Required Minimum Distributions from Non-Liquid Assets

Required Minimum Distributions From Non-Liquid Assets

What is a Required Minimum Distribution or an RMD?

At age 72 (unless it is a Roth IRA), people are required to start pulling money out of their IRA and pay taxes on the distribution. The IRS term for this is a Required Minimum Distribution or RMD. If they fail to take this RMD, which is based on the value of the account and the age of the IRA holder, there is a 50% penalty (of the RMD amount).  An RMD calculator is a good tool to bookmark to ensure compliance with all IRS regulations.  Over the years, there have been occasions when a client has been in a perplexing dilemma regarding liquidity of their IRA-owned asset and their IRA RMD. While RMD’s are based on the aggregate of all your IRAs, regardless of how many custodians you have, the RMD can be taken from any (or all) of the custodians. It does not need to come out proportionally from each custodian.

RMD’s in Liquid vs Non-Liquid Assets

In many cases, our clients have non-liquid assets in their accounts. They take their RMD from remaining cash and/or another, more liquid, IRA account. These are the easy cases. But what happens if a client has a non-liquid asset and no remaining cash or liquid assets to take the RMD? While it is not a situation you want to get into, there is a solution. You can take the non-liquid asset itself (or portion thereof) as a taxable distribution.

3 Possible Solutions for RMD’s in an IRA holding a Non-Liquid Asset

For example, let’s say I am 77 years old and I have an IRA worth $100,000 as of December 31st of 2010. My 2011 RMD is $4,716.98. However, I don’t have any cash left in my account. I only have a piece of real estate valued at $100,000. I have 3 options.

  1. Do nothing and pay penalties of $2,359. Most woud agree this is not ideal.
  2. Sell the asset and take the RMD from the cash. But is market suitable for sale?
  3. Take a percentage of the asset out of the IRA as a taxable distribution.

In this case, I opt for option three. I have an appraisal prepared and fill out my IRA administrator’s distribution form. I also have a deed prepared issuing 5% of the $100,000 property to myself. So now, rather than the IRA owning 100% of the property, the IRA owns 95% while I own 5% personally. The IRA administrator will report to the IRS (and client) that a distribution of $5,000 occurred. This is a taxable event, even though I did not receive any cash. I received $5,000 in value instead.

As mentioned, this is not a situation you want to get involved in if avoidable. There are expenses associated each time this is done (i.e. new appraisal annually and new deed preparation annually). The client could opt to remove the asset in a shorter time frame (i.e. 25% over 4 years). However, the taxable implications would potentially be higher if the distributions occur in a shorter time frame. It is best to talk to your financial advisor or CPA before deciding how much of a distribution is best for you. A little planning ahead can usually go a long way in keeping situations like this from arising. However, it is nice to know there is an option for those stuck in this dilemma.

We have a depth of knowledge and creative solutions for RMD’s as well as other issues that arise with self-directed IRAs. For more information, visit www.MidlandTrust.com or contact us today.

The Basics of Private Lending In Your IRA

professionals passing contract exchange documents and closing instructions

What is a Private Lending?

Private Mortgages provide investors large returns at quarterly to bi-annual compounded interest rates. Still, they remain one of the most stable investment vehicles available. How is it possible for an investment to offer high returns and stability without being too good to be true?

Home buyers traditionally seek a bank or mortgage to finance their new home. But, in this new era, banks and mortgage companies are refusing more borrowers than ever. These home buyers are coming in droves to private lenders to find the private mortgage they need to buy a home.

It is completely legitimate for an individual to offer a private mortgage for a home. This strategy gives buyers a non-bank option for financing. All the lender needs is enough money to lend to a borrower looking to buy or rehab a home.

Private mortgages (also called hard money loans, trust notes, private notes, etc.) can be much safer than paper investments. This is because real property secures the private mortgage. If the mortgage defaults, the lender can sell the property in a quick sale to get their money out of the investment. The title insurance and hazard insurance back the property as added protection. The loan is additionally secured by the borrower’s personal guarantee. These layers of protection are not found in any other investing instrument.

Why Would Someone Borrow From a Private Individual?

Banks are in the business of making money. They want to make long-term loans, and don’t want to deal in short-term or rehab lending. Ultimately, what a bank is looking for is a constant flow of money that lasts for years. This type of loan means the bank will have a regular income stream with little effort involved. It also means there are tons of hidden real estate gems for Hard Money companies to choose from.

Banks and mortgage companies have turned down potential loans in ever-increasing numbers. Hard Money companies can get great, secure deals on investment real estate. Banks are also very slow in procesing loans. They have many channels and a lot of red tape to pass through before completing a loan application. Often, sellers are in a hurry to sell the property and prefer not to wait for processing of a bank mortgage. They would rather offer Hard Money companies a good deal on the property. This way, they get money in their hands immediately rather than wait for a bank to process their loan application.

