Bernard Reisz CPA is the founder of 401KCheckBook.com which gives investors direct control of their tax-sheltered funds for real estate equity and debt opportunities using checkbook controlled IRAs, QRPs, Solo 401K(s) and Checkbook Life Insurance.
He’s also the founder of AgentFinancial.com which provides tax strategy, entity, and financial services to real estate professionals, including real estate agents, real estate investors and mortgage brokers.
[00:07:01] Bernard explains the different types of QRPs out there.
[00:11:17] Bernard explains how to correct a mistake you make in a checkbook 401K.
[00:12:40] Bernard explains about prohibited transactions
[00:13:21] What are the differences between IRA and 401K?
[00:15:02] Bernard explains the rules required to have a solo 401k.
[00:21:51] You have to include someone in a 401K plan only when they work a minimum of 1000 hours per year for your business.
[00:25:36] Traditional IRA, you can put in on an annual basis of $6,000. With QRPs, you can put in $56,000.sz
[00:26:33] Bernard explains UBIT and UDFI.
[00:30:49] Bernard explains how UDFI tax works.
[00:43:33] Cannabis businesses qualify for QRPs.
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Bernard Reisz 0:03
Recognize that you are in control of your financial destiny, whether or not you realize it or whether or not there are people around you that are, you know that are trying to take control of your financial destiny. Ultimately, you’re going to be a beer, the risks and consequences and rewards. So you should take charge of it.
Welcome to the show, you are listening to the real estate lab podcast. In this lab. we decode the stories, secrets and skills of the most brilliant minds in real estate investing and turn their wisdom into practical advice and knowledge that we can use to boost our income. And now let’s turn it over to our host Vee.
It’s a great day to be alive and to invest in real estate. My name is Vee Khu and you’re now listening to my show the The Real Estate Lab Podcast. Hey it’s the 3rd week of the New Year. Are you on track with your goal? What is your goal for 2020? Mine is to buy a mobile home park this year. If I can support you and your goal in any way, hey, please do not hesitate to reach out to me. You can get to me at firstname.lastname@example.org or you can simply schedule a call at www.callwithvee.com Alright, I’ll guess what today came highly recommended by Yonah Weiss. He is the founder of 401kcheckbook.com, which give investor like yourself direct control over your retirement funds. He’s also the founder of agentfinancial.com, a company that specializes in tax strategy, entity and financial services to real estate professionals. Before the launch of his company ReSure LLC, our guests serve as director of whole metrics partners. Our guest today is Mr. Bernard Reisz. In today’s episode, we will discuss about a tax that you might have to pay and are not aware about. If you’re using a self-directed IRA to invest in real estate, pay attention. If you have any kind of retirement account or QRPs qualified retirement plans, make sure to pay close attention to this episode. Now before I get going, make sure you hit the subscribe button, leave a review and give me a five star rating on iTunes. If you haven’t yet, make sure to check out our free Facebook community at www.eastwestventures.co/aims. Ok let’s dive into our episode today with Mr. Bernard Reisz.
Hey, welcome to another episode of The Real Estate Lab Podcast. We have an awesome awesome guest today. He is is so special, he has so many titles that I don’t even know where to begin with. Bernard, are you are a CPA CPCU ARM and ACI what are all the letters means? All right?
Bernard Reisz 3:14
CPA is very recognizable CPA certified public accountant, CPCU, ARM and ACI are all risk management designations. So those relate to taking a really deep dive into risk and insurance, but not in the way that people generally think about insurance. It’s about really about understanding and managing risk, knowing and understanding how insurance companies operate. So it’s a deep dive into risk management.
So how did you get involved in the insurance side and also get involved in the CPA side the two things are not even related.
Bernard Reisz 3:50
That’s what you think. Absolutely. I thought it’s a fair question. So for the most part, I’m really into analysis, taxes, financial stuff. And recognizing that all this stuff, all this financial stuff is really interrelated. And there really is a very specific tax aspect to this, because insurance companies actually have some really, really great tax advantages. So insurance companies get to do some pretty cool stuff. We could probably do a podcast about that in its own right. But the idea is to sum it up in a really, really in a nutshell, when you pay your insurance premiums for your liability insurance. The company takes in say you pay $1,000 in premium.
