determine what early retirement looks like to you

Your Investment Guide to Retirement Early | How to Build Wealth Fast

The feeling of financial independence isn't something you can tally up using retirement calculators. It's also not something you can achieve on a whim. While the average American's retirement age is 61, your lifestyle, both leading up to and during retirement, will determine your true feasible retirement age. 

To help you retire early, I’ve laid out a few investment secrets I’ve learned over the years that allow you to scale your wealth quickly and sustainably for retirement. 

Step 1. Determine How Early You Want to Retire

First, determine what early retirement looks like to you. Do you want to retire in your 60s, 50s, or maybe even your 40s?

For some people, the idea of freely traveling, relaxing, or pursuing hobbies is all the motivation they need to aggressively save during their working years. 

Setting an "end date" is necessary because you have to work backwards from the age you want to retire to the age you are today to work out your investing strategy. 

Step 2. Calculate How Much Savings You'll Need for Retirement

Determine the "monthly nut" you'll need to sustain your standard of living during retirement. Your nut can consist of housing, utilities, transportation, groceries, and anything else you pay for that allows you to "exist."

An easy way to do this is to create a monthly average by looking at your monthly spending for the past six months. While some people think that coming up with a flat sum for their full retirement is the way to budget for retirement, it's actually important to calculate your way forward based on monthly expenses to create an annual retirement need. 

From there, you can see how much money you'll need to cover your anticipated retirement duration. 

Ideally, your monthly spend will not include a mortgage payment. The hard rule of retiring early is that your mortgage and other debts should be paid off by your retirement date. If your home has significant value, selling the home to purchase a smaller property for cash could be part of your plan for early retirement. 

Generally, it's recommended that you create a situation where you're living on 80% of your pre-retirement income to enjoy a similar standard of living. The less monthly costs you can avoid, the earlier you’ll be able to retire. 

For people retiring early, it's necessary to rely on your own investments and savings until Social Security payments can begin at age 62. If you can hold off until 70 before cashing in, you'll get the full benefits. 

Step 3. Start Saving Money

Even the smallest expense burden you can cut today brings you an hour closer to retiring. If you're doing retirement planning as someone who isn't a millionaire, there's no shame in "going cheap" for the sake of your end goal. Here are some ways to start cutting costs to get to the retirement finish line earlier than your peers:

  • Aggressively pursue promotions and "job leaps" that will max out your earning potential as quickly as possible.
  • Choose one streaming service that you like. Cancel all other subscriptions.
  • Pay off or refinance high-interest debt.
  • Open a short-term certificate of deposit (CD) for cash that isn't already being invested.
  • Invest in the annual family vacation fund instead of taking multiple vacations.

While this will help to build a nest egg, there's only so much that cutting costs can do for your retirement plans. It's just as important to grow money in anticipation of retirement. 

Step 4. Grow and Compound Your Money

Open a retirement account to start putting your retirement funds to work early. Receiving a matching 401(K) is a good place to start, though I recommend opening a self-directed IRA (SDIRA).

An SDIRA allows you to invest your IRA in alternative assets like real estate and crypto, which can grow in equity or accrue monthly mortgage payments to fund your retirement. There are several ways to raise money for real estate using your SDIRA that will allow you to compound your earnings without going broke.

If you're over age 50, take advantage of the IRS's catch-up contributions for retirement investing. Other growth and compounding options that are simple enough for the average person without a financial and investment background to use include:

  • High-yield savings accounts.
  • Certificates of deposit (CDs).
  • Bonds or bond funds.
  • Money market accounts (MMAs).
  • Real estate investment trusts (REITs).
  • Dividend-paying stocks.

Step 5. Reduce Debt and Expenses

Pay off all debts before retirement to limit your monthly spending. If your final mortgage payment falls beyond the date you want to retire, consider refinancing to a 15-year mortgage if you're in a position to make larger payments now in exchange for a mortgage-free retirement. 

I still recommend investing your money before paying off debt, though aggressively paying off your debt early will allow you to avoid interest payments. 

Step 6. Avoid Taxes

Many people lose a big portion of the money they've scrimped and saved for their entire working lives to taxes during retirement. If there is one secret the wealthy know that everyone else doesn’t, it’s how to avoid taxes. 

If real estate is your investment of choice for funding your retirement, make sure you're taking advantage of the 1031 exchange to jump from property to property without ever paying for capital gains on your earnings. 

A Roth-structured SDIRA is another great option to avoid getting hit by taxes. With this option, all of your income and gains will flow right back into your IRA on a tax-free basis. That means you're constantly building wealth without paying taxes on it until the day you need to take a distribution. Just remember to follow the IRS’s SDIRA rules.

Step 7. Budget for Healthcare and Other Expenses

The time from when you walk away from employer-sponsored insurance to when Medicare kicks in at age 65 is a long road. While it may seem like going without insurance can reduce your monthly nut, the truth is that one health emergency can leave you bankrupt in retirement.

A retirement health savings account (HSA) is one of the best ways to put aside money for care during retirement because it allows you to tuck away pre-tax dollars. If you've been carrying life insurance, consider swapping it for long-term care insurance once your policy terms are up.

The secret to retiring early is that nobody ever really stops working. That's because managing your investments and finances will remain a priority for the rest of your life. If you feel the nudge to get out of the rat race early, the first step is working with a financial advisor to start planning a realistic retirement budget.

by Ron Lieback

11 Ways Wealthy People Avoid Taxes

One of the most common questions I get asked is: how do rich people avoid taxes without getting in trouble? 

It’s all too common to see headlines of rich celebrities and corporations that pay close to $0 in taxes. Recently revealed IRS files found that wealthy individuals like Jeff Bezos and George Soros have paid $0 in taxes over the years. 

However, the truth is that these individuals are able to do this through completely legal means available to any investor. 

While you may not have a team of attorneys and accountants working on your side, educating yourself on common tax loopholes and laws will help tremendously. 

Rethink your tax bill strategy with these 11 ways to avoid paying taxes like the rich. 

1. Invest in a Tax-Deferred Retirement Account

Capital gains taxes for assets can be as high as 20% depending on how long you held it and how high it was worth. 

One way to circumvent these taxes is to hold your asset for longer to qualify for a smaller capital gains tax. 

However, you can avoid most capital gains taxes altogether by growing your portfolio tax-free with an individual retirement account. 

IRAs offer many of the same tax benefits as a 401(k), except Roth IRAs can be managed almost tax-free. For example, all contributions to a Roth IRA are not taxable, and earnings can be withdrawn tax-free as long as they are within the required retirement window. 

Furthermore, a self-directed IRA under a Roth structure allows you to invest in alternative assets like real estate and crypto without being taxed. 

Other retirement accounts you might be interested in include:

  • SEP IRA: Recommended for self-employed individuals.
  • SIMPLE IRA: Recommended for small businesses.

Just be sure to research self-directed IRA IRS rules to maximize the benefit of your account. 

2. Depreciation

While many people are familiar with capital gains taxes, capital losses actually work in reverse–a process known as depreciation. 

You don't need to do anything special to benefit from depreciation. Under the IRS tax code, your assets automatically depreciate if you sell an asset at a loss. 

The simple depreciation formula requires subtracting the asset's salvage value before dividing the asset's cost by the estimated number of years of useful life. 

The asset's salvage value is the total it's estimated to be worth at the conclusion of its useful life. The number you get at the end is your depreciation expense.

Another method called double-declining depreciation allows you to bulk up your write-off of an asset's value right after its purchase in exchange for declining deductions as time passes. 

This is a good option for a small business that's struggling under the weight of startup expenses. The formula uses two times the number you get when you multiply your asset's single-line depreciation rate by its book value at the start of the year.

