Transcript:

Bernard Reisz  0:00  

What makes real estate tax efficient outside of an IRA will make it equally tax efficient. If a tax does apply inside of an IRA, that you get all your interest expense, your insurance, your mortgage interest, your depreciation, you get all those deductions.

Taylor   0:17  

Welcome to passive wealth strategies for busy professionals. Today, our guest is Bernard. Bernard is going to teach us about the crucial differences between a checkbook control IRA and your standard run of the mill, self directed IRA. 

There’s a huge advantage, a lot of huge advantages to the checkbook control IRA, we’re going to get into other myths about self directed investing, and talk about you bit UDFI lot of tax stuff

Without any further ado, here we go.

Bernard, thank you for joining us on passive wealth strategies today.

Bernard Reisz  0:55  

Taylor, great to be with you. And looking forward to the show.

Taylor   0:59  

Yes, I’m really excited for this topic. We were talking before we started recording about the top the various topics around investing in real estate with tax advantaged retirement accounts. But before we get into that, could you tell the listeners a bit about your background so that we can all know where you’re coming from and what you do?

Bernard Reisz  1:20  

Certainly, I by training, I am a CPA. In addition to that I’ve got a couple other financial licenses and certifications. And my focus is really taking a deep dive into areas of tax and legal to kind of Taylor solutions for each individual investor profile. Prior to starting my own practice and business. I was in management consulting, working with very large middle market firms and the business owners of those companies.

Taylor   1:55  

Thanks for your you have quite the background and your this is a great topic for real estate investors to learn about the tax strategies that we can use when we’re investing in real estate and today we’re going to talk about retirement account investing, which is a very broad topic. 

And we’ve talked about self directed IRAs on the show in the past, I use a self directed IRA to invest in syndications. But before we got started recording, you were telling me about solo 401k, K’s and checkbook IRAs, these are all things that, you know, maybe some folks know about. And there are a lot of misconceptions around though I wanted to get started talking about checkbook IRAs, because I had a lot of misconceptions around that. 

Because I was told by a custodian, a self directed IRA custodian, that there were some significant disadvantages to the checkbook, Ira and 401k hearing from you, that isn’t necessarily the case, or might not necessarily be the case. So what’s what’s the deal here with the checkbook IRA? Tell me about it.

Bernard Reisz  3:09  

Awesome question. And I love I love that question. And what it boils down to is that in the financial industry, it’s really all about incentives. And just like we understand that financial advisor that works at your local bank, will never tell you about self directed IRAs and real estate and IRAs. And we know why he won’t tell you about that. That’s because, you know, if the assets go to real estate, they’re not part of his AUM, it’s not part of his assets under management. 

He can’t get his broker commissions or get his percentage fees on that money. So we recognize that when when dealing with the traditional financial world, and that financial advisors, they don’t tell you about real estate, because it’s not in their best interest. Yes, well, when you move over to real estate investing, so you’ve kind of broken through that barrier, you know, your financial advisor, or somebody has told you that you’re gonna go to jail if you invest your IRA and real estate product, but you saw the light, and you know that the IRS is totally cool with you investing in real estate within an IRA.

 So now you get into that space, the biggest players in that space, are trust companies. And trust companies are on the business of administering IRAs. And they derive revenue from two things. They get and varies they have different models. But let’s talk about broadly speaking, how they’re making money. 

So they have transaction fees. And that’s anytime you want to do something, you get dinged with a fee, they may have acid under management fees as well, that’s slowly diminishing, you know, the ones that have that fee structure is going away. But ironically, in the self directed space to some custodians, that will take a percentage of your assets, and have nothing to do with investments whatsoever. So they have fees. The other way they’re generating revenue is by or generating some sort of ancillary benefit is by holding the funds. So when you have money sitting by them, they are deriving benefits, they are entitled generally to the interest on those funds. And you may think that, hey, I’ve only got maybe 10s of thousands or hundreds of thousands of dollars there. But when you think about it from the custodians perspective, they’re trying to hold on to as much money as possible across 10s of thousands of investors, and cumulatively, they are sitting on billions of dollars.

The value of that is just very, very powerful. So the custodians are incentivized not to tell you about checkbook control, just like the financial advisor at your local Community bank, doesn’t want to tell you about self directed IRAs. self directed IRA custodians don’t want to tell you about checkbook control. Because with checkbook control, you get the money in your bank account, where you can get the benefit of having access to the money or earning interest on the money. And you don’t need them to process your transactions. 

You can eliminate those transaction fees. And even more importantly, you can eliminate their processing, you don’t have to deal with them with their paperwork, you just want to write that check. And then it puts them in an awkward position, because all right, so what are exactly how are we going to justify charging you all these fees, if we all recognize that the custodian is doing nothing. So the custodians, the custodians, don’t, you know, they’re not eager, they’re not very pleased with the growing popularity of checkbook control.

Taylor   6:53  

So that explains why, you know, I might have received some misinformation. But you know, one of the things that one of the services they provide, you know, there’s this, there’s, there’s a lot of paperwork involved, but they help with some of the compliance concerns and things like that, though, if I’m considering switching to a checkbook, Ira, Ira, or checkbook control IRA, I just want to know the differences between the two, the strengths and weaknesses, you know, how am I, what’s the story about the checkbook IRA? 

Because it sounds like, mean, do I just, I know, I don’t just call up my community bank and say, hey, I want to move my IRA there and open an account, and then I’m just going to, I’m just going to handle that I can’t do that. So, I mean, what do I do? What do I do? It’s the self directed IRA processes a lot more straightforward, it seems to me.