Bernard Reisz 4:38
Well, the company took in $1,000, the insurance company, but they may only pay that out never or over 20 years, 30 years right turns company takes in hundreds of millions of dollars of premium each year and or billions of dollars, with the expectation that they’re going to pay some of it out over time. But guess what they get to take a tax deduction this year for just about all of that money. So you taken a billion dollars of revenue, but you don’t pay taxes on it this year, because you tell the IRS, this is money is not really profit, because our actuaries tell us that over the next 50 years, we’re going to have to pay out a big chunk of this. So therefore, they get a tax deduction, they don’t have to recognize that revenue. So insurance companies are really neat for a tax purpose. And frankly, that’s really how I got into this in the first place is really to from the tax side. But to really do anything properly, you got to understand every component of it. And for that reason, I had to learn and master every nuance insurance and risk management.
So how do we on the real estate side, do the same as the insurance company, what are the some of the vehicles that you have been studying and you see that his car is really is an awesome strategy to shelter some of his tax?
Bernard Reisz 5:59
Yeah, there are So many different vehicles and as somebody from real estate strategies, I think we may know perhaps the good ones to focus on our qualified retirement plans and self directed IRAs. But of course, in different scenarios, you know, real estate investors, we may be talking about using S Corp. C corporations, and other entities and other tax strategies, be they 1031 exchanges cost segregation. You know, so many different things that real estate investors can use or should consider using. But everybody’s got a different investor profile. But, you know, tax shelter retirement accounts really apply to everybody, especially to people that are considering investing passively in real estate. For those people, what they have to think about are QRPs, self directed IRAs, and I think that’s a good topic that should appeal to the broadest array of listeners.
So for QRP, and self directed IRA, is QRP just a fancy name for solo 401k?
Bernard Reisz 7:01
That is a great way of presenting it. Technically it isn’t. In practice it is. Man, I’ll explain to you what I mean by that. QRP really stands for qualified retirement plan, which encompasses just potentially an infinite number of tax sheltered accounts. So just some examples of qualified retirement plans are 401k plans defined benefit plans, cash balance plans, profit sharing plans, so there really are so many types of qualified retirement plans. And in the industry, that’s abbreviated as QRP. But when it comes to using qualified retirement plans for real estate, to my knowledge, anybody that’s talking about using a QRP is talking about using a solo 401ks, even though you know, they may not call it a solo 401k what’s being discussed is a solo 401k. So while QRP again, can technically refer to almost any type of retirement plan, when we talk about the real estate investment arena, we’re talking about solo 401k.
Okay, so can you talk about some of the similarity and the differences between solo 401k QRP and a self directed IRA?
Bernard Reisz 8:20
Yes. the you know, there are a lot of similarities, but there are some very important differences. And QRP, 401k you know, has some benefits over using an IRA. At the same time, you have to qualify for that. So, while everybody can have a self directed IRA, or what we focus on, you know, was the checkbook control, IRAs, we actually get the money in a bank account. You know, it’s something that everybody can have, but the QRP 401k has some very specific requirements and in practice, most of most of us, you know, most of us will not qualify for solo 401k. More Americans than ever do qualify for it. And if you qualify, it definitely want to use a solo 401k. But for everybody out there for everybody, a self directed IRA can work. So let’s talk a bit about what each of those are and what it takes to qualify for each one of those. And if I may ask you, Vee do you have any prior experience with QRP 401k?
Not for not 401k or QRP but self directed IRA for sure. I’ve been doing this for about 10 years now. And I’ve sent a numbers of people over to a custodian here in town to set up the self directed IRA account to lend money out.
Bernard Reisz 9:43
And have you do you have any experience with you know, checkbook? 401k CheckBook IRA. So an IRA it actually gives you direct control of the money in a bank account?
Yes. And I learned very quickly that I don’t want to keep on doing that, because if you do something wrong, where you do a prohibited transaction, your IRA account is done.
Bernard Reisz 10:08
Yes, that is and that’s true. That’s a great point. One thing that everybody’s got to be aware of when using any of these types of accounts are the prohibited transaction rules. So whether you’re using a 401k, or some self directed IRA structure, you’ve got to be aware that prohibited transaction rules, in practice, will not have, you know, an IRA. Actually, this is one of the good areas to talk about. One of the benefits of the 401k over the IRA. So in an IRA, if you engage in a prohibited transaction, that kind of broken the IRA, that’s it, it’s not an IRA anymore, but inside of 401k, if there is an inadvertent prohibited transaction, it can be corrected. So in an IRA prohibited transactions cannot be corrected. In a 401k prohibited transaction, prohibited transactions can be corrected. And so there’s much, much, much greater safety when using a checkbook 401k versus using an IRA. And
so how do you correct a mistake like that in a 401k?
