Welcome to Passive Real Estate Investing. I’m your host, Marco Santarelli and welcome to February, 2022. I hope you had a great January. It’s been very busy for us, and I hope it’s been great and busy for you too. Well, this has been an amazing year. There’s been a lot of activity in the real estate market, as well as legislation that has been going back and forth for the last few months, especially as it relates to taxes and tax regulations. And that is really what we want to talk about on show. I think it’s an important show for everybody, especially if you have a self-directed retirement account of any kind, but the big question is are self-directed IRAs and even 401ks doomed. That is a big question. There’s been a lot of regulation that has been proposed to essentially destroy and gut the self-directed IRAs.
Well, IRA in general. And so my guest today, John Hyre is someone who we’re gonna talk about this. Now, granted, this is a very complex and deep subject. And so we’re gonna talk about the, you know, what is going on and what you can do about it, some strategies for the next 30 or 40 minutes, but don’t take it lightly. I think it’s very important, especially if you either have a set off directed retirement account or a traditional IRA, or if you’re planning to set up any kind of self-directed account, including solo 401ks, or 401ks of any kind will Rogers reminds me, you know, with his great famous quote, the only difference between death and taxes is that death doesn’t get worse every time Congress meets. Well, it felt that way in December with all the new legislation that they were trying to push through the door before the end of the year.
And that is no bueno. So fortunately a lot of it has been taken back, but that doesn’t mean that they literally can’t shove that back in there tomorrow. That’s just the way things go with Congress. So you just have to stay vigilant. So anyway, my guest you’re gonna enjoy today. John is an amazing guy and very knowledgeable, and I do intend to bring him back on the show in the future. And if you have tax related questions, I don’t necessarily need them today, but submit them as one of the Ask Marco questions, I’m going to bank them. And then when I have John Hyre back on the show, we’re gonna go through essentially and ask John anything type of episode with tax related questions. So something to be thinking about, especially as you’re listening to this particular episode today.
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So without further ado, let us get to our guest today. It’s my pleasure to welcome John Hyre to the show. John is a tax attorney with 27 years of experience, his virtual practice caters to real estate investors, small business owners and self-directed IRA and 401k investors all over the United States. He is exceptionally knowledgeable on these matters and he painstakingly reviews the core cases to stay on the cutting edge of these regulations. He’s an amazing person. Someone you should definitely get to know John, welcome to the show.
Glad To be here, glad to help people keep what’s theirs.
Yeah, absolutely. I mean, I told you before we started recording here that I hate paying taxes. So I’ll pay my quote unquote fair share, but I try and minimize that as much as possible. So let’s start off with your practice. You have a fascinating practice. You do something that I don’t know, any other tax strategist or tax attorney does, and you literally will go to Washington DC or wherever you go. And you’ll literally read court cases and court documents, and it’s just, you know, admirable, but tell us about your practice and what you do.
Sure. I started out solely in real estate when the internet was young and accountants and attorneys on both were less specialized. The internet allowed people to become more specialized and get a national audience. So I got into real estate investors as a client base, I then accidentally got into self-directed IRA is when I represented somebody in tax court and one in the IRS conceded, there was no case decision that’s even better because we didn’t have to have a trial. The IRS just decided you never mind, we don’t really want to do this. So I got very heavily into self-directed accounts. Be it IRAs, house savings accounts. 401Ks is probably my favorite of the group. And now we have a lot of net high net worth clients from all areas of life that we cater to. Probably the main thing I I do now with the practice.
I don’t have much in the way of employees and such it’s me and one or two other people, because evidently I’m not very easy to get along with if you’re an employee, but move down the Puerto Rico to get my own tax breaks. So I, you know, practice what I preach. Most of our calls at this point are top to bottom. People send us all their stuff, everything I’m talking, not just their QuickBooks and their returns, but we demand politely since there’s a client, a vision, a narrative of where they’re going and not just money wise, but why. And then we do planning from top to bottom. Usually it means I offer a lot of planning ideas and then we figure out what fits your life. Cuz there’s some things that are great planning us that are terrible, terrible life ideas. For example, my wife becoming a real estate professional back when I was in the states and are being able to take rental losses against my practice income. Would’ve been a great tax move and fatal to me, probably not just maritally but physically. I mean that just would’ve been me dead. And then there would’ve been in estate tax issues and so on. So you’ve always gotta kind of fit the tax planning to what works for the client.
Well, I know you’re really, really busy and you’re probably not taking on any new clients, one on one right now, but we certainly wanna make sure that people are aware of what else you can provide in terms of education courses and whatnot, because your stuff is very it’s. laser focused is specialized and it’s not about tax planning as much as it is about tax strategy, which I think is the important thing to start with. You know, it’s putting the horse in front of the carriage, that’s the right way to do it. But you know, I get reminded of what Albert Einstein once said. He said, you know, the hardest thing in the world to understand is the income tax. And that’s probably because it’s changing all the time. And especially lately with all this legislation that’s been kicked around and then introduced and then pulled back and then reintroduced as it relates to IRAs and maybe even 401ks, let’s start with that. What’s going on with this legislation or this new legislation that it continually is being proposed. And should we even be worried about this?