Bernard Reisz  7:51  

It’s so yes and no, but that, that everything’s got its pros and cons. So here’s some of the things you’d want to think about. And provide, you know, it’s good to right some context and also clear up some of the perhaps misconceptions. So the key thing to be aware of, is that regardless of how you structure your IRA, there’s going to be some sort of custodian involved. It says on the tax code, Ira must have a custodian and that custodian has to be a regulated bank, or Trust Company. So wherever we go, there’s going to be a custodian involved. 

The question is, is just which custodian, so just as you may have moved your IRA from fidelity, in order to get to self directed IRA custodian, if you’re going to embrace checkbook control, you may be able to work with your current custodian, or you may have to move away from them, if they’re, you know, being resistant to that. So, in the most part, the custodian community has learned to live with checkbook control. Some custodians have embraced it, and actually a kind of the big part of their business is built upon that, and others have done so more reluctantly, like they’re not going to put it up there, you know, the landing page does not say checkbook control IRA. But if you bring it up with them, they’ll tell you, okay, yeah, you can do that with us. And others, you know, kind of still finding it, you know, they’re still holding out, though you there does have to be a custodian involved. 

But the way you generally you may want to do that is to say, working with a service provider, like myself. So we know, all the custodians, the industry, we know the pros and cons, we have relationships with them, we know the people there, we have advantageous pricing arrangements with them. So if you work with us, kind of we, we take it from A to Z, the will know will kind of give you Hey, here, the custodians, here, the pros and the cons, here’s the pricing structure, this is how you would sign up before with them. So the first step is really to kind of connect with somebody that has a relationship with the custodian community, and knows the ins and outs that industry. 

Now, the so ironically, you know, although there’s gonna have to be a custodian involved, the starting point would be with a service provider that knows that niche. But beyond that, the question then is, you know, what is a checkbook control? IRA? How was that achieved? And this way, you’ll have a better understanding of the kind of questions you have to ask, you know, what is this checkbook control? 

And how do we get there? Now, checkbook control is kind of this term marketing term, or that emerged that describes giving you the investor control of the checkbook. Obviously, today, we can call it an ACH IRA or a wire transfer IRA. And it can be anything you get total flexibility of having the money in a bank account, but how do we achieve that? If an IRA is got to have a custodian? There are

Taylor   11:01  

beats me?

Bernard Reisz  11:02  

Yes. So get on to the listeners, I know we’re going to publish the audio, and they don’t see the facial expressions, if we

see kind of have to jailbreak it, and there are a couple of ways to do it. But broadly speaking, we’re going to create an entity using most likely an LLC, or alternatively, a trust, and we told the custodian, we’re making an investment in an entity, right, just like you can tell your custodian you’re doing your syndication, investment investment with your self directed IRA. Right. So you told the custodian, okay, where the money is going to this LLC and right, and what’s that LLC going to do is going to invest in real estate. 

All right, so we can create an LLC just for this purpose, and it has to be structured, so it’s compliant, and the custodians will review it to ensure that it’s compliant and we tell the custodian we’re making an investment in an LLC, it looks very much like the syndication investment from the custodians perspective, you’re investing LLC, okay, well, we create an entity and then you get the you manage that entity, and you control the bank account that that entity, and then you may have a syndication, you may have a dozen, you may have hard money, loans, tax liens, cryptocurrency, you know, whatever it is that kind of rocks, your boat, or for all of the above, or some of the above, none of the above private equity, more or less, as you can imagine it you can do it, you know, in a checkbook IRA, and most things most put on that all of those and then with the custodian, but with the checkbook control, you completely marginalize the custodian because you have the money in the bank account. 

Then that LLC does the investments, rather than your IRA being the investment in syndication, right. So say we create passive wealth, LLC and go to syndication, who’s the investor, not the IRA, the investor with the passive wealth, LLC, incidentally, passive wealth LLC has been funded by IRA. But that’s kind of besides the point, that’s nobody’s business. So it just streamlines the process. That makes it business as usual. So as you can see, though, now you’ve got a whole new set of questions. 

So what kind of entity Do you want to create? Should it be a corporation? Should it be an LLC? Should it be a trust? And entities can be domiciled in different states? There are 51, domiciled within, you know, the US of A you’ve got 50 states and DC while so where should you put that LLC, you’ve got a lot of choices. What should this tax structure of that LLC be? In most cases, it would just be a disregarded entity. But not always do you want that sometimes we may want to go for some other tax structure. So there’s a lot more nuance available. So you want to look for somebody that’s ready to focus on your needs, your objectives and your strategy, and help you make the best decision what you’re trying to do.

Taylor   14:02  

So okay, so there’s a lot there, I definitely appreciate you breaking that down, because I didn’t know this whole process before. So from a fee perspective, one of the big advantages with the checkbook IRA, is that by setting this up, this LLC controls everything and whatnot, we’re avoiding those transaction fees from the original custodian or the the overarching custodian that actually holds the IRA. Is that correct?

Bernard Reisz  14:33  

That’s That’s exactly it. Because what happens is the custodians generally have a per transaction fee and a per asset fee. So if you don’t use checkbook control, every investment is a new asset and a new transaction. And in fact, a single asset can have multiple transactions. So the fees begin to add up to even if you’re working with a low cost custodian. Over time, you’ll begin to see and the more you invest, those fees begin to add up. And with the checkbook control, your fees are nominal. It’s you save thousands and thousands of dollars.

Taylor   15:12  

Yeah, I mean, this has been one of my biggest pain points with my self directed IRA is just the, you know, I was moving from being a stock investor, I used Vanguard who and I was an index investor. So their fees are nothing, you know, you’re investing in the s&p it’s it’s zero effectively, and then moving to self directed and seeing hundreds of dollars per time, I want to move the money or, you know, investing in entity, whatever, anything. And then every year, there’s a fee and all these things. 