3. Charitable Donations

Claiming charitable donations on your tax return helps reduce your taxable income for the year. 

Both cash and material donations can be tax deductible as long as the recipient is a 503(c)(3) charitable organization. So plan your donations wisely. 

For example, if you anticipate being in a higher tax bracket this year, plan a larger charitable gift carefully to minimize your tax burden without exceeding the limit. If a donation is more than 60% of your income for the year, the excess amount will be rolled over for tax benefits for the next year.

For many, donating to charity is a great way to put the money they would have paid in taxes to better use. 

Remember, keep your receipts. 

4. Long-term Investment Income

As previously mentioned, the long-term capital gains tax is substantially lower than the short-term tax. 

While the short-term capital gains rate is between 10% and 37%, long-term capital gains are tiered at 0%, 15%, or 20% for people in different income and filing brackets. 

All it takes is holding on to an asset for a whole year before you sell. 

5. Tap Into Tax Breaks in Real Estate or Similar Industries

Every industry has its own set of "secret" tax breaks. 

In real estate, 1031 exchanges allow you to continuously raise money for real estate using the sale of your previous property without paying taxes on it. 

Let's also not forget about write-offs for property taxes, property insurance, repair costs, advertising, office space, legal fees, accounting fees, travel, and so much more. Wealthy Americans never leave these breaks and incentives on the table.

6. Step-up Basis

A need-to-know option if you're inheriting assets, the step-up basis loophole allows you to avoid capital gains taxes on inherited property. 

When a person inherits property or assets, the IRS resets the asset's original cost basis to its value on the inheritance date. 

While the heir will pay capital gains on that basis when selling the asset, the overall rate will be lower.

7. Gifting

Did you know that giving money to family members can lower your tax burden?

According to the IRS, a gift is not considered income for federal tax purposes unless it exceeds the annual exclusion of $17,000. 

As of 2023, the IRS allows you to give away $12.92 million in gifts cumulatively over the course of your life without ever paying gift taxes. 

Just be warned that the gift tax rate climbs to somewhere between 18% and 40% if you exceed the $17,000 cap in a single year.

8. Moving

While millionaires and billionaires hang out in the priciest zip codes in the country, they know better than to claim their wealthiest dwelling as their primary residence. 

If you currently live in a high-tax state, moving your primary residence to a home in a low-cost state can instantly boost your net worth. 

Changing tax residency is a complex process that usually requires the help of a tax expert. The biggest thing to remember is to never spend 183 days or more in a state other than the one you've claimed for your primary residence. 

9. Forming an LLC

An LLC helps you avoid double taxation the same way that the wealthy do. 

When you form an LLC, you'll enjoy the structure of a pass-through entity that allows earnings to go directly to you without prior taxation. That means you're only paying taxes on your personal income. 

LLC owners also enjoy tax deductions for business expenses, the Qualified Business Income deduction, and other perks that self-employed people don't get without an LLC.

10. Establishing Trusts

Establishing a trust can help you to reduce taxes in the context of a wealth transfer.

The first thing to know about this strategy is that trusts reach the highest federal income tax rates at lower thresholds compared to ordinary income. That’s why proper trust management is everything. 

The trick to using a trust to reduce your tax burden is to make distributions to a trust beneficiary only if that beneficiary is in a lower tax bracket. 

11. Understanding the Tax Code

This is probably the most important aspect of how wealthy people avoid paying taxes. 

You don't need to know all the tax laws to lower your tax rate, but it pays to know about the laws that relate to your investment decisions. 

Make sure to research various deductions and employ some of these tactics before the new tax year to lower your tax burden. 

Wealthy people don't just get lucky with taxes. They use existing tax codes to their advantage to keep more of their money without breaking the law. 

One of the best-kept secrets in personal finance is that many of the tax-deferral options available to millionaires are available to people making minimum wage, six figures, and everything in between. 

Experiment with some of these methods to try and lower your tax burden. Remember to talk to a financial advisor first.

by Greg Herlean

How Do Self-directed IRAs Work?

While the days may feel long, the truth is that the years are short. This is especially true when it comes to saving away as much money as possible for retirement. 

If patience isn’t one of your strong suits, then looking for ways to build up for retirement as fast as possible may be tempting. 

One retirement plan I recommend to all of my followers and customers is a self-directed IRA (SDIRA). 

Unlike traditional retirement accounts, SDIRAs give you the freedom to explore alternative assets with high-growth potential. As a result, investors like me and Peter Thiel have used SDIRAs to significantly boost our wealth and portfolio. 

So how do self-directed IRAs work? Read more to learn the basics of opening a self-directed IRA.

What Is a Self-directed IRA?

A self-directed IRA is an individual retirement account that allows you to hold alternative assets. Unlike a traditional IRA that limits investments to stocks, bonds, annuities, unit investment trusts (UITs), mutual funds, and exchange-traded funds (ETFs), a self-directed IRA allows for investments in exotic, high-return assets. 

For example, a self-directed IRA allows investors to invest their IRAs in the following assets:

  • Commodities.
  • Real estate.
  • Raw/undeveloped land.
  • Water, oil, mineral, and gas rights.
  • Private stock.
  • Limited partnerships.
  • Cryptocurrency.
  • Precious metals that match specific standards.
  • Crowdfunded startup assets.
  • Foreclosure tax liens and deeds.
  • Foreign currency.

While custodians must oversee self-directed IRAs, each IRA is managed directly by the account holder. The burden is on the account holder to perform due diligence, conduct research, and maintain proper management of assets. 

Pros and Cons of an SDIRA

A self-directed IRA is an exceptional choice for someone seeking diversification of assets. 

For many people facing retirement, investing in alternative assets using an SDIRA is viewed as a shield against inflation and volatility. Here's a glance at the advantages of SDIRAs:

  • Flexibility: Self-directed IRAs provide a much broader scope of asset classes compared to traditional IRAs. Diversification beyond stocks, bonds, and mutual funds can help a portfolio to remain resilient against downturns. In addition, investors can dip their toes into exciting markets with everything from gold to cryptocurrency staking on the menu with SDIRAs.
  • Potential for Higher Returns: SDIRAs are especially attractive to investors looking for assets with higher-than-average investment returns. On the flip side, an SDIRA can also be a powerful tool for investment, such as raising capital for real estate using dormant retirement funds. 
  • Control: The account holder ultimately controls the destiny of an SDIRA. Many investors enjoy using their specialized knowledge regarding specific asset classes to make custom investment decisions. In fact, an SDIRA makes it possible to invest in hobbies and passions!
  • Tax Benefits: IRAs are amazing tax-free investments to build wealth to keep up with inflation without forfeiting most of it to the IRS. 

Some of the "pros" of self-directed IRAs can also be cons. For instance, the freedom and self-direction that make this an attractive option for some investors could turn an SDIRA into a hassle for others. Here's a look at the potential disadvantages of opening a self-directed IRA:

  • Full Control: The success of an SDIRA depends entirely on the judgment of the account holder. The pressure is really on when it comes to making smart investment choices.
  • Loss of Liquidity: While it's exciting to be able to invest in alternative assets, unloading them can take time and effort. Unlike traditional assets that can be sold off with the press of a button whenever the market is open, alternative investments can take years to sell, and some might never find buyers.
  • Fees: Fees can be slightly higher with SDIRAs. While the general cost to set up an SDIRA is reasonable, some custodial firms charge a lot for administration.
  • Complexity: A self-directed IRA comes with a long list of rules and prohibited transactions regarding your own assets. For example, real estate investments made through an IRA cannot be touched for personal use. The simple act of fixing a broken toilet in a property you own through an IRA could result in IRS penalties, interest charges, and forfeiture of your SDIRA tax benefits.