I think we need to keep our eyes on it. In fact, the legislation started out really horribly. There was an awful lot in the initial proposal legislation of very bad things be it for regular businesses, high net worth people, IRAs. I mean they were functionally going and checkbook LLCs and self-directed IRAs. Now, they’re not honest enough to directly say, oh, we’re gonna ban it. They just make it so hard that almost nobody could do it. Thankfully the worst of that legislation has been pulled. The worst of it has been pulled. So the present proposed version, which they’ve not even been able to pass that. And I, I I’m gonna take credit and two respects, one facetious and one less. So I did wish the same success, the same competence at passing the tax law that they showed in leaving Afghanistan. And my wish was granted.
Second we did put up a website, handsoffmyira.com and that got a lot of attention. A lot of investors, one standards stood what was happening with self-directed IRAs because for real estate investors, that’s a big deal. Not, not even some of ’em directly that they invest through. Iras are better yet self-directed 401ks, which is a big deal, but a lot of people get their funding for deals from IRAs and 401ks. And sometimes they don’t even know about it. So this was a massive threat to everybody. So here’s, what’s left in the proposed legislation that they’re presumably trying to negotiate with mansion and cinema effective January one of 22, they banned backdoor Roth IRAs. Now what’s my advice to you. They haven’t passed the law. Usually when they do pass a law, it’s prospective. It’s my very hard to pass something retroactively, especially when you have no majority in the Senate.
So what would I say if you only qualify for contributions to an IRA via the backdoor method, cuz you make too much money to normally directly contribute to a Roth IRA, get the backdoor done before they pass the law. Usually they shift the date and if they don’t with an IRA of the Roth, you can pull the money back out with no penalties so you can pull it back out. They’re also banning mega Roth 401ks. In other words, there’s a separate contribution methodology. There are different ways. Let’s think of the 401k as a bucket, each 401k, depending on your age, you can contribute 50 to 65 grand a year and you can have more than one 401k. I mean we’ve structured it. So people have two or three and they can max contribute to all of them. And they do very powerful, especially with a Roth.
There’s a way to contribute. We call we nickname mega Roth, which means make an after tax contribution. So you get no deduction and then it automatically converts to Roth. And that’s how a lot of people fill up their 401k. A lot of people don’t realize how much they can contribute. They’re banning that that’s a little bit riskier for, for reasons that are technical and would bore you to death. I won’t go into that’s a little bit riskier to see what’s going to, should you do the mega Roth contribution now to your 401k or not? There’s some risk that you may not be able to get the money back out if they were to make it retroactive. Now, if you think it’s gonna be prospective, not a problem. So that’s the immediate changes that are proposed, that, that we care about. There are, if you might ones, I won’t mention here’s some other proposals that are in the proposal legislation still.
It hasn’t been removed 10 million limit on all defined contribution plan. And that’s how they get rid of the Peter Thiel problem. He turned 2000 into 5 billion. So AI would say build it while you can. For the moment they grandfathering people who have more than 10 mil. So it’s you add up all your IRAs, all your 401ks, all your SEP, all your defined benefit plans. If you have more than 10 mil, they force you to distribute half the excess. Let me put that in the numbers. You have 11 mil in these accounts total, all right, the excess is one mill, 10 mill, 11 mill minus 10 mill. You’re a million over, you gotta distribute 500 grand. If you’re showing income of 400 grand or more that year. Now, if you’re not, you’re good, you don’t have to distribute anything. Now here’s an interesting quirk. They did change us to lead us to a planning opportunity.
So they’re, they’re meaning to stick us and they are, I don’t like the limit because adjust, they don’t adjust wealth for inflation. What’s 10 million gonna be worth in 2029. We don’t know. I’ll tell you this much less than today, right? So I don’t, I don’t like I don’t like that. I don’t like that hard limit. And I hope they changed that. And even if it were indexed to CPI, we know real estate and rents are both going up way faster than the CPI. So I still don’t like that, but there’s a silver lining. They did change the original legislation to say that if you have Roth and you’re forced to distribute because of this law. So you’ve got over 10 million, you’re forced to distribute. If you distribute Roth money, they’re not gonna tax it. Even if you’re under 59 and a half. And even if you haven’t had a Roth for five years, what we call seasoning that leads to some planning opportunities that makes me want to get 10 mill worst case.