Definitely appreciate the advantage of reducing the, the fees that we’re paying, but as far as demonstrating that we’re remaining in compliance or staying in compliance mean, there’s a lot, there are a lot more, it’s a lot more potential pitfalls with setting up this LLC. And obviously, we’re not going to late, we’re going to understand the laws, we’re not going to blatantly break the laws. But if somebody comes if the IRS is who’s going to come knocking, if they come knocking on the door, saying, you know, we need you to demonstrate that you know, and you haven’t committed any prohibited transactions are done business with anybody that’s prohibited, namely, yourself, you haven’t self dealt with your checkbook IRA. How do we demonstrate that with us? checkbook control?

Bernard Reisz  16:30  

Yeah, that’s awesome question. And it’s good to, also to clarify, it’s something inherent, this kind of give a given that seems to be assume, is that what the custodian you’re protected, and being somebody that’s in this industry, and not just setting these up, also dealing with people that have all sorts of IRAs, not necessarily set up with us, but they come to us for subsequent compliance services, having a custodian is no guarantee that you’re not there’s not going to be a prohibited transaction. The benefit of the custodian is that you can’t instantaneously do anything, right. If you want to engage in a transaction, you’ve got to do the paperwork, at the very least, it’s going to take a couple of days for it to get done. 

If there’s an obvious prohibited transaction, there, the custodian will generally pick it up the glaringly obvious ones. And even if they would not, there’s time, whereas when you have the checkbook control, you could just write that check. So there’s no guarantee when you have the custodian that there will not be a prohibited transaction. I don’t want to go down the year with any stories and anything that I’ve seen. But that is far from the case, it’s actually up. Having that false sense of security can actually be troublesome, you know, you can get into trouble and when you’re complacent, and you think that the compliance is taken care of by the custodian. And that is certainly not the case. 

Now, what the checkbook control, you must be aware of the rules, but you have to be aware of the rules. And any event, the key thing I would say is, you want to be working with a service provider, that’s not just looking to sell you a structure, collect their fees and move on somebody that is really committed to your success, and will educate you far more and far more on higher level and deeper level than you’d get ever get from a custodian,

Taylor   18:33  

I guess I make the assumption, maybe being a little bit myopic is maybe not the right word. But I do make the assumption that my custodian is going to help keep me in compliance. But also because I understand the transactions that I’m doing with my IRA, I understand the rules, I think well enough, I’m pretty sure well enough to avoid prohibited transactions. 

But we do have people out there that are doing a lot more transact with their retirement accounts with their self directed IRAs and, and other retirement accounts, and a lot more unique transactions, that maybe they’re doing something that’s prohibited in their custodians not catching it. So I don’t know, I guess that’s, that’s

Bernard Reisz  19:16  

the world God, I’ll tell you, there are an incredible amount of unknown unknowns in this space. And when I say unknown unknowns, what I mean to say is your, you know, investors that’s going to Google and think, you know, they’ve seen a couple of websites, amount, I know the rules. It really is not the case, the way what the custodians the kind of transactions that the custodian will catch, or at least protect themselves from liability for their general paperwork is going to ask, okay, do you your father, your son? 

You know, do you own this investment? And if you, right, no, they fund it. But prohibited transactions Can you know, they lurk in different places, and just going through that questionnaire that captures kind of the ones that everybody’s aware of, but not the ones that are not as well understood? We’re not as a parent, the custodians main objective, is actually to protect themselves. Right? 

They want they it’s about their relationship with the IRS, right, their status as a custodian. If there’s a prohibited transaction, they have to report it. They don’t want prohibited transactions. And if there’s a prohibited transaction, they prefer not to know about it. Because that puts them in our awkward position. But of course, they’re never going to their, you know, highest commitment is to the IRS, not to you.

Taylor   20:46  

That’s true. Can you know, we don’t need to get too specific, I’m sure you got a lot of stories, but can you give us an example of a prohibited transaction that would not be caught by those initial easy filters, and that someone who’s, you know, let’s say, an armchair quote unquote, expert, who’s done a bit of their own learning on the side trying to avoid those prohibited transactions? What is one that maybe that’s that’s lurking out there that maybe we don’t see coming, and we need to avoid just for an example.

Bernard Reisz  21:19  

So one example is business partners, business partners. So people that may have financial relationships with other people. They’re doing investing with or running joint ventures with, and they see as Hey, I can use my self directed IRA, and invest. I know, I can’t be part of the transaction, but I can have my business partner be part of the transaction.

So that trips people up quite often.

Taylor   21:43  

Hmm, interesting. So if they’re in an unrelated, but a different business partnership, that I’m you know, I’m in a business partnership with Bill, I can’t then use my self directed IRA to invest in some kind of business that bill has going on the side?

Bernard Reisz  22:04  

That’s right.

Taylor   22:05  

Interesting, okay. You know, this is a very wide topic, right? And there are a lot of questions that I have, and I think a lot of people have, because once you once you crack the egg of talking about investing in real estate with retirement accounts, so many people come out of the woodwork and want to, you know, bring their knowledge to the table with their own their own angle to the table. One of the big things that you hear when you talk about this, this topic of investing in real estate with retirement accounts, is that it’s incorrect or naive or wrong or whatever. Do you invest in a tax advantaged asset, like real estate, with a tax advantage or deferred or whatever you wanna call it? account? Like a retirement account? If people say that’s Yeah, you shouldn’t do that. Why is that? Why should we just not think that way?

