Month: June 2023

Using a Self-Directed IRA for The Ultimate Private Placement.

Or, how to use a Private Placement in Your Self Directed IRA to fund your business with retirement savings and pay no tax!

You’ve worked at a job for the past 15 years and want more from your career. Starting your own business is typically the next step. How would you fund this? By using a self-directed IRA and a Private Placement.

Saving for retirement is something we all think about on some level.  I felt time was on my side when I was young.  Now that I’m in my 60’s, I realize how misguided (politically correct phrase for stupid) I was in my thinking.

Another benefit of saving for retirement is

So what’s the deal with Self-Directed IRA Plans?

I. What’s a Self-Directed IRAs and Why Do I Care?:

The primary difference between a Traditional IRA and a Self-Directed IRA is the custodian of your account.

The “Big Guys” like JP Morgan, Schwab or Smith Barney can all house Traditional  IRA’s for you but you are only allowed to buy the investments they offer.  The IRS has a short list of the type of investment you can hold in your IRA.

The IRS must approve your financial institution to act as a custodian for self-directed IRA’s.

The list of investment options is much larger with a self directed IRA.  It can also be a source of funding to invest in or start a business (this is considered for private placement since the investment is offered privately and not through a public offering)..

II. What Really is a Private Placement Investment:

Generally, private placement is a sale of securities to a preselected set of individuals (or institutions, but that doesn’t matter for the purpose of this article).

Private placements generally have much less government oversight or regulation to be concerned with.

I perform due diligence when I’m in a private placement not of my own doing (i.e. starting my own business or investing in one I have knowledge of).  This is really important at this level since you can’t rely on the custodian of your IRA to do ANY due diligence for you.

Private placements have recently taken the place of IPO’s due to all the hoops the issuing company needs to hop through.  These startups look at private placements as an IPO lite, or pre-IPO.  A great way to get funding without dealing with all of the red herring laws associated with even a small IPO or offering to accredited investors.

III. What are the Nuts and Bolts of this Craziness!?:

Not every brokerage firm can offer you custodianship of a self-directed IRA or allow private placements.  Investment firms which offer Self-Directed IRA tend to be more of a niche firm.  They may offer other services, but they’d be more of the niche variety as well.  Think precious metals or commodities.

A custodian of a Self-Directed IRA must be approved by the IRS and follow the same rules as other brokerage firms, plus additional regulations related to the types of trusts needed to hold your investments.

The custodian has a lot less liability exposure compared to custodians of traditional IRA’s.  Self-Directed IRA custodians are only responsible for the administration and holding of the assets.  They don’t have any responsibility as to the virtue of the investment.  You will solely be responsible for any due diligence relating to the investments.

IV. This Is Where I Usually Tell You About Doing Your Due Diligence:

But not today.  You don’t need due diligence if you’re trying to find financing to expand your own business, or buy a business. A Private Placement can be your business’ financing arm.

The simple explanation to using your IRA to finance your business is as follows:

Create a new corporation for the business.  There will be special tax considerations if you’re moving assets from one corporation to another.  This is done to maintain an arms length.  Self dealing is prohibited.

Create a Self-Directed 401k plan for the business (I’d advise using a different custodian for the self-directed IRA).  You will be an employee. 

Initiate a rollover from your current IRA account(s) to your Self-Directed 401k account.  Your self directed 401k account now has cash that you as the trustee can invest how you wish.

As trustee, you would have the ability to purchase stock in your new corporation.  You would initiate a transfer from your self directed IRA account to the corporation checking account to purchase stock of the corporation.  The corporation will then issue you stock shares which you will give turn over to your self directed 401k custodian.

V. If You Also Want To Invest in Private Placement Investments:

Since you are acting as trustee for your self directed IRA/401k, you have the option of making other private placement investments than your business.  Other allowable investments are:

Real Estate (no mortgage)
Cryptocurrency
Private Investment (non listed)
REIT’s
Convertible Notes
Hedge Funds

Again, do your due diligence.  Your custodian will have the paperwork and a checklist of items needed.

Holding private placements in a self directed IRA are like the wild west of investing.  Treat this as such.  I don’t think you’ll get scammed. But I do want you to understand that these are going to be much riskier investments with much less oversight than a publicly listed investment.  

