase a certain percentage of the property at the initial purchase price. One investor I know was able to use this method to purchase a property at a discount with a tenant in the property. Because the tenant was already in the property with a long term lease, he could not make the deal work using regular hard money rates. His solution was to borrow the money for the purchase and rehab from a friend’s IRA. The IRA received 6% interest plus an option to purchase a 50% interest in the property at one-half original purchase price. The investor walked away from closing with $3,000 in his pocket, a rental property with cash flow, and 50% of the future appreciation! Another possible structure is a loan with an option to convert from debt to equity.

Options on Personal Property. Options are most commonly discussed in terms of real estate. However, there is nothing which says you cannot purchase an option on personal property. For example, in many states the beneficial interest in a land trust is considered to be personal property. You may want to have your IRA purchase an option on a discounted note to see if it can be sold for a profit. I have even heard of people having an option in their IRA on automobiles being purchased by an investor at car auctions.

Options can be purchased in all types of Quest self-directed accounts, including Roth, traditional, SEP and SIMPLE IRAs, Individual 401(k)s, Coverdell Education Savings Accounts (ESAs), and even Health Savings Accounts (HSAs). Options are so incredibly powerful and flexible that I cannot discuss all the opportunities in one short article. I hope this article has opened your mind to new possibilities for your IRA. As I always say in the context of self-directed IRAs, “I don’t think outside the box, the box is just bigger than you think!”

To Pay or Not to Pay – That is the Question Unrelated Business Income Tax in Retirement Plans

Estimated reading time: 4 minutes

Most people understand that an IRA is normally not a taxable trust and its income is not taxed until the income is distributed (or not at all, if it is a qualifying distribution from a Roth IRA). However, there are 2 circumstances when an IRA may owe tax on its income. First, if the IRA is engaged in an unrelated trade or business, either directly or indirectly through a non-taxable entity such as an LLC or a limited partnership, the IRA will owe tax on its share of Unrelated Business Income (UBI). Second. if the IRA owns, either directly or indirectly, property subject to debt, it will owe tax only on the portion of its income derived from the debt, which is sometimes referred to as Unrelated Debt Financed Income (UDFI).

I will refer to either tax as Unrelated Business Income Tax (UBIT) in this article.
From a financial planning perspective, the question becomes “Should I avoid doing something in my IRA which may incur UBIT?” Many people just say “Forget it!” when they learn a certain investment may subject the IRA to UBIT. Or worse yet, they ignore the issue and hope they won’t get caught. However, being afraid of UBIT is short sighted and ignores the opportunity it presents for building massive wealth in your retirement plan. Remember, making an investment which may subject the IRA to UBIT is not a prohibited transaction, it just means the IRA has to pay a tax. The best financial advice on UBIT is simple: “Don’t mess with the IRS!” If the IRA owes UBIT, make sure it is paid.
“But,” you object, “doesn’t this mean I am paying double taxation?” Unless your IRA is a Roth IRA, it is true that in these 2 circumstances the tax will be paid by the IRA and again by the IRA holder when the income is distributed. However, in my view this is the incorrect focus. Is the IRA glass 1/3 empty or 2/3 full? At least the IRS is a silent partner. The double taxation issue is no different when investing in stocks traded on the stock exchange, since corporations pay tax on income before issuing dividends to shareholders, and the value of the stock takes into account that the company must pay income taxes.
Two key questions arise when analyzing a “UBIT investment.” The first question to ask in UBIT analysis is “What tax would I pay if I did the same transaction outside of my IRA?” The only “penalty” is the amount of tax the IRA would pay above the amount that you would pay individually. If you make the investment personally, you not only will pay tax on the income from the investment, but also from the next investment, and the next one after that. At least within the IRA you have the choice of making investments with your proceeds which do not incur UBIT. A second question to ask is this: “Will my after UBIT return exceed what I could make on other IRA investments?” Why should you turn away from an investment in your IRA which will give you an incredible return even after paying the tax?
Let me give you one powerful example of how paying UBIT might make a lot of sense. One Quest client purchased a property in her Roth IRA subject to approximately $97,000 in delinquent taxes (this is the same as a mortgage for UBIT purposes). The owner was willing to walk away from the property for $75 just to get rid of the headache and the lawsuit pending against him by the taxing authorities. With closing costs the IRA spent around $3,000 to acquire the property. Only 4 months later the property was sold to another investor, and the Roth IRA netted around $46,500 from the sale after paying delinquent taxes and sales expenses. Because the IRA purchased the property subject to debt (the delinquent taxes), it owed UBIT in the amount of approximately $13,500 on its short term capital gain. This meant that even after paying UBIT the IRA went from $3,000 to approximately $33,000. That is a return of over 1,000% in under 4 months, or an annualized return of over 4,000%! This client will obviously have an easier time making money with her $33,000 Roth IRA than she could have with her $3,000 IRA. Since this was a Roth IRA, no more tax will be owed on this income if it is distributed as a qualified distribution after age 59 ½ or from any other income generated in this IRA from investments that are not subject to UBIT.