I, I have to keep it at 10 mill or a little bit higher than that, but I can keep distributing money annually tax free, even though I’m not retirement age. So there’s a little bit of an opportunity there last but not least. And by the way, that doesn’t take effect until 2029 so they could pass it and maybe another Congress reverses it and says, no, we changed our mind. We just don’t know. And that’s part of the problem is that uncertainty right last but not least in 2031, what they’re proposing starting in 2031, that if you make 400 grand a year and I’m rounding without getting in the boring tax, talking, going through details that would make you wanna kill yourself and others. If you make 400 grand or more per year, you are not allowed starting in 2031 to convert traditional to Roth at all.For any year that you make that money. In other words, they’re trying to limit the Peter Thiel thing. So what are they telling you? We don’t like Roths. Therefore, what am I interested in Roths? Right? Let me give you a quick something for your listeners. That’s gonna help them a lot. They should be converting to Roth at a discount. What do I mean by that? If I have a hundred grands and I, I put it into a, a traditional IRA, I get a hundred thousand dollars deduction and I’m just making up the numbers, right? Some engineer will call in and say, you can’t contribute that much to a traditional IRA. I’m like, look, I’m just giving easy numbers, right? I have a hundred in a traditional account. I got a hundred grand worth of deductions. Normally when you convert to Roth, let’s say I have cash.
And I convert. I add a hundred grand to my tax return makes sense. I have to pay for that conversion. Here’s a way to do it at a discount. If you invest in a syndication or even a multi-member LLC with friends and the LLC is properly structured and you convert the day, you make that in investment. So let’s take our numbers. You’ll get a discount. I’m just gonna throw out 50%. Now it’ll vary. So if you contributed a hundred grand to traditionals, you got a hundred grand deduction. You invest a hundred grands in a properly structured LLC, or pretty much any PPM or syndication under tax rules. That investment is now only worth 50 grand for the real technical types on the call. If you look at the estate discounts with LLCs, for lack of control and management and lack of liquidity and marketability for the geeks on the call that already know this, that’s what I’m talking about.
That applies in estate planning. Well, it also applies to converting traditional Roth. So what does this add up to? Let’s put it numbers. I got a hundred thousand dollars deduction for putting money into traditional. If I convert properly, not cash, but an asset that the tax law gives me a discount on. I only add 50 grand to my return when converting the entire thing. That’s massive that tip right there when somebody rewinds and processes and thinks that through that is a massive value add. It’s a way to cheaply convert to Roth and to do what Congress clearly does not want us to do. They’re starting to target Roths. So what do I want, whatever they say. I don’t, I can’t have, sorry. Long-Winded lawyers what we do.
That’s fine. So this that apply to everybody regardless of the size of their traditional IRA, or is, does that really make sense for someone who’s got like a hundred thousand or more in an IRA at this point in time?
It makes sense. Regardless of size let’s remember Peter Thiel, who I thought what he did was let’s just be very polite and say it was rather aggressive two grams to 5 billion. And we could talk about that. I argue with tax lawyers over what he did all the time, small amounts can legitimately be made into very large amounts. So regardless of the size, that technique makes a lot of sense and applies.
So for those who don’t understand what Peter Thiel did, maybe touch upon that, like he set up a Roth IRA, he seated it with some capital, and then he made that investment in Facebook, I believe at a very early stage and that small amount relative small amount turned into billions of dollars. Is that correct?
And the problem there, the problem where, right, so he put two grand in, that’s all he put in, he put it into his either PayPal or Facebook. One of those here was the problem, the key problem. And at the time the IRS did not know what to do with it. They just didn’t have the skillset today. You’ve a harder time getting away with this. The stock that he bought was not available to everybody. And that’s the key. It was only available to him personally, as a founder at a deeply discounted price. It was not a realistic price, even on day one. And it was only available to him. That’s the problem. And, and he pushed it hard. I mean, if you look at what it grew into, so we just had, it was funny. We just had a client call, was somebody who was doing a very mini Peter Thiel.
The difference was that the stock, even though it was cheap and a startup is widely available, if anybody can buy it or a very large group of people can buy it, not an issue, or if it’s quote unquote fairly valued, which I really don’t think what he did was fairly valued. But the key was for me, if I were the IRS lawyer and I wanted to attack that, I would argue this, your IRA never had a right to acquire that you personally had the right to acquire it as Peter Thiel because of your position with the company, you transferred the right to buy at this bargain basement price. You transferred this right. Well, that right is property. It’s like an option, right? An unwritten option. You transferred this property to your IRA and there is a problem there. Now the IRS wasn’t swift enough to think of that. They’re getting smarter about it. It takes some time. Yeah. Yeah. Especially once they see it and they get really mad and they start thinking about it. So the object is to play the Peter Thiel game, but perhaps just a little bit more subtly and a little bit less, just a little bit less aggressively.
So side question, purely a side question, but the trainings and the programs that you offer, do you talk about these strategies? Because this is a big one.