Bernard Reisz 11:17
So in a checkbook 401k, you’re able, two things are able to kind of just undo it, you’re able to undo it and the tax potential tax on it is 15%. Kind of as whereas in an IRA, it just is the end of the IRA when the prohibited transaction happens. And have you ever seen any prohibited transaction? You know, maybe it’s not a question to be live with, but you know, what kind of prohibited transactions are you concerned about that can show up inside of an IRA?
Well, what what we were trying to do before was that understand you cannot loan money out vertically so you’re you to your child or to your parents. You can do sideway to your Brother and your cousins. So we actually went to so my business partner and I, we went to different workshops to learn in depth about self directed IRA about 10 years ago, and the rule has for prohibited transaction, I believe are still the same, but the tax code change. So a lot of things I’m not up to date anymore.
But we were just trying to see if there are clever ways to play with the tax code. Since it’s so much out there. I’m sure you can find some loophole that you can play with it. And you can get the money out of the IRA account sooner without paying no penalty.
Bernard Reisz 12:40
And did you and I guess you learned when it comes to prohibited transactions, it’s always worth erring on the side of caution. It’s just not worth taking chances with the prohibited transaction rules. There are certain things that can fall into a gray area. But in general, we say there’s so many things that you can do without lending money to your child. parent, you know, there’s so many, you know, just do the lending to an unrelated party, and everything is great. So there’s so much opportunity that going, it’s not worth there’s no reason to ever consider taking a chance with the prohibited transactions. That being said, you know, there’s just much greater safety in using a 401k because the prohibited transactions can be undone.
Bernard Reisz 13:21
And to take that further, let’s talk a bit about some of the other distinctions between the 401k and the IRA. So an IRA is something that just about any American can have, but a checkbook 401k has to be tied to a business. Only a business can sponsor can create a checkbook 401k or any other qualified retirement plan. So the first condition that would be looking for for somebody to set up a checkbook 401k is to ensure that they have a business and a business has to be a certain type of business. So it can’t be somebody who has investments does not have a business for the purpose of creating a checkbook 401k for the purpose of checkbook 401k, you need the kind of business that’s an active trader business, not an investment. Another thing that we encounter oftentimes is people that will think they’ve got a business because they have an LLC. From the IRS perspective, an LLC does not create a business, it’s having business activity. So if you’ve got business activity, but you have no LLC, you can have a checkbook 401k. But if you’ve got an LLC, and it’s kind of just sitting there, and you’re not actually engaging a business activity, then you cannot, you cannot create a checkbook 401k. So that’s the first component of it. Again, it’s having a business understanding what does and what does not constitute a business.
Okay, so let me stop you there for a second here. Can you define the level of activity needed? So for instance, if I’m just like a direct sales, network marketing, I just joined some company. I have a business and I may or may not make money but you know, as active business?
Bernard Reisz 15:02
Yeah, that’s a great question. And there is no definitive answer to that. That’s the truth. A business can be part time. And the IRA says as much the courts tell us as much we know, a business can be part time. But and a business doesn’t have to make money to be a business. That’s really about engaging in an activity with some measure of consistency for the purpose of generating profit. You don’t have to actually generate a profit technically, but if you never generate a profit, it may not be a business. But just to give you some extreme examples. Have you ever heard of Uber?
Bernard Reisz 15:34
Have you ever heard of wework?
Bernard Reisz 15:36
But are those businesses?
I would say no, because they.
Unknown Speaker 15:42
Bernard Reisz 15:44
Right. So these are bonafide businesses that are losing money, right? They’ve never made a profit. They’re losing billions of dollars, billions and 10s of billions and hundreds of billions of dollars, but it’s a business. So those are businesses. So again, just to illustrate a business does not have to make money. But as you say, you know, somebody is doing something sporadically and it doesn’t make any money. You know, if the IRS ever looks at that, they may say, hey, this is not a business. So definitely, you know, if you have something that’s not clearly a business, that’s kind of a side hustle, you want to either be able to show that you’re really doing some hustling. And it’s nice for if you’re making money. But, you know, obviously, bottom, every business, every startup business loses money, you generally take some time to, to be profitable. So the bottom line is, there’s no definitive answer. But if if you’re engaging in something, consistently, you know, pursuing a profit, it’s a business.
Okay, I want you to take it to another extreme here. Let’s say I create this business. And I understand that the IRS is you at some point have to make a profit. Otherwise if your hobby is not a business, right, so I’m trying to see if I just have a business and I lose money for a few years. I created this QRP for that business then I go out of business, create another company another business. Can I create another QRP?
