Tim Berry and Matt Theriault share the pros, cons, and realities of flipping in your retirement account this Tax Hacker Tuesday! Learn the right and wrong ways to flip in your retirement account, how to get around owing taxes unnecessarily, lies you’ll hear about your retirement account at real estate investing seminars, and much more!
What You Will Learn About Flipping Out Over Flipping In Your Retirement Account:
- The right and wrong ways to be flipping in your retirement account
- A common misconception about flipping in your retirement account
- How to avoid getting burned when using money from your retirement account for investing
- Lies you’ll hear about retirement plans at real estate investing seminars
- How to get around owing taxes on your retirement account
- A real life example of what happens when you’re not careful about flipping in your retirement account
- The difference between flipping in your retirement account and having a mutual fund in your retirement account that makes a large profit in a year
- How many flips it takes to be considered a business by the IRS
- How to decide between flipping in your retirement account or investing in a mutual fund
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Speaker 1: This is Theriault Media. Did you know that up to 50% of your lifetime income will be wiped out by taxes? What if you could stop this madness? Isn’t it about time you play on a level playing field with the wealthiest 1%? Now you can.
Tim Berry, attorney-at-law shares here each and every week current tactics and strategies that anyone can implement to hack the tax code, protect your assets and keep what’s rightfully yours. It’s time for Tax Hacker Tuesday.
Matt Theriault: Hello and welcome to the Epic Real Estate Investing show. It’s Tax Hacker Tuesday with my attorney and friend Mr. Tim Berry. On Mondays here at Epic, we show you new and creative ways as well as time-honored ways of making money using real estate. And on Tuesdays, we show you how to keep it. So if you have any questions for Tim and you’d like him to answer them live here on the show, you can go to taxhacker.com/questions and post it there. Or if you’d like to ask Tim personally, you go to taxhacker.com download his free book and after that, you’ll have the opportunity to schedule some time with Tim. And here one of his members will get in touch with you and they’ll make that happen. Alrighty?
Welcome back Tim, it’s another fun week.
Tim Berry: Yes it is.
Matt: And today we’re talking about what you were sharing with me earlier and I was like, “We should do an episode on that.” Because I think a lot of people misunderstand that when they’re flipping inside of their retirement vehicle. And they have this impression or idea that it’s tax-free. Not always the case. There’s a right way and a wrong way to do it.
Tim: There’s a right way and there’s a wrong way to do it. Yeah, a big misunderstood area of retirement plans is people think that retirement plans are tax-free, tax-exempt, and that’s not the case. If you borrow money inside your retirement plan and you make a profit off that borrowed money, you got to pay taxes on the profits. If you flip real estate, if you’re running an active business and you’re doing a lot of flips inside there, you’re going to have to pay taxes even inside your Roth IRA. Be careful what you’re doing inside your retirement plan. You might be thinking that you don’t owe any taxes but reality might bite you in the posterior.
Matt: So, I’ve been to more than one real estate investing workshop seminar/thing.
Tim: Seriously, you?
Matt: Yes, I have been to more than one. And I have heard this more than once. Too many times that I could not count how many times I’ve heard it. Of where the person on the stage is selling the self-directed plan and you can self-direct this money, flip houses inside of your retirement plan and you can do it tax-free and pay no taxes on it. So were they all lying?
Tim: It’s a hard cruel world out there man. I’m so sorry.
Matt: No, there’s got to be more of an answer than that. How can these people do that?
Tim: In their minds, they’re saying that they’re allowed to go out there and flip real estate, they’re just not telling the consequences. That’s all.
Matt: Oh, you really blowing my mind right now. So they’ve got a checkbook control over their retirement account so they can go out and flip properties tax-free. That’s-
Matt: That’s all false, all of it.
Tim: Well, no, no, no. That’s not false. It’s a true statement. You can go out there and you can flip the properties, no problem with that whatsoever. The problem comes to the end of the year whenever it’s tax filing time. If you have an intelligent tax advisor, they’re going to say, “Hey, you flipped a bunch of properties inside your retirement account. You now have to have your retirement account actually pay taxes on those profits.”