Oh yeah. Among others. I mean obviously leverage, especially in a 401k, if you’re doing real estate, because it avoids a tax known as UT. Yeah. I’ll tell you one of my favorite strategies for making a small IRA into a larger one. I mean, a borrow and pay the [inaudible] on your first deal. And it’s okay. Just pay it on the deal. Once you have enough money in your account, whether it’s an IRA or even better a 401k to do 20% of the deal. And, and I get into my, in my programs into detail, why, where do I get that number? Why 20%. But once the IRA has 20% of the money, I like the IRA to create an LLC put in 20% of the seed money. So actual, real investment. And then everybody that brings in the 80% gets preferred dividends. You find civilians, which there are plenty out there.
I want the kind of guy when, I mean, when I say civilian, not a real estate investor, I mean, someone who, if you offered him a 10% return would think it’s a rip off and runaway screaming. That’s the guy I want, right? If you offer him 6%, he’s gonna do back flips. So we give them a preferred dividend. Let’s say 8%. Let’s think about what we did my IRA put in 20, it got not debt financing. What’s the problem with debt financing and an IRA. It causes EBIT that’s high tax. Yeah. So you get taxed on that. So instead we do equity, fine. You get a nice preferred dividend. It’s still cheap. Leverage. People are like, well, I could get interest, you know, at 4%. Well, that’s great. 8% is really cheap if you’re not paying you, but do the math, that’s a way better deal.
So that’s just one technique to take a small IRA into a big IRA or a good size one into a much larger one. So we do get into those and we go through the spectrum of risk. We start with, here’s the super conservative way to do it, depending on your personality and your nature. And then we start warming up the scale of, you know, we’re getting more aggressive and we stop that. I’m not gonna teach anything. I think that if, if you got audited, if I think you only have under tax law, I have to have, when I give you advice, I have to thank you of a 40% chance of winning the argument. What tax geeks call substantial authority, what normal humans would call a good argument, right? So I’m not gonna go past a 40% or I’m not gonna give you what I think is a 30% chance of winning argument. And so we kind of measure the gray and then you decide investor, how hard do you wanna push it? Right.
Let’s close. The loop on two things. We’ve got a couple of open loops here. You mentioned backdoor Roth. Now two part question, the legislation’s trying to bring an end to that. So was it passed and you have time or is it not passed? And you have time to get your ducks in order to do a backdoor Roth. It may, maybe you should explain what a backdoor Roth is, cuz there’s some people or I’m sure, maybe a lot of people who don’t fully understand what that means.
Sure. So a backdoor Roth, you qualify to contribute to a Roth IRA directly. You can contribute six to seven grand a year, depending on your age directly. If you make less than off the top of my head and I can be wrong, you can Google it. But if you’re single a hundred grand a year, if you’re married, filing joint 200 grand a year, it’s my recollection of the thresholds. If you make less than that, you can just contribute straight in. If you make more than that, you’re technically banned from a direct contribution. So what do you do? You contribute to a traditional IRA that’s after tax. So there’s no deduction. That’s the after tax part and it’s traditional and then you immediately convert it to Roth. So it’s backdoor, it’s an indirect way to do something you’re directly not allowed to do. It’s clearly people have been doing it forever.
Congress, particular parts of Congress don’t like it. So what did they say? The legislation is still a bill, so it has not become law. Okay. So the, the current draft says we would disallow the backdoor Roth IRA as of January one of 22. Now, if they were to pass it and we don’t know if they’re gonna pass it right now, they’re, they’re having a hard time agreeing on the time of day second, if they do pass it, normally it’s as of the date of passage that it’s effective. Meaning if you contribute beforehand, normally you’re not gonna have retroactive legislation. Even if it is retroactive, what’s the solution. I can pull the money out of a Roth IRA because the way that Roth IRA rules work, if I pull money out of a Roth, the first I can take out of my Roth, however much I contributed tax free. So you add up your total contributions over the years, the first money I take out is deemed to be withdrawal of a contribution and by definition non-taxable so how do fix the problem? If they pass the law and it’s retroactive, I did a back door for 22 turns out retroactively. They said, no, no, no, you can’t do it. Well, I just pulled the money back out.
Right? So your risk is low on that. Yeah.
Yeah. Very low.
So as far as these new legislation proposals, what other implications are there? You’ve talked about the 10% ownership rule. What about accreditation status? I mean, this is just crazy, but you know, does that even apply? Will it apply? What are the implications of that?
So they initially had said that IRAs, the first draft of all this of many IRAs are not allowed to invest in anything that requires you to be accredited or other relies on your status. So actually it would’ve killed most crowdfunding as well. Right?
Yeah. Big time.