Bernard Reisz 17:16
couple of things you can you can use the same QRP actually. That’s the truth. You can you actually use the same one. But to be clear, if a company never makes money, it doesn’t necessarily become a hobby. The hobby rules are there to give the IRS the ability to look at something and say this was never a business but right. We work almost ran out of money. Right? They were running. They were run out of money today. They were just bailed out right by Japanese banks?
Bernard Reisz 17:43
I heard wework run out of money and shut their doors. The IRS could never have come to wework and said you’re a hobby. Your 401k plan is was not a 401k plan. You are not entitled to any business tax deductions. Right? If some if the IRS says something as a hobby, you lose all your business tax deductions, you lose so many things. So it’s the the IRS has the ability to say, Hey, that was not a business that was a hobby. And the fact that you never make money is just kind of one of the circumstantial things that the IRS may say, this looks like it was never a business because you never made money. But when something is clearly a business, it’s a business, even if you never, never never become profitable.
Bernard Reisz 18:26
So it’s, it’s more of like a clue. You know, if somebody somebody does something for years, and they’re never profitable, and otherwise, it doesn’t look like a business because they, you know, they only spent an hour a month on it. That’s when the IRS will say, this is not a business. You don’t have a profit motive here. You’re not trying to make money because it doesn’t look like you’re trying to make money. To recap, even if you never make money, you’d still say Hey, that was a business right? If you created a QRP for that business, that means you’re taking the position. This is a business. I’m trying to make money here. I have a profit motive. If it doesn’t work out, well, hey, we know most startups go out of business. That’s what happens. It will you know, it’s a business. And if you eventually start a new business, of course, you can have a QRP for that business as well.
That’s great. That’s awesome. Okay, so let’s go back to your point earlier. So to have a QRP, you need to have a business. So and we have just defined what’s the businesses and you could have, you can make money or not as long as long as you have business activity you qualify, and what else?
Bernard Reisz 19:29
So you’ve got that right that business activity, which means you’ve got a profit motive, and you’ve got some measure of consistency.
Bernard Reisz 19:35
`Now being that the most economical way to do this is to do this with the QRP for a solo business. We’re generally looking for somebody that has a business that does not have any employees, full time employees that are not owners of the business. So let’s clarify that. What are we trying to get over here and why does this make it Why is this qualifying attribute? Well, QRPs or your regular company 401k plan can have lots of risks and costs associated with it. There’s a lot of compliance work that has to be done for your standard QRP. But the reason why that’s the case is because the IRS and Congress are trying to protect the company employees, the people that are not the business owners, so they make all sorts of compliance rules. And if you break the rules, the penalties can be severe.
Bernard Reisz 20:27
But when you’ve got a business where the only participants in the 401k plan, the only participants in the QRP are owners of the business, Congress says, Hey, we don’t have to protect any employees over here. Anybody that’s in this company has an owner or a spouse of the owner, you know, married to one of the owners, so we don’t have to protect anybody here. We can kind of put aside all those rules, all that compliance work just goes away when there are no employees that are not business owners. So to sum up, the second thing we’re looking for, we’re looking for that kind of business where the business only people in the business that are working full time are owners of the business. So that’s number two.
What about in a situation where you are the owner and you’re running this business, but you have 1099 employee?
Bernard Reisz 21:16
So as long as a truly 1099 employees, that’s okay. Because they’re not 1099 employees, you’re either 1099 or an employer.
Bernard Reisz 21:26
Exactly. That’s the idea. So a 1099 is an independent contractor. They’re not really part of your business. And right, you can imagine, think about this way, right? Do you have to every company uses contractors, so they have to include those contractors in their 401k plan? No, of course, of course not. So if your company’s using contractors, you don’t have to include them in the 401k plan. Now that’s a question in and of itself, right. If somebody is right, think of it this way.
Bernard Reisz 21:51
The only people that you have to include in a 401k plan are those that work 1000 hours per year or more. Somebody’s working, doing 1099 contract work for you for thousand hours, um, you may want to consider are they really a contractor or an employee, which is a question of itself. But so long as they’re not employees, they’re 1099 contractors, you’re all good.
Okay, so that’s number two, you need to have, like a business where you’re the owner and you don’t have employees.
Bernard Reisz 22:19
That’s right now you can have partners, you got business partners, because they’re also owners of the company. And you ideally want them each to own at least you know, at least 5% of the business. So so long as you that’s the scenario. Again, if you have part time workers that do less than 1000 hours per year, you can have that solo QRP. So that’s really it the two requirements. And again, with today’s side gig economy, more Americans than ever can have the solo QRP. At the same time, I venture to say most Americans still cannot because you have to have your own biz trade or business and not have any employees. So So while we set up these checkbook solo 401ks, and we want to set them up for as many people as we can, it’s very important to be cautious about getting this set up if you’re not a good fit for it.