Bernard Reisz  23:00  

awesome question. I get that all the time. The really, there are so many aspects of the question. And for some people, it impacts different investors differently. So let’s without getting let’s just assume we’re talking about your passive investor. And they for the most part, they’re not going to benefit from a real estate loss, right? 

Because they’re not going to be able to write off that loss against other income. And that’s a misconception out there. People think, Oh, I can take the real estate loss and offset my w two, which, right? That would be awesome. And and that was the case up until the mid 1980s. When Congress said, Okay, we got to put into that are people investing in real estate just to create losses, though, for most people, real estate losses, don’t really do anything there and being suspended losses, it can’t offset their W2. 

Real estate itself, though, is relatively tax efficient, compared to other investments. And it is certainly true that you want to use tax shelter to accounts, tax free accounts for the assets that are create the greatest tax liability. So that is true. If you’re weighing, okay, should I put real estate or something or a hard money loan into my self directed IRA. So obviously, or, you know, the, if your summit is investing in both real estate equity and debt, then you’re going to do some of it with your personal funds, and some with your IRA, by all means, you should be putting the heart the debt investment, the interest earning investment, that hard money loan, private loan, that’s the one that you would put in your IRA. 

The real estate equity, you would do in your own name. Because the debt investment, which throws off interest income needs more tax shielding. Now, however, if you are not contemplating that choice, then it’s just about putting in the IRA, the investment, that’s going to give you the best return. Real estate is great outside of an IRA from a tax perspective. But that doesn’t mean it’s not great inside an IRA. Ira is great, because you don’t pay taxes at all. Whereas in your own name, you need to get deductions, right, and eventually run out of deductions. You run out of those? 

That’s really the question, you know, what is the best asset that I’m contemplating investing in? For my IRA. That’s what it boils down to. It’s not the fact that it could be relatively tax efficient outside of an IRA is just in material. It’s not part of the calculation.

Taylor   25:48  

I agree. I mean, this, this is what this is probably the thing that drives me crazy about this discussion. But when this comes up, people say, don’t invest in real estate with your retire an account like why the money’s there, I need to put it in something I don’t want to invest it in the stock market, or I already have exposure to the stock market in that IRA, and I want to diversify inside it. 

If I find a good investment, a good syndication investment, for example, why shouldn’t I invest in that investment with my IRA, you know, maybe like you said, maybe there’s a better way, a better potential asset class for me to invest in like a loan that throws off interest, which would be more advantaged inside a retirement account, then outside of retirement accounts. 

I don’t know this, this whole conversation bothers me because well, first, we should strive to make good investments no matter what we’re investing in. And if, for me, and for many people out there, if you’ve got capital in your retirement account that you’re you want to get out of the stock market, or it’s already a stock market, then find a good investment and invest in it. I mean, what’s the problem here?

Bernard Reisz  27:02  

You’re so right. And the irony of this is, there’s probably nothing that’s nearly as tax efficient as the stock market. Because if you think about this, right, most Americans, trillions and trillions of dollars that are sitting in IRAs are invested in the stock market. And nobody’s ever said don’t invest in Iran stocks, because it’s tax efficient. But here’s the lowdown on investing in the stock market, and especially if buying an index fund, we were talking about index funds, what you’re going to type the income you’re going to get is long term capital gains, and qualified dividends. Well, those are taxed at you know, depending on which tax bracket you’d be in outside of an IRA, they will be zero to 20%. 

It’s not your income tax rate, which is going to may be substantially higher. Stock Market investments are tax efficient, relatively, right relative to other investments, compared to your W w two income even will say absolutely right. Yeah, it’s not ordinary income. But you’re generally getting relatively it’s relatively tax efficient. So why do you have an IRA? Right? Well, you have an IRA because tax free is better than tax efficient.

Taylor   28:15  

Yeah, absolutely. And, you know, if we’re, if we’re in this realm, and you were talking thoughts, and I’m sure we have folks listening, who are flippers are considered considering flipping, flipping is an exceptionally tax inefficient way to invest in real estate. Personally, I don’t even really consider it a real estate investment, because it’s taxed at ordinary income rates, which can be excessive if you’re as long as if you’re just, you know, I guess you could probably do it in a some kind of advantaged account. But that’s even more difficult. 

You know, I don’t know, this whole topic is I feel like there’s a lot of misinformation in the sense that folks want to potentially bring on clients because they’re selling a particular type of investment account, though there, you know, the only talking about the pros, the thing that they sell and never talking about some of the cons. Oh, you’re you’re so right.

Bernard Reisz  29:05  

That, unfortunately, is the case. And a key point I’ve been trying to make lately is that you want to work with somebody that can doesn’t really have a horse in the race, that’s more or less ready to send you anywhere. And I said, also look for the kind of person whose background is something more substantive. So I like working with. 

I may have a little bias there. But I do you know, even people have transitioned, that have transitioned to more investment related niches, but medical professionals, people have a background in medicine, law, accounting, you know, so there was something more substantive, and they’re less likely to be pure sales people. But the but you’re totally right. There are things that are getting people in the plans that are not opposite, I’m all for them. 

The flipping thing that you brought up is an excellent, excellent way to illustrate that. So of course, you can do flipping inside of a self directed retirement account. And of course, the most efficient way to do that would be with checkbook control. How ever flipping May, you know, you may not have may not benefit from the tax sheltering, that an IRA or 401k provides. Because what, because when you engage in an active business, inside of an IRA or 401k, it gets taxed

Bernard Reisz  30:39  

Now there are tax strategies work around that. And so ultimately, the question is going to be what’s right for you? Because, say, somebody that’s flipping right, and he, they’re getting these incredible returns, right? If you know, some flippers, you may not do it. But those that do well do phenomenally well. 