VI. Potential Tax Implications and Considerations:

Since you are administering your IRA, you are also responsible for observing and obeying all tax laws and FINRA/SEC regulations.

Since Private Placement investments are different beasts and run in different crowds, they are also less regulated.  You need to be aware of things like Unrelated Business Tax Income, Unrelated Debt Financed Income, Required Minimum Distributions, and avoiding prohibited transactions.

Self-dealing is prohibited. You can’t rent “office space” that you own in a Self-Directed IRA to your business.  You can’t enter into financial deals with disqualified people such as beneficiaries or the IRA, family members or yourself

VII. Conclusion:

Using a self directed IRA for private placement opens up a lot more available options regarding the types of investments you can hold in your IRA.

Since you will be self-directing your investments you need to be aware that the company acting as your custodian will not be giving you investment advice.

You must take care not to trigger a distribution by making a prohibited transaction or dealing with a prohibited person.  If this happens, the IRS goes back to the year of the improper transaction and deems the entire balance of the account as a distribution.

A self-Directed IRA can be a source of funding for you to start or invest in a business.  Since there are rules against self-dealing in the IRS code, a C Corporation is formed and a 401k plan started for the corporation.

A self-Directed IRA can also be used to hold real estate, precious metals, closely held corporations and other non standard investments.

How To Save BIG With These Auto Deductions for Self-Employed Individuals

We all drive.  Almost everyone who is self employed will have to use their car for business.  How do you write off your car?  Let’s take a look at what you can and cannot deduct when it comes to your vehicles.

When it comes to auto deductions for self employed taxpayers, I haven’t met one self-employed individual who doesn’t try to write off 100% of their vehicle expenses, even if they use the vehicle personally as well. This isn’t really their fault though.  I’ve seen ads and heard people talk about how their CPA lets them write off everything.  I had a client ask about writing off an Audi R8.  He didn’t qualify but the fact that someone is asking about writing off a $200,000 supercar on their taxes (and thought he could) tells you how much bad information there is out there.

The reality is it’s pretty easy to figure out what you can deduct and what’s off limits.  Let’s take a look and see what’s best for you.

I. What Do You Mean I Can’t Write Everything Off?:

To determine the portion of your auto deductions for self employed that can be deducted, it’s essential to calculate the business use percentage. This percentage represents the portion of time you use your vehicle for business purposes versus personal use.

The personal use of your vehicle IS NOT deductible.

If we’re talking about a work truck or van (like a contractor would use) that has storage boxes or shelve installed (in the case of a van), you are more than likely writing off everything.  This will be an issue if you don’t have another vehicle to drive during off hours.

II. What’s Legit Deductible?:

If you’re self-employed, then you can write off most auto deductions associated with your vehicle, including:

  • Depreciation
  • Lease payments or loan interest
  • Gas, oil and other fluids expenses
  • Insurance premiums
  • Repairs and maintenance costs
  • Licensing and registration
  • Tolls and parking fees
  • Upgrades to the vehicle (like the example above).  Sometimes theres a way to write off expenses that seemingly don’t belong.  The next example shows one way.

I had a shifter cart business get into the manufacturing of body kits and other go-fast parts for the Nissan GTR series, and started selling them on his website.  He actually bought a GTR to “test” the parts for these cars.  The bHe offered everything for sale on his website and actually made a profit on sales of bodykits and suspension components).

He took the car to shows and became known for his GTR support.  He got to write off a $120,000 car because he actually used it 100% for his business.  This just shows you that a little creativity may be required to get the best legit deduction.

III. Huh?  Why Do You Care If I Have A Home Office?:

Isn’t this an article about Auto Deductions for Self Employed taxpayers? Why does a home office matter?  Part of your mileage deduction relates to your actual miles driven.  The IRS wants you to break it out between business usage, personal usage and commuting miles driven.  If you take a home office deduction, you shouldn’t have commuting mileage.

Commuting mileage is specifically excluded in the IRS code.  Here’s how I explain this to my clients.

The first trip of the day to your first destination is a commute, regardless of you taking a home office deduction or not.

The last trip of the day driving home after your last destination is also a commute.