What's the Difference Between Traditional and Roth SDIRAs?

The difference between a Roth and Traditional SDIRA comes down to its tax structure. You have to consider whether you will be in a higher tax bracket now or at retirement to reap the full benefits of each IRA. 

Traditional SDIRA

With a traditional SDIRA, the account holder contributes pre-tax dollars. This investment then grows on a tax-deferred basis until being taxed as current income once withdrawals begin after age 59 1/2. 

This works for most people because they benefit from deferring taxes on a portion of their income during their "peak" earning years. For the average person, peak earning years are when their income is taxed at a higher bracket. 

The assumption is that people fall into lower tax brackets after retirement because they no longer work full-time. As a result, they will presumably pay a lower tax rate on their IRA withdrawals.

Roth SDIRA

With a Roth IRA, the account holder contributes after-tax dollars that will then grow on a tax-free basis. All withdrawals made after age 59 1/2 will not be taxed as current income. This can be a good option for someone anticipating that they will be in a higher tax bracket during retirement.

Rules, Contribution Limits, and Prohibited Transactions

In 2023, account holders under the age 50 have a contribution limit of $6,500. Account holders over 50 can add an additional $1,000 in catch-up contributions to max out at $7,500. 

Once a person reaches age 59 1/2, they can begin making withdrawals tax-free. However, the IRS only requires withdrawals at age 72, known as required minimum distributions (RMDs). 

Withdrawing funds before age 59 1/2 will result in a 10% penalty. The account holder will also need to pay income tax on the withdrawal amount based on their ordinary income tax rate. 

Fortunately, Self-directed IRAs do qualify for the same hardship distributions as other IRAs.

While much is made of the alternative investment options available through the SDIRA, this account type isn't made for free-for-all investing. For example, SDIRAs cannot invest in art, S-corporations, or life insurance. 

SDIRAs also have strong restrictions against what the Securities and Exchange Commission calls self-dealing. This means that IRA owners are not permitted to essentially "do business with themselves." 

For example, selling your property to yourself, lending yourself funds from an IRA, taking IRA income, and paying IRA expenses with your own money are all prohibited. 

In this scenario, the SDIRA owner is referred to as a "disqualified person" by the IRS. 

In the case of a real estate investment, this distinction means that the IRA owner is prohibited from living at a property, staying at a property, doing any kind of work or maintenance, or directly funding any kind of work of maintenance. 

The disqualified person's title even extends to an account holder's spouse, children, grandchildren, and parents. The same goes for any entity where the account holder possesses more than 50% ownership, holds a director role, or can be classified as a "highly compensated" employee.

How to Open a Self-directed IRA

A self-directed IRA must be opened with help from an account custodian or trustee. While some brokerage firms offer custodial services for IRAs, it's more common to use banks and trust companies that specialize as custodians of self-directed IRAs. Once the account is open, you are free to select investments.

Is a Self-directed IRA Right for Me?

Anyone seeking a bit of diversification and adventure in investing should consider an SDIRA. Although riskier, they tend to yield higher rewards. 

I recommend SDIRA owners research the risk involved with their investments, as well as what is allowed and disallowed in an SDIRA.

Opening an SDIRA isn't a spur-of-the-moment decision. You have to be both passionate and knowledgeable regarding the asset class you're investing in because you're betting on your ability to know a good thing when you see it.

Ultimately, an SDIRA is a great way to enjoy tax-free retirement earnings gained from real estate, private companies, cryptocurrency, and other unconventional asset classes.

Self-Directed IRA FAQ

What Type of IRA Lets You Invest in Cryptocurrency?

Unlike regular IRAs, the self-directed IRA allows investors to invest in cryptocurrency using tax-deferred income.

Can You Manage Your Own SDIRA?

While account holders get to make all of their own investment choices using an SDIRA, a custodian is required to open an SDIRA account. Trust companies and banks typically help with setting up SDIRAs.

What Can't You Invest in with an SDIRA?

While SDIRAs allow you to invest in a range of alternative assets, not everything is permitted. Art and collectibles, life insurance, and S corporations are all considered prohibited assets. In addition, certain precious metals won't qualify.

by Greg Herlean

How to Use Real Estate Syndication to Build Wealth

There's power in numbers when investing in real estate. That’s why one of my favorite investments is through real estate syndication. 

Real estate syndication brings a group of investors together to pool their money to purchase a revenue-generating property. You don't have to be a millionaire to participate in real estate syndications, and it’s a great way to raise capital for real estate investments.

Thanks to the JOBS act passed in 2012, investors can now crowdfund real estate deals to earn passive income. 

Here's a glance at what you need to know about real estate syndication deals. 

How Real Estate Syndication Works

Prior to real estate syndications, single investors were forced to take on the full burden of funding the purchase of a property. Investors were also forced to manage every detail of property ownership. The income earned was anything but passive. 

While most people were simply locked out of investing in real estate due the cost and time required, the ones capable of funding investments had to put in full-time "landlord" hours just to keep a property profitable. 

However, real estate syndications allow you or your real estate LLC to pool your money with hundreds of other investors to invest in high-value real estate assets. While investing in a simple single-family home would be a bridge too far for most people, syndications make it easy to hold partial ownership in a high-value apartment building in a hot market. 

Once the property is purchased, it is managed by the syndicator responsible for originating the deal. That means that an investor isn't forced to deal with tenant issues, and profits and losses are distributed among the investors. 

The Real Estate Syndicator

Investment opportunities offered by a real estate syndication are initiated by a real estate syndicator. Also known as a sponsor, a syndicator is responsible for bringing the deal to life. 

Think of the syndicator as the general partner in the business arrangement. Here's a rundown of everything the syndicator handles in a typical deal:

  • Arranging the financing for purchasing a property.
  • Negotiating prices and terms with the seller.
  • Building a business plan.
  • Attracting investors.
  • Raising capital.
  • Hiring a team to manage the property.
  • Managing investor relations.
  • Handling all tax and financial reporting.

In many ways, an investment is only as good as the syndicator behind it.

A syndicator should be a real estate expert with experience in investing. 

They make everything happen by applying their experience and familiarity with real estate to handling underwriting, making deals, and performing due diligence on behalf of the investors pooling money into a deal. 

The Investor

The investor is an individual who decides to invest in the real estate deal being offered by the syndicator. You can think of an investor as a limited partner in the deal. 

As an owner of a percentage of the property, the investor gets all of the general benefits of property ownership without the administrative burdens that accompany owning property.

Syndicators may take a larger cut due to their active role in deals, but investors have far less liability.  

Benefits and Drawbacks of Real Estate Syndications

Benefits

  • Grow your real estate portfolio without investing large amounts of time, money, and research toward each investment.
  • Gain greater buying power by pooling money with other investors.
  • Access real estate in hot markets outside of your financial reach.
  • Offset gains with “paper losses” to reduce your tax burden. 
  • Invest passively (investor) without the headache of property management. 
  • Generate a high return on investment.
  • Gain knowledgeable advice on lucrative deals from trusted syndicators. 
  • Real estate syndication is available in a real estate IRA via self-directed investing. 

Drawbacks

  • Syndication deals have very specific investor requirements (must be an accredited investor).
  • Deals may be geographically limited. 
  • Deals may take a long time to develop and actualize. 
  • Investors have limited control over property management. 

In many ways, syndications are similar to real estate investment trusts (REITs). However, many investors prefer syndications over REITs because syndications allow investors to choose the properties they want to invest in instead of being forced to go in blindly. 