So that went, that got taken out. There was a huge amount of protest. And I, I gotta give credit to the people. I mean, we set up that website to hands off my ira.com and it maybe a good one to follow. If they try again, that’s why I kept the website up. It got a tension. I got a ton of hits. A lot of them outta DC. People started looking, people started doing their part and writing letters and calling and faxing and making a ton of noise. And we heard it. I had lobbyists tell me, we have seen copies of the letter, your sample letter all over. So the, all the guys listening here, a lot of them did their part and made a stink and it got pulled out. Now, do we have to do this with Congress? Oh yeah. Oh yeah. All the time. Could they try and sneak it back in? Absolutely. Actually Senator Ron Wyden, who’s the Senate finance committee chair hates Roth IRAs. He’s the one. And since he’s the finance chair, he has a lot of power over tax provisions. So we have to keep an eye on him that there’s not a last minute amendment to sneak that stuff back in. And so we gotta stay on top of it in particular, stay on top of mansion and cinema.
Well, we’ll mention again, but the website is handsoffmyira.com and I’ve been there. It’s really good. You have a lot of content on there that explains what’s going on. And how often do you update that? Cause I think it’s good for…
I need it’s obsolete right now. In other words, once they took the legislation out, I did not update it cause so personal story for me to the time it took me to create that website during a very busy moment in my life cost me. It really did, but it was the right thing to do. And so I, once they to, they pulled it out, I haven’t updated it. I’ll probably do that in the next, I don’t know, couple of months, once they took out the really horrible stuff, the website became less relevant. I mean, what they’ve got in there now, I don’t like it, but I can look live with it. And I don’t think politically we’re gonna be able to get rid of it. In other words, arguing against limiting IRAs to 10 mill, that’s gonna be an uphill fight with this Congress. I don’t, I don’t think we could scream as much as we want about no, I should be allowed to have 20 million in my IRA. Yeah. And the present Congress will be like, that’s a, we don’t care. That’s what they’ll tell us.
Well, I mean, ever since these defined contribution plan been pushed on us, which I believe started in 1971 with ERISA act, you know, now we being forced to take responsibility for our own retirement. You know, it’s not coming from employers anymore. So if they’re gonna give us that directive and the responsibility to take control of our own retirement, they should not continually restrict what we’re able to and try at least now to take away our retirement account options. You know, this legislation to me is almost draconian crazy.
Yeah, no, they’re look, this country’s building a Berlin wall, made a paper. They don’t care if you leave, but they don’t want your money to leave. Right. Right. And that applies internally and externally. So trying, they call it loopholes and I just call it. They want a lot more of your money.
Well, that begs the question. I mean, is all this legislation about increasing tax revenue or is it about government control? Yes. Yes. All the above D
Yeah. Yeah. Totally about both. All right. I’ll give you an example. There’s a new law that it’s effective now that makes LLCs more risky and expensive. All LLCs among other corporations and other entities, the lawyer or person forming them has to report to the government. The feds who the human being owners are two things if they don’t report it. So when I set up an entity, if I don’t report who the human owners ultimately are, it doesn’t matter how many layers of trusts or whatever the government wants to know who the human beings are. And I, if, if I commit perjury, you know, I’m not politically connected in like certain other unnamed politicians. If I commit perjury, I go to jail second. If I don’t file that report, I go to jail. Wow.
Sorry. Doesn’t that fly in the face of some state legislation? I mean, there are states which protect the people who set up the LLCs there’s pure anonymity. Does that not fly in the face of that those laws?
Federal law preempts. Really? Yeah. It’s just superior it just preempts and look, the nature of lawyers, myself included is if there’s any risk of me going to jail for not filling out a piece of paper, when I set up an LLC, I’m filling out the paper. And if I have any reason to know that the client’s [inaudible] me in other words, that maybe they’re not the owners that they’re telling me are not really the owners. I won’t do it. I won’t take the risk because I just look it terrible in orange, but there is no privacy. Now the government says they’ll guard the information, you know, kind of like Peter Thiel’s tax returns.
Right. Okay. So where things sit today, do you think IRAs and maybe even 401ks are doomed going forward? I know a lot of the legislation has been pulled off the table, but that could change tomorrow. What do you think? What, how do you feel about the future of our IRAs?
I think this is more like a bow constrictor. First of all, you wanna get grandfathered. There’s a lot of stuff that people did in the past that when they passed a law, as long as you had, for example, the way ESOPs, there were certain things ESOPs used to be allowed to do. And if you have an ESOP from a certain date from, let’s say, be before the earth, early nineties, you’re still allowed to play under the old rules. So a get as much in there as you can get it grandfathered. I do think they’re gonna slowly chip away at a, in particular Roths slowly. They may not get away with it this time. Maybe this passes, maybe it doesn’t, but we already knocked them back a lot over time. They’re slowly gonna chip a way out at why they’re desperate for revenue and the direction of the country is populous on both the right and the left. So I think get, while the gets good, do it while you can grow as much as you can take advantage of the grandfathering.