So the first AND last trip of the day will not be deductible.  Sounds easy, right?  Wrong.

I had a client who lived about 2 hours away from his biggest client.  He made this trip 5 days a week, first thing in the morning.  His old tax person wouldn’t let him write off the mileage driven (about 240 miles a day) since it was his first AND last trip of the day.

The workaround I came up with was so simple, I was shocked his old tax preparer missed it.

I had him establish appointments near his home first thing in the morning.  That trip became his commute.

I had him set up appointments on his way home too.  So now his commute home wasn’t 120 miles, but closer to 20.  This alone saved him close to $2,500 in tax the first full year he implemented this, and it’s perfectly legal.

IV. Record-Keeping and Documentation:

Tracking your auto deductions as a self-employed individual can be divided into two sections.

Mileage

The starting point is to track the miles driven.  The easiest way is via an app on your phone.  I use MileIQ but there are many others available.  QuickBooks online has one built into their package and another one I’ve heard good things about is Everlance.  The point is, you must track your miles to determine that percentage was driven for business.

Actual Costs

This is the second part of the calculation.  It’s also the easiest part as long as you ALWAYS use your debit or credit card when you pay.  Don’t pay for things with cash.  It makes it a lot harder to capture in your books, and it makes it harder to prove to the IRS unless you have the receipt.

To calculate your auto deduction you calculate your mileage deduction first.  Let’s say the IRS gives you $0.60 per mile driven.

If you drove 10,000 total miles with 7,500 being for business, you would have a mileage deduction of $4,500 (7,500 miles x $0.60=$4,500).

Now we’ll take a look at your actual expenses.  In this example lets say your total qualified auto expenses (gas, repairs, maintenance, licensing,  insurance,  lease payments if a lease, interest expense if a purchase, depreciation if a purchase) was $9,000.  Since your business use was 75%  (7,500 of a total 10,000 miles driven), 75% of $9,000 would be $6,750.  You would get a $6,750 deduction for your business auto use.

V. Anything Else You Need To Know?:

  • Personal use needs to be tracked.  If you personally use your car, but don’t track anything the IRS will disallow 100% of your vehicle expenses.
  • There are rules for high dollar vehicle limitations (think Porsche or BMW).  The max cost allowed is $58,000 and limits depreciation, bonus depreciation and section 179 deductions on “Luxury Vehicles”.
  • Your depreciation expense is directly affected if you buy a vehicle defined as a luxury vehicle per the IRS code.  Your tax preparer should know these rules.

VII. Anything I Should Worry About In My State?:

Not really.  This is one area the states have chosen to conform to IRS regulations.  I haven’t found a state that doesn’t conform to the IRS mileage rate ($0.655/mile for 2023)  One difference I do see is reimbursing your employee’s for mileage driven on their personal vehicles.  This calculation changes based on the state.  Since it’s too involved to go over here, my suggestion is to ask your tax preparer for guidance.

VIII. Who Can Help Me The Most?:

When it comes to writing off your self-employed auto deductions you really need to go to a licensed tax preparer.  The IRS takes a look at around 8% of all filed returns.  And the two categories they check the most are Meals and Entertainment, and Auto expenses.

Deducting your auto as a business expense is one of the most abused deductions available, and the IRS knows this.  Stay out of their crosshairs by having a professional prepare your return.

While having a tax pro prepare your return is not a guarantee that they won’t call you out, the reality is most of that 8% referenced above is people who self prepare their return.  Many years ago an IRS Revenue Officer told me that only about 2-5% of returns audited were prepared by CPA’s.

The IRS is a business unto itself.  They will go after the low hanging fruit (self prepared returns) first, before going after someone who has competent representation (that would be the CPA).

Conclusion to Auto Deductions for the Self-Employed:

The key to maximizing your auto deductions is simple.  You must track your mileage.  I us MileIQ to track my driving and the beauty is, it only cost $60/year.  Go to their website every week or month and designate which trips are business related and which are personal.

The reason for this is it will allow you to allocate your auto expenses on a pro rata basis.

As an example, Mary drove 10,000 total miles in 2022 split evenly between months.  She tracked all her driving in Mile IQ and this revealed she drove 5,500 miles for business and 4,500 miles personally.