Ignorance of the tax law is no excuse. You can find out more on this topic by reviewing IRS Publication 598, or by visiting with your tax advisor. After analyzing a transaction, you may come to the conclusion that paying UBIT now in your IRA may be the way to financial freedom in your retirement. Like I often say, “UBIT? You bet!” The information contained in this article is not intended to be tax or investment advice.

How Do I Invest Thee? Let Me Count the Ways!

Estimated reading time: 10 minutes

Many people find it very easy to see the benefits of self-directing their Roth and Traditional IRAs, SEP IRAs, SIMPLE IRAs, Individual 401(k)s, Coverdell Education Savings Accounts (ESAs) and Health Savings Accounts (HSAs) into something other than the same old boring stocks, bonds, annuities and mutual funds. The central idea of a self-directed IRA is that it gives you total control of your retirement assets. With a self-directed account you can invest your IRA funds in whatever you know best.
When I spoke recently at John Schaub’s Real Estate All Stars conference in Las Vegas, Nevada, I outlined some of the top strategies our clients have actually used to build their retirement wealth. A brief description of these strategies is included in this article. This shows the tremendous flexibility of investing through a self-directed account.

Strategy #1 – Purchasing Rental Real Estate for Cash. Even the IRS acknowledges on its website that real estate is an acceptable investment for an IRA. In answering the question “Are there any restrictions on the things I can invest my IRA in?” the IRS includes in its response that “IRA law does not prohibit investing in real estate but trustees are not required to offer real estate as an option.” One of our clients purchased a 10 unit apartment complex for $330,000 cash. In April, 2008 his total rent collection was $5,235. Even after payment of taxes and insurance, his cash on cash return is excellent, and the client believes that the value of the property will increase significantly over time. A discussion of the relative benefits and disadvantages of owning real estate directly in an IRA is beyond the scope of this article, but for those who know how to successfully invest in real estate it is great to know that real estate is an option for your self-directed account.
Strategy #2 – Purchase, Rehab and Resale of Real Estate. In this case study, our client decided not to hold onto the real estate purchased with his IRA. The client received a phone call one evening from an elderly gentleman who said he needed to sell his home quickly because he wanted to move to Dallas with his son. After a quick phone conversation, it was clear that the price the seller wanted was a bargain even considering the needed repairs. Our client dropped what he was doing and immediately headed over to the seller’s house with a contract. The buyer on the contract was our client’s IRA, and of course the earnest money came from the IRA after the client read and approved the contract and submitted it with a buy direction letter to Quest Trust Company. They agreed on a sales price of $101,000. Approximately $30,000 was spent rehabbing the property with all funds coming from the IRA. The property was sold 6 months later for $239,000, with a net profit after sales and holding expenses of $94,000!
Strategy #3 – Purchase and Immediate Resale of Real Estate (Flipping). The previous two examples show the tremendous power of buying real estate for cash with a self-directed IRA. However, both of these strategies require a significant amount of cash in your account. How else can you invest in real estate if you have little cash? One of our clients was able to put a commercial piece of vacant land under contract in his Roth IRA. The sales price was $503,553.60 after acreage adjustments. Using his knowledge of what was attractive for a building site, our client was able to negotiate a sales price to a major home improvement store chain for $650,000. On the day of closing Quest received two sets of documents, one for the purchase of the property for $503,553.60 and the other for the sale of the same property for $650,000. After sales expenses, the IRA netted $146,281.40 from the sale with only the earnest money coming from the account! A word of caution in this case is that if property is flipped inside of an IRA the IRS may consider this to be Unrelated Business Taxable Income (UBTI), causing the IRA (not the IRA owner) to owe some taxes on the gain. Even if taxes had to be paid, it is hard to argue that this transaction was not beneficial to the IRA and ultimately the client! It should also be noted that in this situation everyone involved in the transaction was aware of what everyone else was doing, so there was no “under the table” dealings.