You’re totally right, the IRS does not view flipping as so much as real estate, or business. And that’s why it may be tax isn’t even inside of an IRA. But that doesn’t mean you shouldn’t do it. Because if you can get a 200% return and get taxed on it. Well, you’re never going to get that in the stock market. So do it in the IRA and eat the tax. I mean, it’s just going to destroy whatever else you were doing. But of course, there’s a lot more nuance associated with that. When does that tax apply? And maybe you can mitigate it or eliminate it? How can you manage it or optimize it? So you can do all these things. But it’s about working with somebody that knows these nuances and is happy to share that information with you?

Taylor   31:44  

Absolutely. Another way is new, lots of what while I’ve got you another big thing that comes up when you’re talking about self directed IRAs, and these retirement accounts is Ud FI and UB it You bet, I’ll let you define those. So they’ll probably screw it up. But let’s talk about those because I feel like most people that that warn you about these things from the outside is it here’s a reason why you shouldn’t invest, you know, you need to know about UDFI most people that warn you about it, don’t know anything about it, or they have that best a cursory understanding of it. 

I would say I’m my understanding is even cursory. So teach us teach us about UDFI. And you bet and why it’s not so scary. Or maybe it is scary. I don’t know.

Bernard Reisz  32:28  

Yeah, glad to talk about this. It’s a topic that really needs to be spoken about. Because I’d say I’m spending a lot of my time lately, trying to clarify some of the misconceptions out there about you, the FBI, and the score with you, the FBI is as follows. Those that are don’t want you to know about it, they have an interest, their vested interests prefer that you not be aware of it, do not mention it. And those that are trying to push you to do something else other than an IRA, they kind of put this front and center and totally misrepresent what it is. So let’s talk about what you The FI is what it isn’t. 

Ultimately, it’s kind of like the discussion we had a moment or moments ago about real estate, in IRAs being tax sheltered. You The FBI is never going to be a reason not to invest in real estate inside of an IRA. It’s not going to be the determining factor and a decision that you make. If your decision is okay, I’m doing real estate in an IRA, and how should I go about it? Should I do it? You know, equity investor with that, or should I do it as a loan? That will that’s where it will play a role. But and the overall decision? 

Should I use an IRA for real estate? Should I use a 401k QRP or take a taxable distribution, you The FI is not really part of that equation. So with that being said, What is you define, that you define is the acronym for unrelated debt financed income. And it’s a subset of you bit of UBTI. And those are what we mentioned before now with regard to flipping, unrelated business taxable income. 

So it’s helps to know the chronology to understand what these are and put them in perspective, the Congress instituted this Ubud concept, this tax on tax free accounts, back in the 50s, when charitable organizations were getting involved their own, the University Hospital owns a meal and macaroni company, right. And so now, it’s a 501, c three, which means you’re trying to organizations that are tax free, they don’t pay taxes. Back in those days, taxes were 60 70%, much higher than they are today. And you can imagine they’re operating retail company and merchandising company, they’re manufacturing and selling, and they’re not paying any taxes, they can just destroy the company. 

Right, they can just lower their price, undercut you, and drive everybody else out of business. So Congress realized that, hey, even if you’re a tax free entity, we’re not you’re going to have to pay tax, if you’re getting involved in some sort of business that has nothing to do with your tax free purpose. You’re a hospital, university, anything that you do with regard to being in a hospital, no taxes, you take donations, no taxes. But if you start running some sort of side gig, we’re going to tax you off. Now, then what happened was, these charitable entities were borrowing money to get involved in certain transactions. 

They use their tax advantage status, well beyond what Congress intended. And again, to kind of alter dynamics in the regular business market. So Congress came in and said, All right, if you invest, can be tax free. But if you’re going to a bank and you’re borrowing to do the investment, a portion of that investment will be taxable. To the extent that you use borrowed money, we’re going to tax you many questions about that, is that making it says that making sense if it makes sense, and that I didn’t know that explanation of the historical explanation as to why it was introduced? So I certainly appreciate you teaching us about that. The next question is, okay, so I’m, I’m going to have this taxable liability. And if everybody so scared of it, then it this my liability on this tax on this, you this

Taylor   36:41  

UDFI related tax, what it must be 95%. I mean, there’s no way that it must just completely wipe out all my returns. Hmm. And how much does it really impact the return? If everybody so freaked out about it? Or they freak out? for a good reason? Is it really that? I’m a salesperson, so I don’t want to sales people a bad name, but is it really maybe people being a little too salesy or marketing or whatever? Is it overreaction,

Bernard Reisz  37:15  

I’ll tell you what’s going, you know, give you a little insight. So it is natural for people to kind of be intimidated, you know, just like oh, you UDFI run the other way run for cover, they don’t know what it is just stay away. But what’s putting this front and center is the fact that there is a limited exemption for you the FBI for qualified retirement plans. So what’s going on is as follows. And just so you know, we, I set up qualified retirement plans and IRAs, so I’m completely indifferent. My preference is actually as often as possible, both for my own business interests is to set up a qualified retirement plan as opposed to CheckBook IRA. 

What’s going on is the people that set up the QR PS, which are qualified retirement plans, and which is going to be a solo 401k, in almost all instances, is, and there’s, I’m not aware of any exceptions to that. So they have an interest in kind of making this you UDFI be this big, intimidating thing. 