Eligibility Requirements

Eligibility is where real estate syndications begin to look different from other crowdfunded real estate options. While many investing platforms allow anyone with a few hundred dollars in their pocket to get in on deals, syndications come with very specific investor requirements. 

A person must be an accredited investor to participate in a real estate syndication. 

An accredited investor is defined as someone with an annual income of at least $200,000, a combined spousal income of $300,000, or a net worth of at least $1 million. 

How to Start Investing in Real Estate Syndication

Real estate syndication all starts with finding the right syndicator. 

It's important to look for a competent, experienced syndicator with a history of finding revenue-generating properties. 

A syndicator should also bring experience in property management, a successful track record with previous investments, and knowledge of real estate deals.

Real Estate Syndication Tips

  • Don't rush into anything. 
  • Conduct your due diligence.
  • Becoming familiar with the portfolio of a syndicator you are considering. 
  • Be ready for the long-haul–most syndicators hold a property for five to seven years before seeking buyers willing to purchase the property at a higher price. 

Real estate syndication can be a very high-risk, high-reward proposition.

If you are eligible for real estate syndication, I would strongly recommend considering it as an investment option for your portfolio.

Real estate syndication provides a great opportunity to earn high returns or to ramp up your retirement portfolio using a self-directed IRA. 

Quick Q&A Recap

1. Who Can Invest in Real Estate Syndications?

Unlike REITs, real estate syndications are generally only open to accredited investors. People who qualify as accredited investors are wise to take advantage of syndications instead of using crowdfunding platforms that allow anyone to invest because syndications provide access to high-value residential and commercial real estate. 

2. How Many People Can Participate in a Real Estate Syndication?

A real estate syndication technically only needs to have two investors. However, many have several hundred. 

3. What Are the Tax Benefits of Real Estate Syndications? Investors in real estate syndications can enjoy tax deductions, deferred income taxes, and lower tax rates. As a syndication investor, you also enjoy the benefits of depreciation for potentially paying capital gains taxes at lower rates. In addition, the 1031 exchange tax rule that allows you to defer capital gains taxes if you swap one property for another can apply to syndication investors.

by Greg Herlean

Top IRA Real Estate Investment Strategies for Massive Wealth

Can you use your IRA to buy real estate? It’s a question worth asking as you eye up different investment strategies for retirement. 

To answer the question, not only can you invest in real estate with an IRA, but it could provide massive tax benefits that help compound gains in your portfolio. 

To get started, you’ll need to open a self-directed IRA, which is an IRA that allows for alternative investments. Self-directed IRAs can be structured like a Roth or traditional IRA, allowing you to compound those earnings tax-free until withdrawal–if you choose. 

However, there are several self-directed IRA rules limiting what you can purchase. Nevertheless, many investors still have lots of freedom to invest in multiple types of real estate that go beyond the restrictions imposed by traditional IRA custodians.

To help you get started with your real estate IRA investments, I’ve outlined a few ways to purchase real estate using your IRA. 

Five Strategies to Purchase Real Estate With an IRA

 1. Directed Purchase

The simplest way to purchase real estate is by using cash in your SDIRA account. If your account holds sufficient funds, you can purchase a property directly. Otherwise, you will need to pursue other options. 

Like a 1031 exchange, a direct purchase with an SDIRA is one of many tax-free investments you can use to build massive wealth. 

2. Start an LLC

Opening an LLC allows you to acquire complete checkbook control over your SDIRA funds to purchase and move real estate. Unlike direct purchases, which require custodial support, opening an LLC allows you to access funds directly without the support of your custodian, so you gain full control over your investment funds. 

To open an LLC, you’ll need to register it with all of the standard agencies required for incorporation in your state. A passive custodian is then used to transfer funds from the IRA owner to a new IRA LLC bank account.

Once opened, the LLC owner can exercise checkbook control over any investment they want. 

Additionally, LLCs offer investors additional tax incentives by helping them avoid direct federal taxes, so they are taxed at a lower rate. 

3. Partner Your IRA

Only some people seeking to generate wealth through IRA real estate investments have the cash available to purchase a property. Additionally, it can be difficult to raise capital for real estate. 

Fortunately, you can use your self-directed IRA to partner with additional investors to purchase a property. 

While we often call this partnering your IRA, the official term for this strategy is "purchasing an undivided interest" in a property. Once you've combined your self-directed IRA funds with partner funds, your IRA owns a percentage of the property that's proportionate to your funding contribution. 

In addition, your IRA is responsible for its portion of all property expenses. That same portion applies when proceeds are divided following the sale of the investment.

This approach is a great way to dip your toes in the real estate pool without taking on too much debt or risk. 

4. Invest in Mortgage Notes

What if you want to avoid using your IRA funds to manage a property you own physically? 

Fortunately, mortgage notes offer a passive alternative to traditional real estate investment. 

A mortgage note is a vehicle used to extend credit. Notes are used to back a loan and noteholders by charging interest. 

Portions of mortgages can also be purchased and sold through IRAs. Under this setup, your retirement account will hold an undivided interest in the portion of the note owned as a way to generate income.

5. Use Your IRA for a Non-recourse Loan

A non-recourse loan is another option for someone lacking the full funds to invest in real estate. This type of loan is secured in the name of your IRA using the property being purchased as collateral. 

Unlike personal loans, the IRA holder's personal assets are used as collateral. So a lender can only legally seize the IRA asset being financed.

Alternative Ways to Invest in Real Estate With Retirement Funds

If these traditional strategies require too much upfront capital or don’t suit your interests, there are several additional ways to leverage an IRA to invest in real estate. 

1. Become a Home Wholesaler

It's possible to use self-directed funds to put properties under contract from distressed sellers using your IRA. When you resell the contract as a wholesaler, the money from the buyer can be transferred directly to your IRA at closing. 

When done properly, a down payment ranging from just $100 to $1,000 can easily become $10,000.

2. Purchase Tax Liens

IRAs can be used to invest in tax liens that combine low capital, little responsibility for the investor, and generous returns. Tax liens are imposed on properties for delinquent taxes. 

When investors purchase liens from counties, they will make money in one of two ways. In the first case, the investor earns interest when a lien is redeemed. Secondly, if the taxes are never paid, the deed to the property is given to the investor.

3. Invest in REITs

Many people are surprised to learn that a REIT (real estate investment trust) is one of the investments permitted with a standard Roth IRA. REITs are publicly traded companies that own and manage income-producing properties on behalf of investors. The list of property types commonly offered through REITs includes:

  • Homes.
  • Apartment complexes.
  • Offices.
  • Warehouses.
  • Retail centers.
  • Medical offices.
  • Storage complexes.
  • Data centers.
  • Hotels.
  • Cell towers.

Investors favor REITs for their ability to pay out consistent dividends. In fact, IRS regulations dictate that REITs must pay out 90% or more of taxable profits to shareholders. While REIT dividends paid out to individuals are taxed as ordinary income, dividends paid out to IRAs enjoy tax benefits.

4. Form a Joint Venture With a Contractor

Self-directed IRAs can be used to invest in joint ventures. When designing a real estate joint venture, you can enter into an agreement with a contractor to pool resources to build or rehab properties. 

What makes a joint venture different from a partnership is that a joint venture is only intended to operate for a specific period. It's understood that both parties intend to sell for profit within that time frame, making them easy to enter and leave.

5. Bird Dog With an Experienced Broker

If your goal is to purchase a property through your IRA, there's no doubt that coming up with full funding using your IRA alone is a challenge. This is why many IRA-minded property investors like the "bird dog" technique, using brokers to help them find distressed, underpriced properties. 

While the broker takes a fee in exchange for leads, investors often find this the best way to scoop up bottom-of-the-barrel properties that can be turned into gems.