Strategy #4 – Assignments and Options – Getting Paid NOT to Buy! Another favorite strategy for building tremendous wealth without a significant amount of cash is the use of options and assignments. One of our clients put a property under contract in his daughter’s Coverdell Education Savings Account for $100. The sales price was a total of $5,500 because the house had burned down. The seller was just getting rid of the property for its lot value since he had already received a settlement from the insurance company and had purchased another house. Our client then used his contacts to find a person who specialized in rehabbing burned out houses. The new buyer was willing to purchase the property for $14,000 cash. At closing one month after the contract was signed, the seller received his $5,500 and the Coverdell ESA received an assignment fee of $8,500 right on the settlement statement. That is an astounding 8,400% return on the $100 investment in only 30 days! Even better, our client was then able to take a TAX FREE distribution from the account of $3,300 to pay for his 10 year old daughter’s private school tuition. In a similar transaction, another client’s Roth IRA recently received an assignment fee of $21,000 plus reimbursement of earnest money for a contract.
Strategy #5 – Using the Power of Debt Leveraging. One of my favorite true stories of building wealth in a Roth IRA involves purchasing property subject to a debt. If an IRA owns debt-financed property either directly or indirectly through a non-taxed entity such as a partnership or LLC taxed as a partnership, profits from that investment are taxable to the same extent there is debt on the property. One of our clients used her knowledge of real estate investing and what she learned from a free Quest educational seminar to tremendously boost her retirement savings. After noticing a large house in downtown Houston which was in bad shape but in a great location, our client tracked down the owner in California who was being sued for approximately $97,000 in delinquent taxes on the property. She negotiated a deal with the seller for her Roth IRA to purchase the property for $75 cash subject to the delinquent taxes. With closing costs her Roth IRA’s total cash in the transaction was only around $3,000. Within 4 months she was able to sell the property for a profit to her Roth IRA of $43,500! Because the property had debt on it and because her Roth IRA sold the property for a short term capital gain, the taxes on the profit were approximately $13,500. Still, using the power of debt leveraging her Roth IRA was able to achieve a 1,000% return in less than 4 months even after paying Uncle Sam his share of the profits!


Strategy #6 – Hard Money Lending. Another excellent strategy for building your retirement wealth is through lending. Loans from IRAs can be made secured by real estate, mobile homes or anything else. Some people even choose to loan money from their IRAs on an unsecured basis. As long as the borrower is not a disqualified person to the lending IRA, almost any terms agreed to by the parties are acceptable. In many states there are limits to the amount of interest that can be charged, and loans must be properly documented, but IRA law does not impose any limits other than the prohibited transaction rules. For those wanting to avoid the direct ownership of real estate within their IRA, a loan with an equity participation agreement is often used. Several of my own self-directed accounts combined together recently to make a $25,000, 7 1/2 year, 12% first lien loan against real estate with 6% in points up front. True, this is not exactly setting the world on fire as far as return on investment goes, but I was very pleased with a safe return on a relatively small amount of cash. If I get to foreclose on the collateral my accounts should be able to make a substantial profit, since the land securing the loan was appraised at $45,000. At my office we routinely see hard money loans secured by first liens against real estate with interest at 12%-18% for terms ranging from 3 months to 3 years.
Strategy #7 – Private Placements. Many of the best opportunities for passive growth of IRAs include the purchase of private limited partnership shares, LLC membership units and private stock which does not trade on the stock market. Let me give you two examples from my own retirement account investments. In one case my 401(k) plan invested in a limited partnership which purchased a shopping center in northern Louisiana. The initial investment was $50,000, and in a little over 2 years the partnership has returned $59,321. The plan’s remaining equity is estimated as of 12/31/2007 at $31,598 and the return on investment will be around 82%. Even though the property is debt-financed the taxes on the profit have been almost nothing since the plan has taken advantage of depreciation and all of the normal deductions. Once your IRA or other plan owes taxes due to debt financing, it gets to deduct a pro rata share of all normal expenses. Another of my 401(k) plan investments is bank stock of a community bank in Houston, Texas. The initial shares were sold at $10 per share in February, 2007. The book value after less than 1 year of operations was $11 per share, and shares have recently been selling to other private investors for as much as $14.25 per share! That is a great return for a completely passive investment, and when the bank finally sells the shares are expected to sell for well above these amounts.