This way, they say, hey, but we do QRP. And that’s not subject to you, the FBI. And that’s kind of putting it front and center to drive people to use qualified retirement plans, or QR ps, rather than IRAs. But the fact remains that this question of whether or not somebody should have, you know, whatever client comes to us, we have to determine, you know, help them determine should they use a QRP? Or should we set them up with an IRA? You know, okay, we’re fine, we’re going to set you up either QRP or IRA. 

So of course, we prefer QRP when we can, but the determining factor is going to be through qualifying for the QRP. Not you UDFI. Because the fact that IRAs are subject to UDFI doesn’t qualify you for QRP. Okay, right. So it’s just not part of the discussion. The you know, Now, why should you the FBI, you know, assuming, of course, if somebody is a good fit for QRP, and they want to QRP, we just set up a QRP for them. 

Suppose they’re not a good fit. Now, obviously, we don’t want them go running away and not investing in real estate. But though, how do we put this in perspective, let’s talk about the charitable organization, forget IRAs for a moment. Alright. So charitable organization back in the 60s, they’re going to do an investment. Now they can a couple of things, they can do it all cash, or they can borrow money from the bank. 

So you UDFI tax is not you’re not taxed on all the income. And to illustrate how this would work, say you’ve got revenue, right revenue and accountant speak means just the money that comes in from the deal. Right? And let’s use round numbers, million dollars comes in, that’s your revenue, do you get taxed in a million dollars? Of course not. No. Okay, that’s the first thing you’ve got a cat nail is your net, right? 

First, all your deductions come out, right. So after the ducting all your expenses, that may go down to zero or negative, and let’s just keep the focus on real estate because that’s primarily where this is relevant. So on a real estate investment, in general, the first couple of years, the will be no net income. Because real estate, as we said, is tax efficient, the first couple of years, being that you’re having your depreciation deductions, all the regular deductions that you would have outside of an IRA. 

Those exist even inside of an IRA. Right? So when we said an IRA doesn’t need deductions, that’s what it does an all cash investment. But say it’s using leverage. So then all of a sudden, okay, if you’re going to have tax, then you get deductions. So what makes real estate tax efficient outside of an IRA will make it equally tax efficient. If a tax does apply inside of an IRA, that you get all your interest expense, your insurance, your mortgage interest, your depreciation, you get all those deductions. 

So that’s the first step. So let’s take down a real estate in general, you’re not going to have any net income. Let’s say you’re a couple years into the investment. And now real estate does show net income, well, outside of retirement account, you would pay taxes instead of retirement account. It’s an all cash deal. No taxes. But suppose there was leverage involved? Well, in that case, you’re not the tax does not apply to the total net income. It’s only to the extent that leverage was used, which makes a lot of sense. So say you’re in the deal. 40% equity and 60% debt, the tax will only apply to the portion that was financed that making sense.

Taylor   42:01  

Yeah. Yeah, that makes sense. So that way, it only applies to the portion. That’s finance. Absolutely.

Bernard Reisz  42:08  

And now here’s the thing now that you hear that, hopefully a couple of lights should be going off off your equity investment is tax free forever. Right? Congress wasn’t coming in to see if you have $100,000 in your IRA and a borrows 300,000, that we’re going to tax you on the full 400. Right now hundred thousand that you put into the deal, that remains tax free. Now the cool thing is, right, if you’re at Vanguard, and you say, hey, I’ve got $100,000 in my IRA, I’ve got s&p 500 index fund. Give me another $300,000 of s&p, you’re going to get that No way.

Taylor 42:43  

No way.

Bernard Reisz  42:44  

No way. Right. But by the way, Vanguard would do that for you, you know what you would have UDFI. It’s got nothing to do with real estate. If you if all of a sudden somehow you’re getting OPM that you get taxed. There is a tax on that. I mean, most cases, you got to be a fool to say I’m doing cash only. Right. 

That’s the beauty of real estate that you can get the OPM All right, yes, you pay interest on the OPM, right, you’ll pay the bank their percentage, but you get the benefit of leverage. Same thing here, well, if you go in the stock market, you can also have you The FBI is just, hopefully is going to lend it to you. But of course true. But of course, suppose you had that option available to you, many people would borrow money and leverage their stock portfolio, it’s just not available. 

The beauty of having real estate in your IRA is you can get a non recourse loan, the bank will lend you money, and you can buy $400,000 worth of real estate, even though you only have $100,000. And yes, there may be a tax on the portion that the bank gave you. But you just got the benefit of OPM, it’s just the cost of using the bank’s money. That’s all it is.

Taylor   43:55  

Yeah. So I think the next logical question, though, is all right. So there’s a chunk of it is, is subjects attacks in some way. You know, even though my my original equity is not subject based on the logic you just covered, though, what is that rate that the other the finance portion is taxed at? Is it 1,000,000,000%? And therefore, it’s all pointless? Or is it something that’s far more reasonable?

Bernard Reisz  44:24  

Okay, let’s talk about the tax rates, because there is incredible misinformation about that. Now what it is true, that what happens is the tax brackets or you the FBI, or record compressed, so you very quickly hit the higher tax brackets. So if you would, as a regular income tax brackets, but you at lower levels of income, you’ll find yourself at a higher tax bracket. So what happens is the first thousand dollars of you The FBI is tax free, you got $1,000 freebie, but above that you get a quickly progress. 

If you have $13,000 of you, the FBI, then anything above $13,000, you’re already at 37% tax rate, you’re at the highest tax bracket at just $13,000 of you the FBI, in practice, you don’t see that level of you UDFI. Because again, it’s real estate and you have all those deductions, we’re it would apply, where would you therefore apply it at the sale? Yeah, the capital gains, if I ask you, what’s the tax rate when IRA souls an asset that’s leveraged?