6. Purchase Options and Flip Raw Land, Farms, Vacant Lots, and Storage Units

IRAs can absolutely be used to fund "flip homes." Using a self-directed IRA, you can purchase homes in need of repairs for the purpose of either generating rental revenue or selling. 

However, it's important to be aware that the IRS has some pretty strict rules in place regarding who can perform work on an "IRA flip" property due to the disqualified person rule.

7. Sell Options on Existing Homes in Your IRA

Once you've added a property to your IRA, you can capitalize on that property by selling real estate options. Many investors are attracted to real estate options today because traditional real estate investment channels have become "crowded." 

With a real estate option, you're creating a contract that allows the buyer to purchase your property at a set price within a specific period of time in exchange for an option premium. If the buyer declines the purchase at the end of the contract period, you can move forward with another buyer with your premium in tow.

Using an IRA to invest in real estate is a great strategy for staying partially insulated against the stock market. Using the strategies above, investors can combine the tax benefits of IRAs with the growth of real estate to build massive wealth.

by Greg Herlean

11 Best Tax-Free Investments to Build Wealth

Few people build wealth on salary alone. Instead, investments compound earnings by putting money to work passively. 

However, it's important to remember that how much you keep is more important than how much you make. Risk and taxes are the two causes of investment losses, but there’s no safer investment than a tax-free investment.  

Allowing your portfolio to grow tax-free removes the stress of moving your money around through 1031 or tax havens. Plus, you have a better chance of beating out inflation without the added burden of taxes. 

So whether you’re self-employed or a salaried individual looking to build wealth for retirement, here are 11 tax-advantageous investments for building wealth. 

1. 401(k)

The best way to tap into tax-free assets is to open up a retirement account. With a traditional employer-sponsored 401(k), employee contributions enjoy tax-free growth while reducing taxable income by transferring earnings out of each paycheck. 

As a result, you can contribute money to your 401(k) without having it taxed while also reducing the amount of taxable income from your regular salary. The only kicker is you’ll eventually pay taxes when you withdraw your funds at retirement.

An individual 401 (k) provides the same tax benefits as an employer-sponsored plan for self-employed people and small-business owners. 

While a 401 (k) is primarily used for investing in mutual funds, it can also be used for index funds, large-cap funds, small-cap funds, foreign funds, bond futures, and real estate funds.

2. IRA: Traditional, Roth, and Self-Directed

IRAs are another popular retirement account used to grow your wealth tax-free. 

There are a few different types of IRAs, including:

  • Traditional IRAs: Individuals contribute pre-taxed money to their accounts and are taxed at the time of withdrawal. 
  • Roth IRAs: Individuals contribute already taxed earnings and can withdraw their funds tax-free at retirement.
  • Self-Directed IRA: These retirement accounts allow people to invest in alternative assets, like crypto, gold, LLCs, or real estate, using a traditional or Roth structured account. 
  • SEP IRA: The Simplified Employee Pension IRA allows employers to contribute to their employee’s traditional IRA accounts. 
  • SIMPLE IRA: The Savings Incentive Match Plan for Employees allows employers to match contributions to an employee’s IRA. 

All IRA accounts are fine options for retirement, with the major difference being whether or not you think you’ll be in a higher tax bracket at retirement. If so, a Roth IRA may be right for you.

Additionally, all IRAs limit your investment options to standard stock market assets, such as stocks, bonds, ETFs, and CDs, with the exception of an SDIRA. 

3. 1031 Exchange

A 1031 exchange is an investing strategy that allows you to "swap" one investment property for another as a way to avoid short-term capital gains. Under normal circumstances, a person must own a home for one year before selling it if they want to avoid getting a hefty tax bill for income earned by selling real estate. 

The 1031 exchange allows you to avoid paying taxes at the rate of your ordinary income if you use the money earned from the sale to buy another property. 

4. Tax-loss Harvesting

Tax-loss harvesting works by selling an underperforming, money-losing investment to reduce taxable capital gains. For example, dumping an underperforming property can offset your ordinary taxable income to reduce your tax burden for the year. Once the property is off your roster, the money from the sale can be reinvested into a better investment option. 

5. Long-Term Capital Gains

Another way to lower your tax bracket is to hold an asset for more than a year to reduce your capital gains tax. When you hold on to a property or any asset for longer than a year, you'll pay long-term capital gains instead of short-term capital gains. While the short-term capital gains rate ranges from 0% to 37%, long-term capital gains are taxed at 0% to 20%.

6. Form an LLC

Forming an LLC allows you to avoid double taxation. An LLC is considered a pass-through entity by the IRS, which means LLC owners aren't on the hook for paying taxes on the corporate level. For example, many people form real estate LLCs to reduce their tax burden for any sale they make involving their investment properties. 

LLC owners can instead report their profit shares and losses on their personal tax returns, greatly lowering their taxable burden. 

7. HSA

Unlike a Flexible Spending Account (FSA), a Health Savings Account (HSA) doesn't require an employer sponsor. Your HSA will allow you to invest tax-deferred, tax-free earnings for eligible health spending. HSA funds can be rolled over yearly to ensure you don't lose the money you don't spend. The money can keep rolling all the way through to retirement to allow you to cover health services and products in your golden years.

8. Charity/Donations

Charitable donations can be tax-efficient investments. In addition to putting money toward a good cause, a charitable donation can reduce your adjusted gross income for the year. Everybody wins if the money you give to a good cause allows you to move into a lower tax bracket with a lower tax rate.

9. US Series 1 Savings Bond

A Series I bond is issued by the U.S. federal government with dual interest-earning potential that offers inflation protection. Every Series I bond earns both a fixed interest rate and a variable rate that changes with inflation. 

Series I bonds are never taxed at the state or local level. While federal taxes are based on the interest earned while an I bond is held, you can choose the method you want to use to pay your I bond taxes. The first option is only to pay tax on your Series I bond when it's sold back to the government one day. The second option is to pay the tax that is due on interest earned for the year that was added to your principal. 

10. 529 Education Fund

A 529 fund is a college savings plan sponsored by individual states. Money in an account can be used for school tuition, books, and other qualified expenses at most institutions. Contributions to a 529 account are counted as after-tax deductions. 

However, contributions can grow free of federal or state income taxes. Therefore, no income tax is paid when 529 funds are withdrawn for qualified expenses.

11. Municipal Bond

Finally, a municipal bond is issued by either a state or local government to fund investment projects in the community. When purchasing a municipal bond, you're effectively lending money to the bond issuer in exchange for interest payments. 

While short-term municipal bonds may mature in one to three years, long-term municipal bonds may mature 10 to 20 years in the future. Interest on municipal bonds is generally exempt from federal taxes. The bonds are also exempt from state and local taxes if you reside in the state where your bond is issued. 

Final Thoughts on Tax-Free Investment Strategies

We often focus on reducing risk when investing. However, a core principle of investing "for keeps" is to make choices that minimize taxes. The fun begins when you realize that this can be done using investments that involve everything from real estate to health savings accounts. 

by Greg Herlean

The Five Best Retirement Accounts for Self-Employed

Unlike workers, self-employed business owners and freelancers often need to figure out their retirement plans on their own.

While some of the rules and regulations surrounding IRAs and 401(k)s can appear a bit confusing, finding the right retirement plan for self-employed people is simple. 

What's more, it's even possible to create a match plan for employees if you own a small business that employs others. 

So let’s look at the five best retirement accounts for self-employed people to see which is right for you.

1. Traditional IRA

A traditional individual retirement account (IRA) lets you direct pre-tax income toward investments for tax-deferred growth. Capital gains and dividends taxes aren't assessed until a withdrawal is made. 