There are other reasons why a borrower might prefer the speed of working with Hard Money companies too. Sometimes, they need some short-term financing. They may need to pay off some creditors to get their monthly expenditures under control. They might need to free up equity for family needs such as unexpected hospital bills. On the other hand, they might have an opportunity to move fat on the deal. Regardless, there are many reasons why a borrower might look to private lenders for financing.

Typical Rates of Return

Every mortgage is unique. The property’s situation, condition, and location factor into the mortgage structure and rate of return. Hard Money companies must turn down deals that won’t produce strong enough returns for hard money investors. Those that do qualify for Hard Money loans present an excellent opportunity for an investor. Some of the other factors that play into the return an investor can get from a private mortgage are:

  • The term of the note
  • The quality of the borrower’s credit
  • Loan-to-value ratio
  • The purpose of the loan
  • Exit strategy of the borrower
  • Direct lending or lending through a mortgage pool

The above factors make some deals better than others. Private lending in an IRA offers considerably higher returns than traditional mortgages. They have outperformed the stock market over the long-term. Conservatively speaking, private mortgages return anywhere from 9% to 14%. But, most private mortgages give investors an average return in the 12% to 15% range.

Private Lending in Your IRA

If you’re concerned that you’re going to miss out on your chance to offer a private mortgage due to a lack of cash-flow, there is good news. Investors can use their IRA to invest in private mortgages. Most IRA administrators only allow you to hold investments that they sell. So, it is very likely that they will tell you that you are not allowed to invest in private mortgages with your IRA. The fact is, you can. It all depends on the administrator. With that said, to invest in private mortgages with an IRA, you need a self directed IRA administrator. Midland acts as the IRA administrator that handles the IRA’s private mortgage investment.

What is a Self-Directed IRA?

Many people hear the term “self directed” IRA and think that it is a special tButIRA. In reality, the IRS does not recognize a self directed IRA as a special type of IRA. Any IRA, whether it be a Traditional, Roth, SEP, or SIMPLE can be self directed. We use the term self directed because our clients are making 100% of the investment decisions. The client directs Midland to make legal investments on behalf of their IRA.

Why do you need Midland’s services to invest in Private Lending in an IRA?

Anyone who wants to take control of their retirement investments. Typical IRA custodians only allow you to invest in the products that they sell. Since Midland doesn’t sell products or offer financial advice, we do not limit clients’ investment decisions. A self directed retirement plan with Midland allows for IRA investments in a multitude of areas. Also known as alternative assets, these can include real estate, Private Placements, and more. Most people are unaware that IRAs can invest in alternative assets.

The Advantages of Investing with IRA Funds There are Three Primary Reasons People Put Money in an IRA:

Building for Retirement

It is safe to assume that most Americans do not want to rely on Social Security as their only retirement income. Baby boomers only have $35,000 in median retirement savings. 69% will rely on at least working part-time for retirement income. Hope is not a strategy.

All Earnings Grow Tax Free (Time Value of Money)

The Time Value of Money states that, at the present time, money is worth more than the same amount in the future. So, why would you want to pay the IRS capital gain tax after each investment’s sale? Instead, through an IRA, you can pay them later. The money you save in taxes can be invested to create even higher wealth. This is the primary reason clients use IRA accounts.

Tax Deductions for Contributions

Most IRA accounts allow investors to write-off contributions as a tax deduction. So in essence, Uncle Sam is funding part of your retirement savings. For example, if an individual is in the 25% income tax bracket, and contributes $4,000 to their IRA, they save $1,000 in income taxes. This means that ally only contributed $3,000 to their IRA and Uncle Sam contributed $1,000.

Steps for Private Lending in an IRA

Clients must follow specific steps to ensure the investment is purchased correctly and safely.

Step 1: Open and fund Midland Trust (funding can be done via Transfer, Rollover, or Contribution).

Step 2: (Newly Formed LLCs) Provide Midland with the LLC Operating Agreement with proper vesting: Midland Trust FBO Client Name IRA #, Articles of Incorporation, and Funding Instructions (Pre-Existing LLCs). Provide Midland with the LLC Subscription Agreement or Assignment of Interest with Proper vesting.

Step 3: Provide Midland with a Buy Direction Letter, Private Placement Disclaimer, and Indemnity Agreement form (both forms provided by Midland).

Step 4: Step 4: Provide Midland with the LLC or Private Placement Check Writing or Bank Wire instructions.

Frequently Asked Questions

  1. How quickly can Midland fund my investment? Most of our clients have to transfer funds from their current IRA custodian. This process generally takes about 2 weeks. If it is a newly established IRA, a transfer might not be necessary. In this case, the client is writing a check to Midland as an IRA contribution. As long as Midland has cleared funds, there is no delay.
  2. What are my fees? Midland has a one-time IRA set-up fee of $50, a one-time $100 fee to buy the asset, and annual administration fees of $325 (see application fee disclosure for determination).
  3. How much can I invest? Midland has a required minimum balance of $250 to in the client’s money market account. You can invest all other funds in the IRA.