Mary also tallied all of her vehicle expenses (not including loan payments, but including the interest paid on the loan).  This total came to $12,000.

Her mileage deduction calculation would look like this:

5,500 miles @ $0.585 = $3,217.50

4,500 miles @ $0.625 = $2,812.50

Total mileage deduction would be $6,030.00

Based on miles driven, total business cost is $6,600 (5500/5500+4500= 55% times $12,000)

Since the actual costs pro rated is more than the mileage deduction, you would take the actual costs as a deduction on your taxes.

And that’s how to calculate your auto deductions for self employed taxpayers.

How To Deduct Travel Expenses as a Real Estate Investor and save $1,000’s!

I’ve had a lot of clients who were real estate investors and they all want to write off their travel expenses to visit a property or check a prospective property they may purchase.

Can you deduct travel expenses? For the most part (remember later that I said “most part”) you can deduct your costs of traveling, lodging, meals and incidentals.  Let’s take a look at a thoroughly confusing topic and shine a little light into the fog.

I. Two types of investors:

Before I tell you how to deduct your real estate travel expenses, we need to categorize your business activity. You’re either a Real Estate Professional (REP) or you’re not.  At least for tax purposes.  Being an REP is definitely preferential for tax purposes, but qualifying is not easy.  Here’s what you need to do:

  • First, you need to spend more than 50% of your total time working in a real property trade or business.
  • That total must be more than 750 total hours.  No part timers allowed.
  • Lastly, you must “materially participate” in each rental activity.

To have “materially participated” is a facts and circumstances kind of thing.  Hiring a management company to manage your rental properties would absolutely disqualify you.  Being the guy up on the ladder at 10pm painting the interior 2 days before the new tenant moves in would lead me to believe that you are materially participating.

Not many will qualify.  The material participation rule is pretty easy.  It’s the first qualification that gets most people.  I’ve had clients with a dozen rentals who did all the work and more than likely spent 750 hours during the year, but they had a full time non-realty gig (2000 hours) so they failed the first test.

Here’s a couple of examples:

Melanie:

Melanie worked at a stained glass shop full time.  Over the course of the year she worked 1,900 hours making stained glass windows.  She also owned three rental properties and did all the work on them.  She will not qualify unless she can prove that she worked at least 1,900 hours in real estate, materially participating in all aspects of managing her properties.

Steve:

Steve worked part time preparing taxes for H&R Block during the busy season.  He works 980 hours.  Like Melanie, he also owned three rental properties and did all the work on them.  He worked 1,200 hours managing and maintaining his rental properties.  Steve would qualify as a Real Estate Professional.

II. Which one do you want?:

I just made a big deal of the requirements to qualify as a Real Estate Professional, so that one is obviously the most preferential.  As an REP you aren’t limited in how much loss you can take from your rental activities.  As a non REP (regular taxpayer with rental property who doesn’t satisfy the tests above) you will be subject to Passive Activity Loss rules and limited to a maximum of $25,000 in losses annually. Your ability to deduct for real estate travel is tied directly to this classification.

Passive Activity Loss rules don’t make tons of sense in this example because a passive activity by definition means you aren’t materially participating.  But most owners of rental property are in charge of getting renters, repairing things and are 100% responsible fore everything.

The biggest negative in my mind regarding the Passive rules is the loss amount available.  There’s a maximum $25,000 available, but your income affects the ultimate deduction.  The $25,000 available is reduced dollar for dollar once our income hits $125,000, with no deduction available once your income exceeds $150,000.

Maybe the most important benefit is not having to pony up for that lousy 3.8% Net Investment Income tax on investment income over $250k for a Married Filing Joint taxpayer.  With real estate in many states selling for over $1,000,000, being classified as a Real Estate Professional has real benefits.

An example:

Nick and Dianne are not Real Estate Professionals.  They sold a rental home and netted a $1,000,000 capital gain.  They would pay an additional $28,500 in Net Investment Income tax due to the sale.

In this example, Nick is a Real Estate Professional.  Nick is an REP and isn’t required to pay this tax.

What about the other guys?

Well, you get the previously mentioned $25,000 passive activity loss you can use.

