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Self Directeed IRA Myths Busted: Part 1

By: Daniel Cordoba

There was a story I learned as a child titled Chicken Little, in which the main character, Chicken Little, needed attention and so he went about creating alarm by providing misinformation about atmospheric conditions—attempting to convince everyone that “the sky was falling.” Since he was one of the few chickens that took it upon himself to forecast, the other chickens in the pen quickly accredited him as an expert and became quite convinced that the Blue Sky Armageddon was upon them. Naturally, the truth eventually became known and Chicken Little became remorseful and repented.

The children’s story resonates in today’s investment world with the analogous warning issued about the practice of holding real estate assets in a self-directed IRA (also referred to as a real estate IRA or IRA real estate by investors). The warning is this: “Don’t invest in real estate because at age 70 ½ you’ll be faced with minimum required distribution and you’ll have an illiquid asset to contend with.” Although it is in fact true that you may end up with an illiquid asset, this statement fails to take into consideration the bigger picture. Let’s take a more realistic view and consider a few important points:

1) No one should have just one asset in his or her IRA to rely upon solely for retirement—consider telecommunication and Enron stocks, the demise of many an IRA;
2) The real estate asset should have been producing a return on investment, for example, rent;
3) A forward thinking person would consider that at 68 the asset should be placed on the market for sale.
4) If a custodian won’t allow such investments stating that they are against IRS regulations, it means only that it is against their policy. This blog response by the IRS (on the IRS site) verifies that custodians can impose their own rules: http://www.irs.gov/retirement/article/0,,id=111413,00.html.

LSay you went into a coma at age 68 and awoke at age 70, told your custodian that you would pay the equivalent tax for the minimum required distribution and took personal ownership of the equivalent value of the asset. Let’s break this scenario down (you can plug your own numbers at http://www.kiplinger.com/personalfinance/php/ira/question.htm):

At age 70 ½, a lot you originally bought for $10,000 is worth $20,000 and it is the only asset in your IRA. The whopping MRD (minimum required distribution) would be $754.52, assuming a 20% tax bracket. Assuming the value of the asset did not increase the portion of the asset allocated to you would 1/26 of the asset. After paying the IRS $150 you would personally own that portion of the asset. Year after year, the process would continue. Alternatively, you could take the entire distribution, paying $4,000 to the IRS, and would then own the entire asset.

Although some still might argue that you would be in a higher tax bracket, keep in mind they are probably the same people that told you that you would be in the lower tax bracket when it was assumed that you had few other assets to rely upon.

There will always be nay-sayers about any investment choice, but a clear understanding of the self-directed investment process and strategy eliminates the fear of risk that can lead to doubt among the uneducated. Educating yourself also allows you to navigate through the influence and directives of organizations who may operate based on their own clearly defined agendas rather than what is in your best interest.

Copyright 2006 © Daniel Cordoba, CEA

Article Source: http://www.bluearticles.com


Daniel Cordoba is a Certified Estate Advisor and Principal of Asset Exchange Strategies, LLC. Asset Exchange Strategies, LLC (http://www.MyRealEstateIRA.com) helps investors gain greater control over their self-directed IRAs.

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