Tim: And then here’s the other killer. The tax bracket, anything over 12,000 bucks is going to roughly be at a 37% tax bracket in the blink of an eye. So if you made 100 …I mean, I’ll give you a real-life example. We had one client, they made $200,000. They had 60,000 inside the retirement plan at the beginning of the year and they made $200,000 in profit off that 60,000 by flipping. They were on top of the world and they called me up about something I said, “Okay, we’ll do the tax filing for you.” They said, “Okay, cool. That’s great.” We filled out the tax return. They owed, I forgot how much in taxes, about 80,000 or so. That might be off, but they owed a lot in taxes and I sent it back to ’em.
Poor guy almost had a coronary. He didn’t know that he was supposed to pay taxes on it. He thought he was just supposed to file an information return. And he was all upset. It was very interesting.
Matt: Huh, I imagine that extra ton of grand put him in a different tax bracket.
Tim: Well, he didn’t know. Because once again on IRA, a retirement account, anything over 12,000 is in the highest tax bracket immediately.
Matt: Oh, the highest, got it.
Tim: Yeah. So there’s no messing around for those guys, they just zoom. And another example, talked to someone just, what was it? Yesterday, the day before. This guy absolute genius. He’s flipping eight, nine million dollar office buildings and he wanted to do that inside of his Roth IRA and he was afraid of this tax. And the way he was doing it, there’s a very simple way that he could do this and not be subject to that tax. So yes, you can do some flips without being subject to taxes. But if you’re doing a lot of flips, you’re going to owe a lot in taxes.
Matt: Okay. I’ve got a couple of questions and they’re circulating in my brain now.
Matt: The first one was … Oh, so how was this different than if you just had a mutual fund in your retirement account and that made a whopping profit in a year?
Tim: IRS’s mutual fund are longterm investments. So they’re generating capital gains and dividends. And inside the section the tax code that charges the taxes, they specifically exclude capital gains, dividends, annuities, interest, royalties and rents, rents from real estate. Those are specifically excluded. So if you earn one of those six types of cash flows or if you recharacterize the flips into one of those sorts of cash flows, you don’t have taxes. But if you’re doing a flip and it’s just generating that short-term gain really fast, you’re going to be busted and you’re going to owe taxes.
Tim: And a quick side note. A quick way to get around that, there is something called a shared …
Matt: That was my next question. Was how do we get around that?
Tim: Oh yeah. It’s just legalese, you do paper shuffles. You file the proper forms whenever you’re doing the deal, you structure it the proper way and you get around it. There’s something called a shared appreciation mortgage. A lot of people have these whenever they renegotiated their mortgages with their lenders way back when. The lenders probably got a shared appreciation mortgage where they took a percentage of the appreciation of that property. In the eyes of the IRS, and most cases, the shared appreciation is interest.
Tim: And so now if your retirement plan makes a shared appreciation mortgage loan to someone else and it gets paid back a portion of the profits via this sort of appreciation mortgage, that’s interest which is one of the specifically stated things. It is still tax exempt.
Matt: Got it. Okay. We’re getting closer. You said something in your language there, I was listening very intently. That you’d said something if you flip one or two you’re okay but if you’re flipping a lot of ’em you’re not. Is this … If I forget what this is called, I’m going to sound like a fool on my show. UBIT?
Tim: This is … Yes, we are talking about UBIT. You’re not a fool, you’re a genius man. You’re a genius on your own show.
Matt: Okay. I wasn’t sure if I had the right acronym order for UBIT. What does UBIT stand for?
Tim: Oh, hell if I know man. What I would I … No, kidding. Unrelated Business Income Taxes.
Matt: Unrelated … I guess I am a genius. Okay, Unrelated Business Income Tax. So this is if … What we’re really talking about is if you’re using your retirement plan and running a business out of it.
Tim: Yes. And IRS in many cases thinks doing flips is a business.
Matt: How many flips a year do you need to do to be constituted or considered a business by the IRS?
Tim: Once you know that answer Matt, please speed dial and let me know.