Taylor   45:35  

I don’t know. I’m not I’m not a tax expert. That’s that’s, that’s okay.

Bernard Reisz  45:42  

If you’re listening to what’s out there, you’re going to hear 40% its capital gains rights. No, yeah. So again, it’s going to be zero to 20. So it goes, in essence, those high those high tax brackets, in most cases, never materialized. It’s a figment of imagination, because it in almost all cases, real estate investing with an IRA, you’re going to have your net, you UDFI is going to be a very low number, it’ll be non existent first couple of years, then will begin to show up but a low numbers, were really where you really have that high number is going to be at the sale. And then you’re looking at somewhere between zero to 20%. 

Okay, so still, it’s but it this discussion is really, it’s, it’s not it’s not bad. The key thing is, it’s not really a factor in the decision, you should be aware of this. And yes, it’s again, if you’re choosing to invest my IRA, perhaps just what should I do an old cash investment or a leveraged investment, that’s really where the calculation comes in. And then if you’re gonna do a leveraged investment, whatever the kind of investment, it’s going to be be real estate. If you’re going to leverage and then lend money, you know, wherever there’s going to be leverage inside of an IRA, you’re going to have your there’s the potential for you, the FBI. So are you going to do cash only? 

Or you’re going to use leverage? Well, if I’d ask you, when you invest in real estate, in your own name, do you use leverage? Or do cash only? Right, the bank comes the banks, the bank account, right? Well, you know, you’re looking at Should I do the million dollar deal or the $4 million deal? The bank says we’ll give you 3 million, they say, Now keep the money I’m going to do the million dollar deal.

Taylor   47:19  

I’ll take the small deal. No way.

Bernard Reisz  47:23  

Exactly. So that’s it’s just a, it’s been the perspective that’s being thrown out. And this is completely, you know, that I’m encountering every day is just not the right way to look at the question is all right, if you’ve made that decision, and you realize that you want to get into alternative assets, and again, it’s almost always going to be real estate based. And that’s because you realize that for whatever reason, your financial plan, your what you want to be in is real estate, that’s what your needs are IRA for, then do it and then navigate to the FI but it doesn’t impact the decision. 

UDFI is a reason to use AQRP if you qualify for it. But if you don’t qualify for it, just like you should not take a taxable distribution, right, ironically, spoken to syndicators and say, we don’t take money from IRAs anymore, because if you UDFI, that’s not good for the syndicate, or it’s not good for the investors, because most people don’t will not qualify for QRP. It’s a shame for them not be able to be forced to either take a taxable distribution from their IRA, if they want to use that money for real estate, because if somebody has $200,000 in an IRA, and they take out taxable distribution, they’re probably gonna be left with $100,000 after taxes and penalties. 

So that’s not a good way to go. And to put the money in a QRP that they don’t qualify for. is also mistake. Of course, the IRS doesn’t cashew, you’ll be okay. But when they do, you know, it’s probably not going to be, you’re not gonna, you’re not going to be happy with the outcome there. Thing is, get into a plan that suits you and do the deals at you, the FBI is just something that you have to deal with. But it’s a cost of OPM.

Taylor   49:08  

Yeah, I mean, it seems like putting, in many cases worrying about or, in my opinion, every case, worrying about UD fi and not doing a deal, because of UDFI are not investing in a deal solely because you might be subject to UDFI is just putting the cart before the horse here, you’re not worrying about the right thing, we need to be focused on doing good deals first, and then optimize our tax strategy and how we invest in it. 

But if, from my perspective, if I come across a good deal, and I’ve got funds sitting in my retirement account that I’d rather put in this particular deal, I don’t care, I’m investing in the deal period, because it’s a good deal. The first priority should be to do a good deal and not to sit on the sidelines. And I think you example, from earlier, you’re talking about the tax situation around stocks is, is very helpful, because I haven’t thought about it that way before. That they’re already very tax advantaged compared to less tax advantage, the investments that we can do with self directed retirement accounts.

Bernard Reisz  50:20  

Yeah. That’s That’s it. So right. And yes, of course, I come back to that if you have access to a hard money deal, or you like that, and and you want to do that kind of deal, then by all means, that’s the kind of deal that’s optimal for a tax filtered account. But if you’re doing real estate, you’re just getting the UDFI is actually something great because it’s a sign of the fact that real estate is a hard asset, they’re going to lend you money against it. And yes, you have the option of what do you UDFI doing the cash only, but you’d never do that. So that’s really way to look at it. 

And another beautiful thing, but you the fi, you know, because the way I put the perspective I put on it, it’s the host of OPM, right, it’s just a cost of leverage, right? Because you can do an all cash deal. And even when you borrow the money, your equity investment remains tax free. The only portion of the return that’s taxed is the portion that’s attributable to the OPM. Well, when you borrow money from a bank, right, you pay them that fixed percentage, no matter what your deal is doing. The deal is a great deal of deals a bad deal. They get their money, or they take your property, right? 

With the IRS, if you’re not having if you’re not having net taxable income, they don’t get the money. So on a way, they’re better than the bank, because they’re not taking their you know, they don’t take anything and the deals not doing well, or the deal, at least doesn’t have net taxable income, because you have depreciation, you’ve got write offs, then there’s nothing goes to them. So it’s the cost of OPM. And the way to look at again, is, do I want to do cash only stock market investments? Or do I want to get the benefit, get into real estate get the benefit of leverage?