What about SEP? Is there any language in there regarding SEPs?
Not directly, they are to the $10 million limit. Oh really? Yeah. And SEP are never Roths. So all the anti Roth language does not apply to a SEP cause those are always traditional. And they’re also for the most part, an inferior account. There are some very specialized situations where they can make sense, but 401ks are way better than SEPs. Especially if you’re self direct.
You’re talking about solo, 401k, not…
Generically 401ks. So they’re, they’re all I for layman, I describe 401ks as three types. Now there’s really way more, but to make it intelligible for normal humans who don’t really want to fall asleep and pound their forehead on the keyboard, three types of 401ks, they can all be self-directed or they can be not self-directed. That depends on the plan doc, right? The plan documents decide does self-directed mean I can pick whatever mutual fund I want or to self-directed me. No, I really can buy whatever the heck I want. As long as I don’t break the, the law. So a normal 401k is very expensive. The compliance costs and the complexity of running a normal standard corporate 401k, you’re talking tens of thousands per year minimum. That’s nobody nobody’s small entrepreneur wants to do that. The other end of that is a solo 401k. What that means is the, you don’t have any employees other than you, your spouse partners, by which I mean business partners, not domestic partners.
What’s the benefit of a so, okay. They’re super cheap. They have all the same contribution limits. They have the same prohibited transaction, the same EBIT rules as the other, the normal 401k, but because it only involves you, your spouse, maybe some business partners, the IRS and, and the department of labor say, you don’t have to follow all these rules that are designed to protect all the employees. And so your compliance goes from here to here. I mean, solo case can be super, super cheap and simple. And then there’s an intermediate kind. Let’s say you have employees, but you’re not really huge. There’s something called a safe Harbor 401k plan. And the IRS kind of makes you a deal. There’s always a, a trade off with those guys. So what they say is, all right, we’re not gonna require all this bureaucratic stuff that a normal 401k has to do.
We’re gonna relieve you of a lot of the costly compliance, but in exchange we want something. So what’s a Safe Harbor Plan with employees run you in terms of admin, you know, 2500, 3 grand a year, not bad. The trade off is you have to contribute 3% of everyone’s salary to their 401k annually or 4% of their salary, but only for people who actually contribute. So depending on what kind of have employees, you have, like, if you have a bunch of lawyers who contribute the max, you want the 3%. If you got a bunch of people who are not prone to putting money into the 401k, you take the 4%, but you’re probably only paying for that on a third of the employees or 20% of the employees. All those can be self-directed. So those are three basic flavors of 401ks, same basic rules, very different cost structures.
I know you can have multiple IRAs, can an individual have multiple solo 401ks?
Probably not multiple solo Ks, but multiple solo and safe Harbor Ks. Let me give you an example without, and for the accountant types and the geeks on the call. I’m talking about the controlled group rules, which I’ll do it, everyone in favor and not describe, let me just give you an example. Let’s say you, me and someone else, who’s not family, not otherwise related to us. We set up a, a company and it’s got a 401k plan. And we’re like, well, maybe, actually, you know what we could, if we were partners, if the company were a regular LLC, that would qualify as a solo, cuz we’re all partners let’s assume there are no employees, just the three of us we’re partners. So we can have a solo there. Me having a hundred percent owned company is considered a different controlled group. That’s the key term.
So it can have a solo. K, just to give you an example. Now that’s a super simplified example on the controlled group roles, but if you have different controlled groups, here’s the classic. I have a w two job. I own a tiny percent of the company or none of it. I can max that 401k, cuz that’s a different controlled group. I don’t have any ownership or my ownership’s tiny. And then I have my own other company, my, my, my entrepreneur company that has a 401k and I can max out to it. That’s the most common example by far.
Okay, so we’ve touched on some strategy conversation here in this conversation. Obviously this is a much bigger conversation than we can pack in 30 minutes. So let’s just kinda wind this up a little bit with a little bit of strategy. Talk, first of all, are you an advocate of holding real estate in a self-directed retirement account of any kind? Some people are, some people aren’t, there’s, there’s different arguments about it and the biggest, you know, complaint or argument against it is that you lose the depreciation tax benefits from it. And I know you can argue this both ways, but what are your thoughts on that?
You, well, the lawyer answer is it depends. And it’s a good answer for a reason. The generalization of you shouldn’t put, let’s say all you’re good at is rental real estate, but you’re really good at it. My IRA should not buy rental real estate, even though it would make money on it. And it’s something I’m really good at because I can’t take the losses. So what should my IRA buy T bills? Right. Right. So now on the other hand, let’s say I’m also really good at crypto. Okay. Now it makes sense to buy the real estate me for the losses and to buy the crypto in the IRA. And those are two very basic examples. That’s a lot more nuanced than that. Look, I bought real estate in 2009 to 2016, cheap I’m talking low income, single family stuff that with rehab, we had 30 grand in through my Roth 401k and boy, am I glad I did?