The benefits of a traditional IRA include the following:

  • No income limit.
  • Tax-deferred growth. No taxes on earnings and contributions until required distributions begin at age 72. Money earned in a traditional IRA can also be deductible for the contribution's tax year.
  • Traditional IRAs allow you to invest in nearly all stocks, bonds, mutual funds, and exchange-traded funds (ETFs).
  • Unlike 401 (k) accounts, IRAs have early withdrawal exceptions that make it possible to take out money to cover expenses for college, adopting a child, buying a first home, and more.

A traditional IRA is a great choice for self-employed people who can benefit from the upfront tax break as an incentive to start saving for retirement. In addition, high earners get a benefit from the tax-deferred status. 

While the traditional IRA ultimately offers a "cheap" way to start saving for retirement, it does force you to face a tax burden in retirement that you can avoid with an individual Roth IRA.

2. Self-Directed IRA

A self-directed individual retirement account (SDIRA) is an IRA that allows you to invest in alternative assets prohibited by other IRAs. As the name implies, a self-directed IRA gives you full control over your investment decisions.

SDIRAs can be structured like a Roth or Traditional IRA, depending on your anticipated tax bracket at retirement. 

Like the traditional IRA, the SDIRA allows you to save for retirement on a tax-advantaged basis. 

However, SDIRAs offer greater flexibility regarding investments beyond stocks, bonds, mutual funds, and other common investments. For example, SDIRAs permit investments in:

SDIRAs are advantageous because they allow for high returns and also greater diversification. Of course, investing in alternative assets also comes with a bit of risk. 

Almost anyone can open an SDIRA. However, using a federally insured trustee or custodian specializing in SDIRAs is important. 

Be sure to research self-directed IRA investment rules before investing.

3. SEP IRA

Designed for both self-employed workers and small-business owners, Simplified Employee Pension (SEP) plans allow you to set aside income for retirement without the enrollment and operating fees of conventional retirement plans. This is a common option when setting up a simple match plan for employees. 

The SEP-IRA rule allows account holders to invest up to 25% of an employee’s compensation (up to $61,000 in 2022), making this a great choice for high-earning individuals. Here's a rundown on how SEP IRAs work:

  • Eligible participants are employees over age 21 who have worked for an employer for at least three of the past five years.
  • Eligible employees must have earned at least $650 during 2021 and 2022.
  • Employers must match all self-directed distributions for enrolled employees. For instance, an employer who stashes away 10% of their own compensation must contribute 10% to each employee's compensation.

A SEP IRA can be combined with traditional and Roth IRAs, and all contributions are deductible. There is no commitment to contribute every year after opening a SEP IRA. No catch-up contribution option exists for people aged 50 and over with the SEP.

4. SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA is a tax-deferred employer-sponsored retirement plan designed for small businesses with less than 100 employees. 

A SIMPLE IRA allows an employer to make either non-elective contributions of 2% of each employee's salary or dollar-for-dollar matching contributions of each employee's contributions (up to 3% of salary). 

While the maximum annual employee contribution for the SIMPLE IRA is $14,000 (2022), employees reaching age 50 and over can make additional catch-up contributions of $3,000. 

5. Solo 401 (k)

Designed for self-employed business owners, the solo 401(k) offers many of the same features as employer-sponsored retirement plans. 

In order to contribute to a solo 401 (k), you must be a business owner with no employees. While the maximum contribution on the solo 401 (k) is $61,000 (2022), there's a $6,500 catch-up contribution option if you're age 50 or older. 

A solo 401 (k) can be opened as either a traditional or Roth account. With a traditional solo 401 (k), contributions are made on a pre-tax basis to reduce your tax burden. Roth 401 (k) contributions are made with after-tax dollars. 

IRA Contribution Limits

IRA contribution limits are routinely adjusted for inflation. Typically, limits are determined using either a capped figure or salary percentage. Here's a rundown of current IRA contribution limits for self-employed IRA options (2022):

  • Traditional IRA: $6,000 ($7,000 over age 50).
  • SDIRA: $6,000 ($7,000 over age 50).
  • SEP IRA: 25% of compensation/$61,000.
  • SIMPLE IRA: $14,000.
  • Solo IRA: $20,500 ($27,000 over age 50).

When considering any type of IRA, it's important to factor in income bracket, expanded contribution allotments for age, and other stipulations that could allow you to invest the maximum amount possible while receiving a tax advantage on your employment income.

Which Self-Employed Retirement Plan Is Right for Me?

The Traditional IRA is a great starting point for someone who simply wants to start putting money in a retirement account when they don't have any kind of savings incentive match plan from an employer. 

However, self-employed people with high-income levels or employees should consider an SDIRA, SEP IRA, Simple IRA, or solo 401 (k) to discover which features allow them to save for retirement while enjoying the biggest tax deduction. 

Self-employed people catching up with retirement savings should also consider plans that increase maximum contributions after age 50.

Finally, everyone who earns income should open a retirement account. For self-employed people, a retirement plan can allow you to take a tax deduction on your tax return, reducing your taxable income. 

For small-business owners, matching contributions can help elevate their status as desirable employers while providing them with a tax advantage.

by Greg Herlean

Self-Directed IRA Rules, Assets, and Prohibited Transactions

Uncertain market conditions can make even the best investors question their retirement decisions. While there are many flashy investments for retirement planning, the best types of investments are proven ones. 

While a traditional IRA provides offers a proven portfolio of investments with steady long-term growth, sometimes investors want an extra cushion against inflation or something more stable. Unfortunately, traditional and Roth IRAs provide little investment opportunity when it comes to real estate, precious metals, or other investments that beat out inflation.

One retirement plan I recommend to all of my customers and readers is a self-directed IRA. Owning a self-directed IRA allows you to invest in alternative assets, such as cryptocurrency, real estate, and gold. But, most importantly, with the right self-directed IRA custodian, you will have free reign to choose which assets you want to invest with.

To learn more about self-directed IRAs, let’s explore all of the rules and regulations surrounding them. 

What is a Self-Directed IRA?

A self-directed individual retirement account (SDIRA) allows investors to invest in alternative investments for their retirement. And, unlike traditional or Roth IRAs, SDIRAs are usually offered through custodians instead of brokerage firms. 

While a self-directed IRA comes with the same IRA contribution limits and tax-advantage basis as both the traditional IRA and Roth IRA, it has different asset rules. We'll cover what these "alternative" assets encompass in a bit. But, first, take a look at the rules of operating a self-directed IRA. 

Self-Directed IRA Rules

Disqualified Persons

Transactions are tightly controlled with self-directed IRAs. While your IRA is intended to fund your lifestyle after retirement, it's not intended to start benefiting you before retirement. That's why any transaction that might be interpreted as "providing immediate financial gain" is prohibited. 

The disqualified-person rule doesn't just apply to the IRA holder; it can also include:

  • Your spouse.
  • Your children.
  • Your parents.
  • Your employer.
  • Any financial advisor, fiduciary, administrator, or custodian providing IRA-related services.
  • Any business entities you own at least 50% of on either a direct or indirect basis.
  • Any business entity that is influenced by a disqualified person.

The list of prohibited transactions includes:

  • Transferring IRA plan income to a disqualified person
  • Transferring plan assets to a disqualified person
  • Extending IRA credit to a disqualified person
  • Providing goods or services to a disqualified person. 

Things get murky when determining who counts as a disqualified person if you run lots of transactions using your self-directed IRA. One classic example of a violation would be hiring your own son or daughters to build a deck on a rental apartment that your self-directed IRA owns. Seeking legal guidance to separate disqualified persons from your self-directed IRA is advised.