Strategy #8 – Owning a Business in Your IRA. One of the most innovative strategies we have seen is the ownership of a business by an IRA. Although neither you nor any other disqualified person may provide services to or get paid for working at a business owned by your IRA or other self-directed account, this does not mean that your IRA cannot own a business. Some companies do market the ability for you to start a C corporation, adopt a 401(k) plan, roll your IRA into the plan, and purchase “qualifying employer securities,” but this is different than an IRA owning a business directly. For example, my Health Savings Account invested $500 for 100% of the shares of a corporation which arranges for hard money loans to investors. The company is fully licensed as a Texas mortgage broker. The structure of the company is a C corporation. Since being a mortgage broker is a business operation, profits from the venture would have been taxable to my HSA if the entity formed to own the business was not taxable itself, and the tax rates for trusts such as IRAs and HSAs are much higher than for corporations. While normally dividends from C corporations are taxable a second time to the shareholder, dividends paid to an IRA or HSA are tax free as investment income. The corporation is run by non-disqualified persons who handle the due diligence on the loans and the legal work, as well as by a licensed Texas mortgage broker who sponsors the corporation’s mortgage broker license.


Strategy #9 – Using OPI (Other People’s IRAs) to Make Money Now. Even if you have not found the investment strategy of your dreams among the strategies discussed in this article, or if you have no IRA or if you are more focused on making money now to live on, your time spent reading this article can still be of great use to you. For each of the above strategies I have focused on the possibility that your IRA could be the investor. But what if you are the recipient of the IRA’s investment money? Are you a real estate investor having a hard time finding funding for your transactions? If you know people with self-directed IRAs or people who would move their money to a self-directed account, you can borrow their IRA money and virtually create your own private bank! You can also partner with OPI where the IRA puts up the money and you share in the equity for finding the deal and managing the project. Simply by explaining to people that they can own real estate in their IRAs you may be able to sell more property, either as a real estate broker or as the seller. You can even provide financing for your sales by having OPI make loans to your buyers. Finally, OPI can be a great way to raise capital for your business venture, although you must be aware of and comply with all securities laws. One bank I know of told me that 42% of their initial capital came from retirement accounts! Although you cannot use your own retirement account to benefit yourself at present unless you are over age 59 1/2, these are just some of the ways you can use OPI to make money for yourself right now. A good network is the key to your success.
What I have discussed in this article have been some of the more common investment strategies actually used by our clients. The only restrictions contained in the Internal Revenue Code are that IRAs cannot invest in life insurance contracts or collectibles. Almost any other investment that can be documented can be held in a self-directed IRA. As long as you follow the rules and do not invest in prohibited investments, your only real limitation is your imagination!