Have you ever seen anyone screw up so bad where a 401ks, you know, they just have to pay the penalty to 15% penalty consistently.
Bernard Reisz 23:20
Oh, absolutely not. I have never seen that. I’ve seen things that should not have been done, but I’m going to leave that for off the air discussion.
I was going to ask you just you know, see what’s the most creative way someone have came up with to you know, use this QRP?
Bernard Reisz 23:38
Yeah, it’s not there’s not it’s not that there’s so much room, you know, with the creativity side, because when the rules there are fairly clear. And and we feel it’s not worth taking chances with them. It’s not worth taking liberties of this and it’s almost like a total, shall we say? cognitive dissonance. me know people. If you want Want to engage and you know, people that use the QRP, it means to say, hey, I want to pay play by the rules. I want to look at the tax code and look at what the tax code gives me. And within the rules, the tax code, maximize what I can do. If somebody’s the kind of person who just wants to break the law. You know, there are a lot of other things that they can do. Using QRP means to say, Hey, I’m the kind of person that wants to play within the rules. And I don’t want to have risk with the IRS. I want to do what is legal, and within that world do the most that I can.
So within the QRP, what kind of tax liability are we talking about here? What do we have to pay Uncle Sam’s here?
Bernard Reisz 24:40
Okay, so awesome question. So QRP is actually going to have, you know, want to think about any kind of tax vehicles out there. It’s the one with the absolute least high tax liability for the most part, QRPs right? They function very much like IRAs in the sense that you get tax deductions. If you use a you know, tax deductible QRP. And if you use a Roth QRP, you don’t get the tax deductions. But all earnings are forever tax free. So for the most part using QRP, you have no tax liability, very much very similar to IRAs, but it has some substantial tax benefits over an IRA, particularly within the real estate investing arena. So the first tax benefit is you can get much greater. This whatever you can do in the IRA world, inside of the QRPs, you can just magnify that.
Bernard Reisz 25:36
So with an IRA, Roth IRA, traditional IRA, the most you can put in on an annual basis of $6,000.
Bernard Reisz 25:43
Whereas with a QRP, you can put in 56k. So, think of it as IRA tax deductions or Roth IRA on steroids. So it’s it’s just much much more powerful. The magnitude is much greater than an IRA. The The second thing is there are certain cases where even tax sheltered retirement accounts. And really any not for profit entity can be subject to tax. There are some really great exceptions to that tax for QRPs. So have you ever heard of UBIT? Have you ever heard of UBIT UDFI, UBTI?
Yes. UBIT is unrelated business related income.
Bernard Reisz 26:28
So yeah, UBIT is unrelated business income tax.
Bernard Reisz 26:33
And where you’re most likely like one would that tax potentially apply? So the words most relevant to real estate investors is when they have something called UDFI unrelated debt financed income and when you have UDFI, which you may be wondering, you know, we’ll talk from home what that is, I know it sounds a bit like UFO there’s the potential for tax liability and is really great. Carve out that exempts QRPs from UDFI created by real estate.
Bernard Reisz 27:05
So what is UDFI? UDFI stands for unrelated debt financed income, and it’s what you have when a tax free entity borrows money to invest. And it’s important to note this is not unique to IRAs and 401 K’s or any tax free entity, you know any charitable organization that doesn’t pay taxes a non for profit, if it borrows money goes to a bank borrows money and then invest that moneym then there’s the potential for tax there. And when now UDFI applies to any tax sheltered entity, but QRPs are exempt from UDFI related to real estate. So a QRP 401k whatever we’re going to call it, if it borrows money for real estate investment, there is no UDFI but if an IRA invest money, you know in real estate using borrowed funds, there is a potential for UDFI there. So that’s a really, really great benefit of the QRP over 401k. But at the same time, it’s very important to put it into, you know, in context. You know, if I were to ask you, now that you’ve heard about this UDFI thing, would you stop using self directed IRAs to invest in real estate?
Bernard Reisz 28:23
And what would it depend on? You know, what, what were your thoughts be on that? What would it What would it hinge on?
I’m not sure it’s just a lawyer answer.
Bernard Reisz 28:32
Okay, yes, you can never go wrong with it depends.
Bernard Reisz 28:36
And here’s the thing. Let’s put this into into context. You know, how does UDFI work? And there are a couple of layers of this. But the first and most important thing to point out is as follows. Understanding how UDFI is calculated. So if I were to tell you, you can, you know, you’ve got $100,000 in an IRA So first question to you is you’re going to invest in real estate. Do you want to use a QRP? Or self directed IRA? What will your response be?