Disallowable Assets

The restrictions on self-directed IRAs also don't stop at "who" can participate in plan-related transactions. The rules also restrict "which" assets you can invest in and, while there's no official list of approved investments for self-directed IRAs, the rules are pretty clear regarding what's prohibited. For example, here's a list of disallowable assets in an SDIRA:

  • Collectibles: This includes gemstones, art, coins, and other valuables with intrinsic, historic, or novelty value. However, some United States and foreign coins with 99.9% purity are allowable if the IRA custodian has physical possession of them.
  • Life Insurance: IRAs are prohibited from investing in whole life, universal, and term life insurance policies. If these investments are attractive, consider a 401(k) plan.
  • S-Corporations Stock: S-Corporation shareholder restrictions prevent them from allowing IRAs as shareholders.

Certain actions are also prohibited when you're handling assets that are allowed with a self-directed IRA. When operating a self-directed IRA, you are prohibited from borrowing money from the IRA, selling or leasing property to the IRA, or taking payment for managing a property held by the IRA. In addition, all income earned from an IRA must be returned to the IRA.

Personal Benefit

The personal benefit rule reiterates everything we discussed above. Essentially, an SDIRA cannot be used for personal gain that circumvents tax law. For example, no income derived from an SDIRA can be used for a personal savings or checking account. 

Taxes

The tax-deferred benefit of a self-directed IRA means that you do not have to pay taxes on any interest and gains earned through your IRA until you withdraw funds. What's more, contributions made to any IRA can entitle the account holder to tax deductions. 

Unfortunately, violating any of the rules of the SDIRA will nullify your account’s tax advantage. In many cases, this could mean that your account will lose all tax benefits and pay full taxes on any contributions and withdrawals. 

Contribution Limits

Finally, it’s important to understand how much you can contribute to an SDIRA before signing up for one. The 2022 contribution limit for self-directed IRAs for people under age 50 is $6,000. The limit bumps up to $7,000 for people over age 50. This is a per-person limit instead of a per-account limit. 

Self-Directed IRA Alternative Assets

Now, that we have a good understanding of what’s allowed and not allowed in an SDIRA, let’s explore a list of assets you can invest in:

  • Cryptocurrency.
  • Crypto staking.
  • Real estate.
  • REITs.
  • Startup companies.
  • Crowdfunded assets.
  • Undeveloped/raw land.
  • Promissory notes.
  • Tax lien certificates.
  • Gold, silver, and other precious metals.
  • Water rights.
  • Mineral rights.
  • LLC membership interest.
  • Livestock.
  • Commodities.
  • Private stock.
  • Private equity.

Self-directed IRAs open doors to assets that are prohibited by most of the other retirement investment plan options. For example, the ability to raise capital for real estate using an SDIRA allows you to invest your retirement account in single-family homes, multi-family homes, commercial properties, mobile homes, and more. 

What's more, account holders have a unique opportunity to "invest with their conscience" by investing in socially responsible and sustainable investments that they pick by hand. 

Are There Any Cons to an SDIRA?

Like all IRAs, the self-directed IRA requires you to take required minimum distributions beginning at age 72 to avoid steep penalties. However, taking distributions with a self-directed IRA that is tied up with illiquid assets can sometimes prove to be more complex without professional assistance. 

In addition, self-directed IRAs tend to have a higher annual fee compared to other options, although this depends largely on the custodian.

Is a Self-Directed IRA Right for Me?

The big advantage of a self-directed IRA is the ability to access alternative assets with higher growth potential than standard IRA investments. For this reason, a self-directed IRA is attractive for anyone seeking to avoid the daily turmoil and volatility that comes with the stock market. 

One detail that often gets overlooked when discussing the diversification of self-directed IRAs is that account holders can also continue to invest in traditional investments that are permitted by other types of IRAs.

So even if you just want to extend your retirement portfolio to stocks and precious metals, an SDIRA helps you out. If you're looking for more investment advice, be sure to browse my site for educational resources. For those interested in opening an SDIRA, visit Horizon Trust to speak to a custodian about opening an account. Horizon Trust offers low fees, friendly service, a state-of-the-art investment dashboard, and easy guidance to help you open an account and invest in what you want quickly.

by Greg Herlean

How to Form a Real Estate LLC: Benefits and Costs 

Is it a good idea to form a real estate limited liability company LLC after buying a property? 

After raising capital for real estate, it’s often recommended to protect your investment by forming a real estate limited liability company (LLC). 

A real estate LLC offers extraordinary benefits for a real estate business. But does that mean it’s the right choice for your setup? Here's what you need to know before you sign on the dotted line. 

Pros and Cons of a Real Estate LLC

The LLC structure is a natural fit for a property investor because it offers easy entry with plenty of room to grow without changing structures. Like any business structure, an LLC offers both benefits and drawbacks for real estate investors. 

Let's start with some of the pros and cons of forming an LLC for real estate. 

Real Estate LLC Pros:

  • Protection of Personal Assets: While a real estate investment that's a rental property can lead to tidy profits, being an investor also exposes your personal assets to risk unless you have liability protection. Forming an LLC limits exposure to personal lawsuits because it shifts legal responsibility from the investor to the real estate business.
  • Pass-Through Taxation: This is one of the biggest LLC advantages for business owners because it prevents double taxation. In addition to offering protection against personal legal liability, LLCs also offer protection against double taxation by exempting businesses from paying taxes as "entities." Instead, income is passed to business owners in the form of personal income tax based on their share of the business.
  • Easy Management: Unlike corporations, LLCs can be managed by either third-party operators or direct owners. Officers and directors are not required.
  • Lower Fees: State-level fees for LLCs tend to be much lower compared to fees imposed on corporations.
  • Flexible Ownership Rules: An LLC can legally have anywhere from one member to an unlimited number of members.
  • Easy Ownership Transfers: LLC ownership can be easily transferred from person to person. This is helpful when conducting savvy investments, such as purchasing real estate with delinquent taxes. 
  • Safety in Numbers: Real estate investors are permitted to create a new LLC for each rental property they own as a way to shield the entire portfolio from claims made against a single property.
  • Flexible Cash Flow Distribution: Unlike other business structures, an LLC isn't required to be in proportion during cash flow distribution. That means that high performers can be financially rewarded without conflict.

Real Estate LLC Cons:

  • Annual Fees: While LLCs are extremely cheap to maintain, owners will still need to pay filing fees to keep their LLCs active in most states.
  • Potential Self-Employment Tax: Could you get saddled with self-employment tax for a real estate LLC? It's possible. The workaround is to register as an S corporation with the IRS for tax purposes while staying registered as an LLC at the state level.
  • Properties in Different States Can't Share an LLC: If you're investing across multiple states, you'll need to set up individual LLCs for each property. While this isn't a big deal, it does mean paying fees for establishing and maintaining every LLC.
  • LLCs Can Be Subject to Lawsuits: LLCs are not legally impenetrable. While LLCs provide strong protection against personality liability, there are situations where individual members can be held responsible if fraud or negligence can be proven.
  • Complications When Changing Members: There are several layers to this downside. The first is that transferring a rental property into an LLC could trigger a "due on sale" clause requiring a mortgage to be paid off when property ownership changes. There's also a potential for city, county, or state taxes to kick in when property ownership changes.

Overall, the downsides of forming a real estate LLC don’t outweigh the benefits. In many cases, proper planning can help investors avoid unexpected fees.

Real Estate LLC vs. Liability Insurance

A real estate LLC and liability insurance are not interchangeable. An LLC is a business structure that offers built-in protections against personal liability. Liability insurance is a policy that helps cover the cost of injuries, property damage, and other types of claims. 