As mentioned above, you still have a rather large potential deduction at your disposal.  In regards to travel, the potential big deduction you will lose is the ability to write off travel to visit prospective purchases.  Add the travel costs to basis once you purchase the property.  If you don’t buy there is no deduction.

III. Eligibility Criteria for Deducting Travel Expenses:

What’s the relationship of the expense to your real estate activity?  If there is a direct relationship, i.e. traveled to make repairs or meet with contractor to go over improvements?  Fully deductible.

Where it gets sketchy is when you commingle work with vacation.  Take a week and visit your rental in Lake Tahoe?  Ski 5 of 7 days and work on the property the other 2?  You must allocate the expense between business and personal enjoyment. 

IV. Travel Expenses for Property Acquisition and Management:

If you are a Real Estate Professional, you get a travel and meals deduction for travel to visit prospective properties.  Even if you don’t buy.  Since you are in the “business” of real estate, checking on available properties out of your tax area is likely.  It would be the same if you were in manufacturing and had to visit a prospective vendor of a raw material used in making your product.  Its necessary to the success of your business.

If not an REP, then no deduction.  In the eyes of the IRS, if you can’t qualify as a Real Estate Professional, you aren’t in the real estate “business”.  It’s a passive activity, almost like its nothing more than an investment in Microsoft stock.  Even though you’re doing all the work, they still categorize it as a Passive Activity and you have to abide by the passive rules.

V. Travel Expenses for Rental Property Visits:

Buy that condo on Maui or in the Bahamas.  Deduct your travel expenses to inspect or work on your rental property will be deductible.  But be careful with this.  You actually have to work on the property to get any kind of deduction.  Take a 2 week trip and work 1 week on your property?  You can take 50% as a tax deduction.

VI. Track your information better:

If you’re a Real Estate Professional, you need to maintain a set of books.  It’s your business.  I’m a fan of QuickBooks Online since it’s relatively easy to learn and being online allows you (or anyone else who works on your books) to access from anywhere there’s WiFi.

Not maintaining good records can ultimately cost you.

I had a client many years ago who was ok, but not great at her recordkeeping.  She would pay for a lot of expenses with cash and not put it in her books.  Every year she would tell be she spent “a couple hundred” with cash for me to add to her return.

One year I bet her the cost of her return that if she just saved all her cash receipts for the year, it would be over $1,000 instead of the “couple hundred” she always told me.

The next year she brought her stuff in with an extra envelope full of cash receipts.  She averaged over $500/mo.  $6,000 in additional deduction that saved her around $2,400 in tax.

Do your books people.

VII. Make sure your tax person knows these rules:

Get someone who knows who can deduct travel expenses. Since real estate is one of the biggest industries in the US, the tax code is filled with rules specific to the industry.  With a cost of entry low enough that almost 7% of taxpayers own residential rental property, it makes sense that this is a spot Congress can look at when forging policy (not to mention the fact that Real Estate is on of the four largest industries in the USA).

With the majority of people who own rental property not classified as a Real Estate Professional, you will need someone who knows the rules, and more importantly, knows how you specifically are classified as a taxpayer and how best to utilize those rules to your benefit.

Conclusion:

You want to deduct travel expenses? As a Real Estate Professional, the IRS sees you as primarily in the real estate industry.

As a Real Estate Professional, you will be able to deduct travel to and from anything related to your real estate world.  This includes travel to see perspective properties to purchase.  This deduction is not available for passive properties.

A real Estate Professionals primary focus is making money through buying, selling, renting and renovating real estate.  Travel may be an integral part of business.  Travel is a direct cost so it’s a deductible expense.

If you don’t qualify as a Real Estate Professional you will be limited to a max $25,000 loss in a tax year.  Your rental activity is considered a passive activity for tax purposes.

Someone who has a passive activity however is limited to deducting travel for visits to already existing properties.  If you have a property on Maui, you could conceivably visit every year to inspect and make any repairs or upgrades, and your trip would mostly be deductible.  If you take  a one week trip to visit your property and spend 4 days working on the property and 3 enjoying the island, you can deduct 4/7 of your travel.

On the other hand, if you are visit Maui with an intention of buying a property, but ultimately don’t?  No deduction.  Not even with t