Without knowing the tax implication? I would say self directed IRA
Bernard Reisz 29:13
Vee. what’s going on? We just spoke about all the benefits of the QRP?
I know, but I’m saying if I’m just a normal listener, right, we Yeah, just learning about this for the first time. And before this episode, I would say self directed IRA.
Bernard Reisz 29:28
Yeah, okay. 100%. Right. Right. I get that completely. So the answer would definitely be QRP is for especially because of the QRP does not have this UDFI. And most, most real estate deals have leverage. In fact, that’s why you want to invest in real estate is because you can go to the bank, get the bank get give you 60 to 80% of the money. There’s a potential for UDFI, which the QRP is going to be accepted from, in contrast with a self directed IRA, which may have to pay some tax there.
Bernard Reisz 29:59
Now that’s great for the folks that qualify for a QRP. But the folks that do not qualify for the 401k, you know, I’ve seen lots of folks that have been talked out of using IRAs for real estate because of UDFI. So it’s important to understand why that is generally a mistake. If you can put $100,000 you know, in your IRA, and put that into into a real estate deal, you can do an all cash deal with $100,000 and not pay any tax. No UDFI no potential UDFI, or you’re given the choice, hey, you can take your hundred thousand dollars, get $300,000 from the bank, do a $400,000 deal. But you’ll have to pay tax on 75% of the income which would you prefer?
You pay tax
Bernard Reisz 30:49
Yeah, because I mean, of course, if you’d like you can do the hundred thousand dollar deal and have no tax but again, you can do a $400,000 deal and pay some tax. That’s definitely the Way to go. So the key thing to understand is that even the event that you UDFI applies, it does not apply to your total investment. It’s only applies to the portion of the return that’s generated by borrowed money. So it’s not as if you borrow money, all of a sudden your IRA becomes taxable. It does not. It’s only the portion of the deal that was financed with borrowed money can potentially be taxable. So you don’t lose by taking the loan. You come out way ahead, because on the contrary, you get the benefit of leverage. And your principal, your IRAs investment will always be tax free. It’s the bank’s money that would be subject to tax. So that’s the first thing that think that people gotta understand. When they think about you, UDFI and recognize that UDFI should not intimidate them or not stand in the way because you’re always coming out ahead, almost always coming out ahead when taking that was taking that loan. Now. The other thing to understand is, for the most part in real estate, Vee, based in your experience in the how much taxes to real estate investors paid?
Bernard Reisz 32:13
That’s right. So real estate investments generally actually have no taxable income. So if you have no taxable income, there’s no UDFI. So just like your regular real estate investor, you get your depreciation deduction, your mortgage interest deduction, you get all those great tax deductions that real estate has. So after all your leverage, you have no income, you have no taxable income, you have cash flow, but you have no taxable income. Well, same thing inside of an IRA. Even if the IRA has the potential for UDFI, it’s generally a phantom thing. If you don’t see it, it doesn’t exist because you’re not have taxable income. You have all those tax deductions to offset it, even within Ira, you’re generally not going to see UDFI.
So Bernard what you’re saying is that just clarify something. Earlier you mentioned, let’s say, we have $100,000, we’re taking a loan from the bank, and we only have to pay UDFI taxes on 75% of the income, is that because we are leveraging 100,000 to get another 300,000 and more by a $400,000 property, and that’s the proportion that you have to pay taxes on, based on the income.
Bernard Reisz 33:29
That’s That’s exactly it. It’s oversimplified. But that’s the concept. The idea is that you’re paying taxes only on the portion that was financed with debt. You don’t have to pay taxes, your IRA is tax free, and it stays tax free, right? The only way an IRA really is going to pay taxes if you break the IRA, right, but over here, you’re doing it a passive real estate investment, which is, you know, which is a great investment for an IRA. Okay, the fact that you took some of that outside money so that outside money is literally not IRA money and so there were returns generated by an outside money will be taxable.