I wouldn’t have gotten much benefit. I mean was so cheap. What kind of depreciations is that gonna throw off? Right? Of course that was the old days now. Second let’s remember a lot of people cannot use the depreciation. If you have a passive loss problem where your rentals create a loss and it’s considered for you a passive activity loss and it just sits on your return. You’re not getting the benefit of that anyway. So there’s a lot of nuance to that question. What I tell people to do invest your IRA or 401k in what you’re good at investing in. Assuming we can do that. So for example, if you’re really good at drug dealing, I probably am gonna recommend against doing your heroin business through your 401k or IRA for, for a number of obvious reasons. But by and large, you should do what you’re good at. If it’s permissible and it usually is through your IRA or your 401k. So if you’re good at rentals, I would cherry pick the sweetest deals cuz you lose short term short term, you lose write offs, assuming you can use them, but long term, the thing being tax free in a Roth in particular. Now you gotta do some math and see now you gotta see the numbers. What’s the numbers on the property.
I think another way of saying what you’re saying is the investments that produce the greatest or highest long term returns are what you should be focused on in your retirement account.
I would absolutely cherry-pick the best deals are gonna go into my retirement accounts.
Got it. So highest alpha. Okay. Strategy wise. Does it make sense given the legislation, as it stands today to convert or roll over any retirement accounts into anything else being turning them into Ross or 401ks, is there any value in that?
Yeah. Given the McNaught case that limits checkbook LLCs, which was not legislation, that’s just a case that came out about two months ago, right? Limits checkbook, LLCs and IRAs. First of all, 401ks are superior to IRAs for self-directing the only disadvantage of a 401k, especially if you qualify for a solo, which is easy to do for most people, only disadvantage of a 401k compared to an IRA is when you hit 72, a Roth 401k has to make required minimum distributions and a Roth IRA does not. And the solution is you keep the 401k, you keep contributing massive amounts to it. You just roll everything. But a hundred bucks when you hit 72 every year into the Roth IRA. So 401k is for reasons we don’t have time to go into are generically superior, better prohibited transaction rules, better EBIT rules, more control in some cases, better asset protection, easier to do a checkbook LLC Roth in a think about this bracket creep, traditional IRAs are subject to bracket creep.
Eventually, you’re paying taxes on the money. What happens in an inflationary environment? The tax brackets are increasing at a high rate. Why? Because of inflation. So if you’re gonna have bracket creep, a Roth becomes comparatively more valuable. So I’m a big proponent of converting to Roth. If you’re internal rate of return is good. Okay, well what’s good. Depends on your bracket, but by and large, if you’re able to consistently pull 12% or greater returns inside a retirement account, even if you’re in a high bracket, Roth probably makes sense to you. Especially if you can convert at a discount, the way we described, then it really makes sense. Cuz the cost of conversion becomes a lot lower.
So as I listen to you, I keep hearing all, all roads lead to Roth, IRAs or solo 401ks. Tell me if I’m wrong, but if I’m right, when does it make sense to keep a traditional IRA?
So first of all, your internal retain rate of return is low and your tax bracket is high. So the deduction is valuable to you. Cause with the traditional IRA, you get an immediate tax deduction with the Roth. You don’t get any you. And if your rate return internally is very low, which by the way would apply to most of corporate America, right? The officers, high brackets employees, some of them high brackets rate return internally. I I think when you average it out right now, we’ve had, you know this, but that’ll stop at some point. I think in that case, it makes sense. The traditional, let me think. What else would that make sense for somebody really it’s high bracket or low internal rate of return because you just run the math on. Here’s how you run it. You run an internal rate of return function in Excel.
Your investment is the cost of convert from traditional to Roth or not having the traditional deduction to begin with. That’s your investment. You paid extra taxes. How much was it? Right? What’s your return? Well, how much am I getting tax free? When, when I have to guess, when will I start taking money out? How much tax would I have paid? How fast will things grow inside my account? That’s all guesswork, but you can run a spreadsheet, an internal rate of return on I rrr and play with the assumptions. And it’ll tell you personally paying the tax to have a Roth today. Here’s my rate of return on having paid that tax. And I’m just telling you if your internal rate of return is 12% or more, the rate of return on Roth is…
Yeah. Makes sense. Well, you know, the whole subject of taxes probably creates brain damage for a lot of people, unfortunately. But the thing is, like I said before, Albert Einstein said, you know, the hardest thing in the world to understand is the income tax and just educating yourself and working with the right tax professional will help you because the fastest way to get a raise is to minimize your tax. It’s just, it’s like quick free money right here right now. So proper tax strategy is critically important. So on that note, share with our audience, how they can learn more about you and your practice. And more importantly, you know your courses. I know you have one coming up, but you’re different online education programs.