Investors who own multifamily properties, commercial properties, or industrial properties should strongly consider having both LLC protection and liability insurance because a higher number of tenants means greater liability exposure. In general, all property owners should consider doubling up. However, landlords owning a single-family rental may be safe choosing one option.

Steps to Form a Real Estate LLC

1. Perform Due Diligence

It's important to research state-specific regulations for forming a real estate LLC. Each LLC must be formed in the state where the property is located. This is true even if you live in a different state.

In most cases, filing is handled by the secretary of state for your state.

While having experience with forming an LLC in one state may help the process along, you should expect different rules for each state. Therefore, consider consulting with a lawyer in the state where you're forming a new LLC.

2. Choose a Business Name

Feel free to bring a little creativity into this step. The LLC name designates your company as a legal entity. While every LLC must have a name, the name doesn't have to align with your name, your brand name, or any other category. Some states require LLCs to include the "LLC" designation in the name.

3. Submit Articles of Incorporation

While every state has its own rules, articles of incorporation are typically short. Expect about a page worth of documentation for this one. The general rundown for articles of incorporation includes:

  • The name of your LLC.
  • The address of your LLC.
  • A brief description of your LLC's purpose.
  • The "effective date" for your LLC.
  • The name and address of the registered agent.
  • The signature of the person filing the articles.

The person filing the LLC articles doesn't need to be the owner. In many cases, the filer is the owner's lawyer. However, some states require the names and addresses of all LLC members to be listed within the articles of incorporation. 

4. Create an Operating Agreement

An operating agreement is a core document used by LLCs to outline plans for financial and functional decisions, rules, and regulations. According to the U.S. Small Business Administration (SBA), its purpose is to govern the business's internal operations in a way that suits the specific needs of the business owners. The three purposes of the operating agreement are:

  • Protecting LLC status.
  • Clarifying verbal agreements between members.
  • Protecting agreements in the eyes of the state.

The SBA recommends that operating agreements touch on ownership percentages among members, voting rights and responsibilities, powers and duties of members and managers, distribution of profits and losses, meeting schedules, and buyout/buy-sell rules. Specificity is important. Operating agreements can ultimately settle disputes among members. 

5. Obtain Proper Permits and Licenses

Most small businesses need licenses and permits from both federal and state agencies. The most universal requirement is a state business license. In addition to obtaining permits and licenses, business owners must keep all credentials current through renewals. 

Forming a real estate LLC provides unmatched protection against personal liability. While the LLC shield isn't fully impenetrable, it prevents personal assets from being touched in ordinary cases that don't involve provable fraud or negligence. 

While anyone starting a business should investigate all structure options before forming an LLC, the LLC is almost universally the best option when seeking tax benefits and personal liability protection for a rental property.

by Greg Herlean

How to Avoid Capital Gains Tax

Are you wondering how to avoid the capital gains tax? 

First, let's clarify exactly what the term capital gains tax means. A capital gains tax is the fee you're responsible for paying to the IRS after making a profit from selling an asset. It applies to stocks, bonds, securities, real estate, cars, boats, gold, furnishings, and other assets. 

A capital gain is assessed based on what you pay for an asset versus the amount you get when you sell it. Additionally, there are two ways capital gains are taxed, based on how long you hold an asset. 

If you hold an asset for a year before selling it, you're in the sweet spot to qualify for a favorable long term capital gains rate. However, if you sell before a year, you'll be taxed at a higher rate for a short term capital gain.

The good news is that there are plenty of tips for staying tax-free to get the perks of a capital gain without the penalties. 

1. Invest in a Tax-Deferred Savings Plan

A capital gains tax liability isn't triggered when you buy or sell securities within tax-deferred retirement plans. This includes Roth IRAs, traditional IRAs, SDIRAS, and 401(k) plans. 

Your capital gains won't be taxed until you begin withdrawing funds from your account. This strategy isn't just delaying pain until that day. Capital gains are taxed at your ordinary income rate. so people who slide into lower tax brackets after retirement can benefit. 

What's more, any Roth IRA and 401(k) funds specifically are immune to capital gains taxes under some conditions. 

2. 1031 Exchange

Are you planning to be a repeat investor? Some perpetual property investors never get stuck holding the bag with capital gains because they take advantage of the 1031 exchange loophole. 

Section 1031 of the U.S. Internal Revenue Code allows you to avoid paying gains taxes after selling an investment as long as you reinvest the proceeds from the sale within a certain window of time. The stipulation is that you must reinvest in a similar property that's of greater or equal value to the one you sold. However, this strategy is a great way to raise capital for real estate. 

3. The Primary Residence Exclusion

What exactly is the primary residence exclusion? This little-known IRS rule allows people who meet specific criteria to exclude $250,000 (single filers) to $500,000 (married filing jointly) in capital gains tax after making a profit from selling a home. Here's what's required:

  • The home you sold was your true primary residence.
  • You've owned and used your home as your main residence for at least two out of the five years prior to its sale date.
  • You haven't already used the primary residence exclusion for another home during the two-year period before the sale of your home.

You must report the sale of your home even if your gain is considered excludable. The IRS also provides some exceptions for the five-year usage test. Homeowners on extended duty in the military or intelligence community may be eligible to have the period bumped up to 10 years.

4. Donate to Charity

One of the smartest ways to offset capital gains if you cannot avoid selling assets when your income places you in a high tax bracket is to utilize tax deductions for charitable donations. An accountant may be able to help you donate the right amount to slide into a lower bracket to avoid a larger-than-necessary tax bill. This strategy applies if you're itemizing your deductions. 

5. Offset Gains With Losses

A capital loss is any loss on the sale of a capital asset. This includes stocks, bonds, and investment real estate. Capital losses are actually divided into long-term and short-term losses using the same calendar used for measuring long-term and short-term gains. 

In fact, short-term and long-term losses are actually first deducted against short-term gains and long-term gains. While tax laws are always changing, you can generally expect to be able to deduct an overall net capital loss for the year against salary, interest income, and other forms of income. Excess net capital losses can also be carried over to future tax years.

6. Invest in Long-Term Stocks

This next tip shouldn't necessarily be done without the help of a tax professional. One slightly intricate way to potentially defer capital gains tax until 2026 is by investing unrealized capital gains within 180 days of a stock sale into something called an Opportunity Fund. 

In addition, some investors take advantage of small business stocks to have up to $10 million in capital gains excluded from income. 

The trick is understanding how to invest during inflation to counteract any losses. 

8. Figure Out Your Cost Basis

You can keep more of your capital gains by subtracting the cost basis from your sale price. How you calculate cost basis can impact your capital gain rate. Many people find that adjusting the original purchase price to account for commissions and fees can reduce taxable gains.

9. Gift to Someone or Move Somewhere With a Lower Tax Bracket

Finally, some creative strategies are available if you're stuck with paying capital gains based on the way your sale price intersects with your income bracket. For example, consider gifting the appreciated asset to a family member instead of selling it. 

The IRS currently allows taxpayers to gift a person between $16,000 (single filer) and $32,000 (couple filing jointly) without needing to file a gift tax return. When you gift the asset to another person, the gains are taxed based on that person's income instead of your income. Just be cautious about using this strategy to gift assets to children or students under the age of 24 because dependents are taxed at the same rates as their parents. 

Final Thoughts on How to Avoid Capital Gains Tax

The key to understanding capital gains is knowing that the tax code rewards investors in it for the long game. The simplest way to avoid capital gains tax when selling an investment asset is to get past the one-year threshold for ownership before selling. 

Capital gains are taxed based on your ordinary income rate, so reducing income through losses, donations, or other means is the other strong alternative for avoiding a huge tax hit.

 
 

by Greg Herlean