Okay, so let’s say in terms of a syndication let’s say you have this GRP and you want to partner in syndication you buy membership share in an LLC and the syndicator now, after here she bought the building goes to your friends, Yonah Weiss from Madison SPECS and you do cost seg right? Then write off everything you cost seg, you do bonus depreciation. So now you have a huge phantom loss. You don’t pay taxes on on that,
Bernard Reisz 34:39
that that’s exactly it. Cost Segregation is something you definitely got to talk to Yoanh about all the ins and outs in practice. You know, the, you know, even without cost segregation, you’re generally not going to have income. In the first couple of years of a real estate investment with without cost segregation. The real benefit of cost segregation is to create Losses now, are you going to have a benefit from the loss? Whether or not you benefit from real estate losses, you’ll really depend on being a real estate professional for the most part, even without cost segregation, you generally will not have any taxable income. The benefit of the cost segregation is to create a loss in year one,
right? And by having a loss, you don’t have an income. And so, you know,
Bernard Reisz 35:25
I’ll illustrate a bit. Usually the first couple years of an investment even without cost segregation, you’re not going to have any taxable income. So like once you take your whatever your profit is, right, the rental income comes in. But once you deduct your standard depreciation deductions, you deduct your mortgage interest you direct all your operational costs there in the first couple of years of a deal. You just won’t have income once you subtract your expenses, you will not have taxable income. Right? And the key thing in real estate is, is that you’re while you’re not having taxable income can still have cash flow because depreciation which you get no matter whether or not you will cost seg study depreciation is a non cash expense, right? It’s the kind of this it’s a phantom expense and away on the tax bill on your tax return you right? We had depreciation expense, but it doesn’t cost you any money. So that’s that’s so you get cash flow, but no taxable income.
Bernard Reisz 36:23
But suppose you want to take, you want to put your depreciation deduction on steroids and create a loss. That’s where cost segregation is super powerful. Now the benefit of a loss is not that you don’t have income, the benefit of a loss is that you can take that loss and offset some other investment that you made, that does have taxable income. Or you may be able to take that loss and offset your W2 income or your business income, not every investor. This is subject of itself, but only certain people are positioned today. Take advantage of real estate losses. And I gotta clarify, there’s something called passive activity loss limitations, which means to say is that unless you’re a real estate professional, you can only use real estate losses to offset real estate income. So if you the only way for somebody that’s not more or less full time real estate to benefit from real estate loss is if they have other real estate or other passive real estate investments that have taxable income. Otherwise, the loss is suspended and you know, get no current benefit from that, from that real estate loss. Does that make sense?
Yes, totally. I’m trying to see if there are other ways that someone who was trying to invest in a syndication has to pay attention to in terms of using the QRP in a syndication
Bernard Reisz 37:51
so it’s Think of it as very much like using an IRA except you do not have to have a custodian involved. There is no requirement whatsoever to have a custodian. So an IRA, it’s in the tax code needs a custodian. So there’s got to be some sort of financial institution involved. So even when we set up the checkbook, you know, even we set up the structures that give clients IRA money in a bank account, we have to partner with custodians. In contrast, 401k, there is no requirement for custodian to be involved at all. So it’s actually in a way much more streamlined than using any type of IRA because you’re definitely going to get the money in a bank account. There’s no need to get any custodian counter signature. You don’t have UDFI. So it in any other way, it’s very much like using an IRA, just just simpler and no potential for you UDFI.
Bernard Reisz 38:48
So QRP is is a really kind of the obvious choice for anybody that qualifies for it. You know, because the UDFI thing will you We’ll encounter it and let’s bring this full circle will you will encounter UDFI on a real estate syndication is on the exit at that disposition is where there is the greatest potential for encountering UDFI Because at that point, you know and a successful syndication, right, you’re going to exit out to five to seven years. And the idea is that you’re going to sell for much higher price than you actually paid. So at that point, you’re going to be looking at a at a gain at a taxable gain. And again, would potentially to the IRA investor, it’s going to be taxable to the extent that borrowed money isn’t the deal. Whereas to the QRP investor, there won’t be no tax whatsoever.
So everything is then just tax deferred until you cash out
Bernard Reisz 39:51
with an IRA investor then the first couple of years, you’re not going to see any UDFI if you stay in the deal long enough. There definitely is the potential UDFI but certainly at the disposition of the asset, when the asset when the deal is actually exited, and this, you know, on the partnership wraps up, right at that point you’re planning to show on the K one you plan to show that you sold it for a gain. That’s where you’re going to be looking at UDFI for an IRA investor, and a QRP investor will not have any that UDFI
right so after everything you’ll have to explain right now it seems like it’s very easy to get into a QRP just based on the all the reason that you’d explain and all the things that you need to do to qualify it seems like not much for for you to qualify. So why would someone still do self directed IRA over QRP. If you can qualify for the QRP You certainly, you know, in almost all scenarios, that’s the way to go. There is one other one other factor,
Bernard Reisz 40:55
you know, perhaps but this is not the answer the this is not going to answer your question because this doesn’t explain Enough why people are not using QRP. But that is Roth IRA money cannot be rolled over to a 401k or QRP. So if people have money in a Roth IRA, it’s got to be the investment has to be made through a Roth IRA. But in any other scenario, if somebody does qualify or can qualify, and they certainly should, now, it’s, it is easy to qualify, you know, obviously, somebody’s got a business already going, they qualify. If somebody wants to qualify, it does mean that they have, they’re probably going to have to change or they’re gonna have to do something for that they have to start some sort of business.