So two things we take clients, not many, we’re usually one to two months out and I’m not a good fit as your tax lawyer. And the reason is there’s one of me I’m really good at planning, putting a structure together, delegating tasks, helping you find team members, if you lack some. So I’m good at that. But usually there’s a wait, what I’m not good at is I have a last minute call. I have a closing. I need you to call me back today. Oh Lord, that’s not gonna happen. Just forget it. And then we do a lot of educational content at taxreductionclass.com, taxreductionclass.com. Right now what we do this thing has grown nicely. It started as one call a month on an esoteric, strange topic. We even told people of the 12 topics I pick annually. It’s whatever I happened to be researching.
Cause as you noted, I, I research a lot, way more than your normal tax person. So whatever I happen to be researching, that’s the class for the month. I told people, half of them are gonna you’re you’re not even gonna watch it. It’s just gonna bore you. The other six, you’re gonna watch. Two of them are gonna make you so much money. It pays for the class for the next 10 years and that’s what’s happened except we got so many signups. We, we got a lot of really people, prop boning us and all that now might do it three weeks, three weeks of the month, we do an advanced class, for example, on rollover business startups or preferred dividend LLCs for Roth IRAs or discount conversions for Roth IRAs. Usually it’s an hour to an hour and a half of talk and then half an hour to an hour of Q and A.
So it’s people’s chance to ask comparatively simple questions. You get somebody who sends in a book and it’s like, no. The, the second class of the month is beginning to intermediate. So we get into passive losses, depreciation, bookkeeping, basic things that people should know, cuz we started having enough people get on that the advanced topics went. So we started adding and then finally the last call of the month is pure Q and A. And, and I’ll tell you some of the stuff the callers come up with in terms of planning. Ideas is gold. We actually now have a fair number of CPAs who signed up, cuz they get so many planning ideas and they’re mostly real estate focused CPAs that they sign up for the content, even though they’re not getting credit, they’re not getting CPE credit. Wow. So that right now is the main one.
And then in about another two months, I will be putting out a class on self-directed IRA, 401ks. That’s completely online. It’s something I’ve done physically, you know like a two day seminar. We’re putting it together as a nice niche course, but it’s gonna be about another two months before that’s edited and all that sort. You know how it is putting yeah. Putting together all the work. Yeah. So that’s, that’s what we’re putting out there. And I mean our retention rate on those webinars and the amount of new signups we’re getting, we must be adding value.
Yeah, for sure. Cool. No, that’s great. We’ll have all that in the show notes. Any final comments for our audience before we wrap up John?
Yeah. If your accountant tells you, you don’t qualify for a solo K cuz all you have are rentals. Start thinking about a management company and I’m saying do it, I’m saying, think about it for some of you, a management company makes sense for some of you it doesn’t. And that’s assuming you don’t have some other source of what we call compensation. For example, if you’re flipping or wholesaling or you’ve got a salary from your own company, that’s compensation, you can fund a 401k. But if you’ve just got rentals, think about a management company, there are other perquisites, but you do have to have a certain size for management company to make sense, right? If you’ve got four single family residences have a management company is probably not a really great idea for you. So I guess size does matter. Some I’ll leave you with that.
Beautiful! John, thank you so much for coming on. We’ll have you back on later this year, cuz taxes are always changing and there’s so many conversations we can have about it. I geek out on it a little bit, but it still drives me a little bit batty.
Cool. My pleasure. Thanks for having me.
Thanks for being on John. That is it it for today. I hope you enjoyed today’s episode and our guest. Remember to download your free report, the ultimate guide to passive real estate investing available as a free download on both of our website at passiverealestateinvesting.com or our main website at norarealestate.com – N O R A D A. If you have questions about real estate, go ahead and submit them on to the Ask Marco button on our website, get your free strategy session. If you are interested in real estate investing or thinking about it, that’s what we’re here to do. There is no cost, no obligation and there’s no cost ever before during or after the services we provide. So we provide you a ton of free education, knowledge, resources, guidance, and of course the turnkey investment properties that we have a pipeline of. We don’t put much of it on our website because it turns over so quickly.
Sales are very brisk today. We are pretty much in a seller’s market all over the country. So markets are strong or very strong in terms of price, growth and demand. And, but that’s a good thing if you’re a real estate investor. So don’t discount the fact that times are still good. I’m still very bullish on investing in real estate. The question is not if, but when, and it’s also a question of where, so keep that in mind. There’s always a good deal out there. It’s not a question of when, but where that is it for today. Remember to subscribe if you haven’t done so already that way you never miss another episode, help us spread the word, visit us on iTunes or wherever you listen, give us a rating and review. We appreciate it. Thank you for being here and we will see you on our next episode.
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