Top Ten Mistakes I See People Make With Their Self-Directed IRAs

Estimated reading time: 7 minutes

1) Not understanding the “self-directed” part of self-directed IRAs.
Unlike more traditional brokerage style IRAs, self-directed IRAs do not come with any tax, legal or investment advice, nor do self-directed custodians and third party administrators offer or endorse investment products. Self-directed means just that – it is self-directed and you must find your own investments and decide how you want to structure those investments. If you make a million dollars in your self-directed IRA all the glory belongs to you, but if you lose everything you have there is no one to blame but yourself.
2) Not investing in what they know best, but rather investing in something they know nothing whatsoever about.
One of the primary benefits of a self-directed IRA is that it allows you to invest in what you know best, especially if that is not the more traditional IRA investments like stocks, bonds, mutual funds or annuities. Some people get very excited about the idea of self-direction and invest in something they know nothing about, which often leads to an investment disaster. Most of my mistakes in investing have been because I have strayed from what I know how to do best.
3) Not understanding the disqualified persons and prohibited transaction rules.
Disqualified persons are those persons who are deemed to be too close to make a transaction within your IRA an arms-length transaction, which means these persons cannot enter into transactions with your IRA nor can they benefit from those transactions, either directly or indirectly. Prohibited transactions are what your IRA cannot do with any disqualified person. The penalty for entering into a prohibited transaction is DEATH (of the IRA that is) along with taxes and penalties. If you have a self-directed IRA you must have a good basic understanding of these rules as they apply to your investing strategy.
4) Not vesting assets correctly – all assets in self-directed IRAs should be vested as follows: “Quest Trust Company, Inc. FBO Your Name IRA #Your IRA Number.”
A lot of time is spent in attempting to get clients, title companies, and investment providers to understand that all assets must be vested in a specific way in order to be held within a self-directed IRA. Common errors include failing to vest in the name of the custodian or administrator at all, or only putting the client name after the “FBO” so that it appears we are holding the asset on behalf of the individual instead of the individual’s IRA. Another common mistake is where the client attempts to use their own Social Security Number instead of that of the IRA or the administrator or custodian’s trust tax identification number.


5) Failing to submit proper paperwork to allow smooth opening of IRAs and processing of transactions.
Another large time waster is chasing down paperwork from improperly completed documents for opening the IRAs, for transferring money into the IRAs and for transactions. This leads to a frustrated client and frustrated staff. Taking the time to learn how to properly submit paperwork and allowing yourself enough time to do so is critical in successfully navigating the self-directed IRA world. Remember, it is better to ask questions in advance than to submit incorrect paperwork and cause a delay.
6) Not understanding what they are investing in.
This is a big one. It is almost incomprehensible to me how some people don’t have any understanding of what they are investing in at all. For example, a person called the other day and thought she had a note and an option agreement. Instead, she had a simple option where she had paid $28,000 for an option to buy 50% of the property for $10. This was meant to help the owner out of foreclosure. The homeowner had the right to buy back the option at a profit to the IRA of about $5,000. The good news is that it worked for a time period and the homeowner got to stay in the house for an extra two years. The bad news is that the homeowner still wasn’t fiscally responsible and the IRA lost every dime when the lien holder foreclosed. Since all the IRA had was an option (not a note as she thought) she could not even sue to recover some of her money, and even if she had exercised her option her IRA would have only owned half of the house.
7) Not understanding Unrelated Business Income Tax and how it may affect your IRA.
IRAs may be taxed in three circumstances. First, if it runs a business, either directly in the IRA or indirectly through a non-taxed entity such as a partnership or LLC. Second, if the IRA owns and rents out personal property (rents from real property are exempt from this tax). Third, if the IRA owns debt-financed property, again either directly in the IRA or indirectly through a non-taxed entity such as a partnership or LLC. Just to be clear, it is not necessarily all bad to make investments which cause your IRA to pay tax, especially within a Roth IRA or other tax free account, but it is something you should understand up front.
8) Trusting someone with your hard earned IRA money without doing proper due diligence and proper paperwork.
Let me give you a hint – con men are very good at what they do. Make sure you understand what you are investing in, and do your due diligence on the investment and on the person you are investing with before making an investment decision. Also, make sure you have proper paperwork. I wouldn’t loan money to my own mother without proper documentation! Proper paperwork protects both your IRA and the person your IRA is investing with. Think about what would happen if either you died or the person you invested with died. Would either party’s heirs understand what the investment was all about? Even if you trusted the person you invested with absolutely, would their heirs know about your handshake deal and honor it? Probably not! An excellent rule of thumb in investing is that if it sounds too good to be true it probably is. Also, a common thread in scams is that it must be done NOW or you will miss out on this incredible opportunity! This is an attempt to draw you in without allowing you time to think about or due diligence on the investment.