Bernard Reisz 41:39
Now today, it’s easier than ever to have a business right now. I’m going to know if I get to ask you how many of your friends are doing some sort of side hustle or a full time hustle, you know, gig economy, freelancing, Amazon, Etsy, you know, some sort of something in the sharing economy. To be at ridesharing consulting, there’s so much opportunity to have your own business. But it’s something that people should consider doing for so many tax and financial reasons. But if they don’t have it already to qualify for QRP 401k, they’re definitely gonna have to do something. And some people, you know, to each their own, and everybody, some people can’t, you know, don’t want to change what they’re doing. Some people do want to change what they’re doing. Yes, by all means, if somebody can qualify and wants to take action, and qualify for a checkbook 401k power to them.
So in the situation of someone who is running an Airbnb business, is that something that you would consider as qualify?
Bernard Reisz 42:43
That is something that I would say as follows. Airbnb businesses, is definitely something that might qualify. You want to have consistency with what you’re doing your tax return. So when people call us And have Airbnb businesses going on what we try to tell them is be consistent, and rather than say, oh, you’re Airbnb qualifies. Now, where are you putting it on your tax return, you’re putting on a Schedule E or schedule C. And there’s, without getting into what should or shouldn’t be done, we can do that on a different podcast if you’d like. You know, all the tax rules around the Airbnb and one of my belong and Schedule E one of my belong a Schedule C, we generally want to see something on Schedule C, in order to set up a QRP.
Okay, and then one other business type that I want to ask you about is any pot-related businesses like if you grow marijuana or you own warehouse to rent out, so that someone could grow? Does that qualify?
Bernard Reisz 43:52
So if you’re growing, that sounds like a schedule seat to me, by all means, if you’re renting out warehouses, that’s really not a pot business. You know, incidentally, There’s a, you know, you’ve got a cannabis business renting from you. But you’re a real estate you’re collecting real estate rent, and which would be a Schedule E, which I think is not a good fit for a for QRP. So if you’re the grower, you know, you’re buying and selling pot. I know. Absolutely. And I know you’re, you know, you’re in Colorado, Colorado is where it all began. So while spreading to other states, that certainly the pot capital, so by all means you’ve got a pot related business. It is a business. And it’s really cool. Because think of this way at the federal level, right pot is still illegal. My it’s only the states that have allowed it. So it’s really cool to realize that, hey, this is a business. And we’re going to we’re using federal rules, right to QRP 401k. As a federal concept, but this has precedent. If you think about real drugs, you know, the tax code, talks about drug related businesses, and then even Al Capone, I think when they got they locked him up, you know, when he’s Doing they were drug running and maybe during Prohibition selling alcohol, they took him on tax evasion. But even a drug dealer in general is, is entitled to tax deductions. It’s a business, you know, the fact that it runs afoul of certain federal laws doesn’t mean it’s not a business.
This is so great. This is awesome. I’ve not ever heard that before.
Bernard Reisz 45:21
Yeah, I’m serious tactical talks about this. And yes, if you are running an illegal business, it’s still a business. And you got and you have to pay taxes. Right? The fact that you have a pot business, which is illegal doesn’t mean you don’t have to pay taxes, you have to pay taxes, the IRS can come to you for tax evasion. If you don’t pay taxes on your, you know, on your drug running, and your drug dealing. So, pot business is a business.
Oh, man, this is so great Bernard. One last question before I let you go. What is your most favorite success or mindset quote?
Bernard Reisz 45:53
Can it be my own quote?
Bernard Reisz 45:54
I got to distill this into like one pithy sentence, but what I say is recognize that you are in control of your financial destiny. Whether or not you realize it or whether or not there are people around you that are, you know, that are trying to take control of your financial destiny. Ultimately, you’re going to be a beer, the risks and consequences and rewards. So you should take charge of it.
Awesome. Thank you so much for your time Bernard. This has been great. I learned a lot and I certainly did not know that. You know, a drug business just related business. Can you kind of write off the tax and get a deduction? That was awesome.
Bernard Reisz 46:40
Okay, awesome to have been on the show. Vee. Thanks so much for having me on. And I’m looking forward to hearing the recording and hearing future episodes. Awesome.
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