Taylor   52:00  

Yeah, absolutely. I mean, when you’re talking about real estate investments, and you know, multifamily, for example, I mean, the only folks that I see, I can even see doing all cash deals right now, or people with deep, deep pockets that have a lot of capital to deploy, but even then, mean they’re taking out, they’re doing their finance deals, too. I mean, that’s just the way the industry works. I mean, people are doing all cash deals, for sure. But I don’t see it personally, I don’t see it happening at the gal that I invest that the deals that I invest in, so that nobody

Bernard Reisz  52:31  

wants to on all cash deal. Because you the leverage is you. from a financial perspective, from a finance perspective. If you calculate your ROI and your leveraged ROI, you just come out way ahead with the OPMI. 

The one you’re going to see the cash only deals is going to be people that they just don’t see themselves having any other deals to do. And they’ve got the deploy capital, but they’re sitting on hundreds of billions of dollars. And they’re just like, what I’m gonna do this, I don’t know where a pension fund or something and I don’t know, are there are investors are expecting us to do something. And there’s just not enough deals to go around. So we’ll do an all cash deal. Or they’re going to do that to snag a deal. But nobody ever wants to do an all cash deal. Because unless your interest rates are incredibly high, your leverage the ROI can be so much higher.

Taylor   53:22  

Yeah, yeah, you’re can’t show any kind of good cash on cash return. If you’re putting up only cash and not using any of that lead sweet bank financing out there. It’s available. But I feel like we could talk about this, this topic all day. And I’d love to have you on again, soon. First, we’re going to take a quick break for our sponsors. Though, Bernard, I’ve got three questions that I asked every guest on the show, at the end of the show. First question, what is the best investment you ever made? best investment

Bernard Reisz  53:52  

I’ve ever made? I’d say is investing in education? Hmm,

Taylor   53:56  

yeah. Is there anything in particular that comes to mind,

Bernard Reisz  54:00  

it guides everything that you do, subsequently, to the best investment is really investing in yourself. So that you’re positioned after that to maximize ROI and everything else that you do. And I’d say, that type of education, only to a limited extent, is formal education. It comes from experience, and getting out there and doing things. 

Even if it’s the kind of information that comes from a book, it’s probably not the textbook that you got in college, it’s probably something unique, what you know, in both taking a deep dive into something specific that you want to pursue, and also things that have a much broader perspective, you know, that just develop your overall philosophy, towards engaging with life with people with investing with everything. So, you ever heard of, you know, Charles monger, Charlie Munger?

Taylor   54:56  

Oh, yeah. Warren Buffett’s business partner? Correct?

Bernard Reisz  55:00  

Yes. So he’s kind of that’s he’s a big proponent of that. Realizing that there’s when you look at an investment, it’s not just about the spreadsheet. It’s about bringing to beer, your total life experience, and so many other things you’ve learned them and exposed to and so many different disciplines that should inform your perspective on an investment. 

On the other side of that, what is the worst investment you ever made? I’m going to continue on the same vein, I think the worst investment that I’ve made, is about, it’s not about a deal, I think you have to work with the right people. And that’s a big part of success is who you’re working with, who you’re associating with, and working with the wrong people is, you know what, it was a factor in the places where I’ve seen it or have not seen the success that I would have hoped to

Taylor   56:00  

who you work with. Now, my favorite question out of these three is what is the most important lesson you’ve learned in investing,

Bernard Reisz  56:07  

you are responsible for your own success? Do not the board innate your judgment to anybody else, there is nobody that is going to put your interests to give it the priority that it deserves, and needs other than yourself. So whatever you do, Think for yourself.

Taylor   56:31  

I like that. Yeah, absolutely. My favorite dollars, my favorite dollars in the world are the ones that are sitting in my bank account, or are deployed and are entitled to me. So I think it believes that apply. I believe that applies to everyone out there, it should apply to everyone out there. nobody’s looking out for you and your money better than you are, and nobody’s more responsible for your success that you are. So I like that.

Bernard Reisz  57:03  

Yeah, I’d say there’s definitely a continuum. Right. So there are the folks that you know, that they’re willing, they want to see you successful, they want to help you out. But at the farthest extreme, you know, on the continuum, who’s looking out for you, it’s you by a long shot. And after that, you know, somewhere there’s a continuum, people that are helpful people that are sincere, and then you know, there’s the opposite ends of the spectrum. But at the right end of the spectrum for who’s looking out for you, nobody more than yourself.

Taylor   57:38  

Absolutely. I love it. Bernard Reisz, thank you for joining us on the show today. This is a huge topic that we talked about. We I don’t even know if we scratched the surface. We just covered some of the common misconceptions. We’ll we’ll call it that are out there today. In the world. If people want to learn more, where can they get in touch with you?

Bernard Reisz  57:58  

Best place, say Google ReSure financial. That’s the best way to do it. Of course, they can visit our website at 401kcheckbook.com. But the best way to do it, make sure you get to the right place. Google ReSure financial, and you’ll find us you’ll find podcasts will find the website, you’ll find reviews, lots of helpful info.

Taylor   58:24  

Awesome. Awesome. Been a great conversation. Thank you for everything. And you know, I learned a lot here had a lot of my questions answered. And,

you know, I really enjoyed it. So thank you for that.

Bernard Reisz  58:37  

Taylor. Thanks for having me. I very much enjoyed being on the show. And I’d love to do it again. Awesome.

Taylor   58:43  

We’ll definitely do that to everybody out there listening and thank you for tuning in. I hope you learned a lot today. If you’re enjoying the show, please leave us a rating and review on iTunes. It’s a huge help helps other people learn about the show. It’s a big, it’s very much appreciated. You know anybody out there that could use a little bit more

passive wealth in their lives, share the show with them and let’s get them started on their passive income. Well, once again, thank you for tuning in. I hope you have a great rest of your day a great week and we will talk to you on the next one.