9) Failing to follow proper strategy when loaning your IRA to other investors.
There are at least 10 simple rules to follow when lending your IRA money out (or even your personal money). They are:
a) Do not loan on something you wouldn’t be excited to own if the borrower defaults.
b) Generally, do not advance money for repairs until the repairs are done, and then inspect the repairs before advancing the funds.
c) Do not loan to someone you would feel uncomfortable foreclosing on!
d) If the loan goes into default, do not delay – take action immediately!
e) Collect interest monthly so you will know if the borrower is getting into trouble.
f) If you are unsure about a loan, hire a professional to help you evaluate the deal (at the borrower’s cost, of course!).
g) Get title insurance on your loan. If done at closing the incremental cost to the borrower is very small.
h) Verify that hazard and, if necessary, flood and wind insurance are in place naming your IRA as an additional insured.
i) Insist on evidence that taxes, homeowners association dues and hazard insurance are paid when they come due during the term of the loan.
j) Get a personal guarantee when lending to a non-individual borrower or a weak borrower.


10) Attempting to figure out how to get around the rules to get a benefit for themselves or other disqualified persons rather than simply investing within the rules.
It seems to be very tempting for people to want to use their own IRAs to make money or obtain some other benefit for themselves or other disqualified persons right now instead of letting all the benefits go to the IRA so that they have a nice retirement. To make matters worse, a lot of gurus are teaching how to hide the fact that you are violating the rules instead of teaching people how to use the rules properly to their advantage. My personal motto is, use the law to your advantage but don’t abuse the law. After all, the “R” in IRA stands for Retirement. It is not an INA (or Individual NOW Account)! To make money now, use OPI (Other People’s IRAs), and to make money for your retirement, use your own self-directed IRA.

Investor Awareness: Private Placements

Estimated reading time: 3 minutes

A private placement is the sale of securities to a limited number of qualified private investors. While an IPO is the initial sale of shares to the general public, a typical private placement is offered only to institutional investors and accredited individuals and entities that meet certain eligibility requirements.


For companies, private placements can provide an infusion of cash more quickly and less expensively than a public offering. Private placements are also generally not subject to public disclosure obligations. They typically allow companies to have a great deal of control over the process – the company can decide how much to sell, at what price, and to whom. However, those decisions do require a tremendous amount of due diligence and careful deliberation.


Private placements are exempt from the registration requirements of the federal Securities Act of 1933 and public disclosure requirements as long as certain requirements are met. The sale of securities through private placements cannot involve any public offering, public solicitation, or advertising. In addition, private placements must comply with state laws and anti-fraud provisions of securities laws. Companies must disclose to potential investors all of the pertinent information needed to make a fully informed decision.


Securities sold through private placement securities can take different forms. Typically, they involve the sale of either debt or equity.


Investments in private placements carry a high degree of risk for various reasons. Securities sold through private placements are not publicly traded and, therefore, are less liquid. Additionally, investors may receive restricted stock that may be subject to holding period requirements. Companies seeking private placement investments tend to be in earlier stages of development and have not yet been fully tested in the public marketplace.


Investing in private placements requires high risk tolerance, low liquidity concerns, and long-term commitments. Investors must be able to afford to lose their entire investment.

A company seeking a private placement issues a Private Placement Memorandum or PPM. The PPM details the company’s financial situation and business plan, as well as any other pertinent information about the company and the offering. Once investors decide to invest, they complete a subscription agreement.


Due diligence begins with a background inquiry on the company and its management and an analysis of all the information presented by the company and its offer. The principal thrust of due diligence focuses on compensation, self-dealing, background of insiders, litigation history or potential, risks and accurate discussion of the nature of the business. An internet search can provide essential information. Do not depend on the accuracy of information supplied by the company or its agent, but engage in an independent investigation that is customized for each offering. Most offerings may have certain unique features that require additional due diligence. Ask for clarification on any information provided that you do not understand and request back up documents to support their claims. Remember that Ponzi schemes pay until they can’t so follow the money and make sure the income is income.

Investor Awareness: Promissory Notes

Estimated reading time: 2 minutes

New Real Estate Loans:

IRAs can loan money for the purchase of real estate including property owned by the IRA, but not persons defined in prohibited transactions. The IRA should insist that the buyer complete a detailed loan application form and thoroughly verify all of the information the buyer provides. That includes running a credit check and verifying employment, assets, financial claims, references, and other background information and documentation. The IRA owner is responsible for negotiating mortgage rates and terms with the borrower.


Title Insurance

Loan closings should be held in a title company or attorney’s office and a mortgagee title insurance policy issued in the name of the IRA.

Hiring a Loan Servicing Company

The IRA can hire a loan servicing company to help draw up the mortgage, mail statements to the buyers, collect payments, and otherwise administer the mortgage. If loan payments are made to the IRA, the IRA owner is responsible for keeping a record of principal, interest and escrow.


Preexisting Notes, also referred to as cash flows, mortgages, trust deeds, paper:

A note is a debt. When you buy a note, you buy a debt. A note is always written. It is never just an oral agreement. A note is signed by the payor, the party who owes the money. When you buy notes, you’re actually buying a certain kind of note: a seller-financed note. This type of note originates when a real estate owner sells property to a buyer and extends credit for any amount left owing after the down payment, plus interest. The debt is between the seller of the property and the buyer. The buyer of the property becomes the payor on the note. The seller of the property receives the payments made by the payor. You can buy the seller-held note for cash — at a discount. You will pay less than the full amount owing on the note, and you will receive payments over time from the payor for the full amount. It’s a three-cornered relationship: you, the seller and the payor which is different than making a new real estate loan.


Things to ask for:

  • Copy of note and deed of trust document or other mortgage documents
  • Verification of payment history
  • Copy of HUD statement for original purchase
  • Statement verifying types and amount of improvements/rehabs completed
  • Copy of latest real estate tax bill
  • Copy of hazard insurance policy
  • Verification of title insurance

Investor Awareness: Real Estate

Estimated reading time: 3 minutes

Purchasing and owning real estate in your IRA, whether it’s a single family rent house, vacant land or a 50 unit apartment building, it will require a time-consuming process of additional due process. It means taking caution, performing calculations, reviewing documents, procuring insurance, walking the property, essentially doing your homework for the property before you actually make the purchase. Here are a few of the steps:

Know the contract. Read the contract. Be one with the contract. The contract should allow you time, from one week to a couple of months, depending on the nature of the investment property, to perform due diligence and be able to walk away for any reason and have your earnest money returned in full. If you need help with the contract, rely on a real estate professional or an attorney experienced in commercial real estate. If a seller pushes you vigorously to shorten your time-frame, train your mind to hear a warning buzzer.

Title Review

One of the first things you should examine as part of your due diligence is the title history on the property. All title documents are public records that can be researched and reviewed. A thorough title review will expose whether there is any litigation pending that might threaten the title of the property, whether the seller actually has title to the property, and whether the seller has any encumbrances or financial obligations attached to the property such as a mortgage or tax lien.


Have a professional inspection performed on the property. A licensed, professional inspector can review the structural integrity of any building on the property and can also point out any potential physical problems with the property.


An appraisal will give you a third-party estimate on the value of the property. This will tell you whether the amount of money you’re about to spend on the property is worth what you think it is. Appraisals are generally necessary if you want to finance the real property purchase with a mortgage loan, but you should get an appraisal even if you are paying cash because it will help you evaluate the value of the investment.
Environmental Assessment

If a visual inspection of the property reveals any potential environmental hazards or problems, you should consider ordering an environmental assessment of the entire property. Things that might cause you to order an environmental report include leaking gas or oil containers, former use of the property as a manufacturing or mining facility, or possible wetlands or clean water issues associated with water on the land.

Land Use Controls

Your final consideration should be whether the property is zoned for the purposes that you want to use the property for. For example, if you want to use the property to start a business, you need to verify with the local zoning authority that the property is zoned for commercial or that you have a reasonable chance of having the property rezoned as commercial.

Commercial Real Estate

Requires more in-depth due diligence and you will want to get a rental history, vacancy rates, maintenance fees, property management fees (if property management needs to be hired out), taxes, insurance, leases (read the leases very carefully – Triple net? – who pays what? – who’s responsible for what? ect.). You’ll want to investigate your financing options, determine your fixed and variable costs, in order to see if your return on investment is in line with what you had in mind.