Tim: It’s a gray area. Nobody really has the proper answer to that. There are some people who say five to six. I’d love to know what they’re using that as the basis. Some people would say one or two, I’d love to know what their basis is as well. Now, a couple little-
Matt: It’s not clearly stated anywhere is what you’re saying.
Tim: Is not stated anywhere whatsoever. In the court cases they say, what’s the intent? Whenever you bought the property, what did you intend to do with it? Did you intend to sell it in a rapid manner? In that case, it was probably a flip and it was inventory and you’re probably going to owe taxes on it.
Tim: If you’re intent was to buy it long term and hang onto it and then things changed, well, at that point, you might be able to say it was an investment and is not a flip. But unfortunately, the IRS doesn’t know how to see what your intent was at the time. So, therefore, they say, “Oh, your intent was to flip it and we’re going to bust you.” And that’s whenever you start the fight.
Matt: Got it. So they have a lot of discretion there as to what your intent was.
Tim: Yeah. But also the actual section of this code says that you have to be doing this on an ongoing basis throughout the year. Well, if you just do one flip and you did it January through March and you made enough for you, you didn’t want to do anymore or you did just the mutual funds after that, did you do that on an active basis throughout the year? There are court cases out there that are saying no, you have to do it each and every day. There are all sorts of vagueness and grayness to this. [00:09:35]
Matt: Okay. Alright. I’m feeling a little better ’cause you were blowing my mind on my own show for a second. I guess the next question would be, if you wanted to do, say half dozen of these flips a year, what would be the proper way to do it so you didn’t have that tax obligation?
Tim: Gosh, it depends. If you’re risk-averse, what I would do is I would set up a C corporation inside of your IRA and I would do the transactions within the C corporation. Reason being is the C corporation is taxed at a flat 21% as opposed to the high of 37 and change right now. So that would almost cut your taxes in half. But that means that you’re paying taxes.
If you’re a risk taker, what I would do is I would make loans over to whoever is doing the actual work, the flips. And this kind of goes to that control over ownership thing we talked about in a previous thing. I would have someone else doing the flips. I would have my retirement account make a loan to them, a hard money loan and then a second [00:10:44] loan that was a shared appreciation mortgage and try to suck out as much profit as possible via interest payments.
And then there’s another way to do it involved in options or it could be a convertible bond. You make an interest, you make a loan to the person doing the flips. You also have an option to buy out units of their LLC later on down the road and that you would hopefully help you avoid that UBIT as well. So there are some different things …
Matt: And that’s if you’re intent is to do multiples a year.
Tim: If you’re doing multiples a year, yes.
Matt: Got it. Alright, one of the options I heard was you loan shark yourself.
Tim: You loan shark yourself. Oh, not yourself, someone else who’s actually doing the work. Let’s say you have a contractor, so you’re going to loan shark the contractor and you’re going to make sure whatever their payment was going to be as a contractor as profits and the rest comes back to you as interest.
Matt: Got it. So you’re loan sharking yourself indirectly.
Tim: There you go.
Matt: Okay. Shark and bandits and all kinds of… [00:11:51]. Great. Okay, thanks for clearing that up. So it’s all about your intent really. And the IRS has a full say of what your intent was.
Tim: They can try to say what your intent was and then unfortunately you got to fight them tooth and be able to say, “Au contraire, it was something else.”
Matt: Got it. And then we can revert back to the last episode on how to fight the audit, right?
Matt: Okay. Sweet, we’ve covered every base here. We’re doing really well. Any last bit of advice there Tim?
Tim: Yeah. One quick thing of advice, and this is a lot of CPAs are going to tell you not to do flips inside of real estate because you’re going to have to pay taxes on this. And my thinking is, so what? Even of you get hit with the highest tax bracket, if you’re like this guy who went from 60,000 and made 200,000 dollar profit in one year … And I know that not everyone has the ability to do that, but even if you got to pay taxes, if that’s a better alternative than investing in a mutual fund that’s going to make a whopping 10% or whatever, why the hell wouldn’t you do it? Is not like this is something you can’t do. You can do it but just be aware of what the consequences are.
Matt: Got it. Yeah, what I always say, it’s always just a math equation. It’s pluses and minuses. If you start adding pluses and minuses of penalties and tax consequences and you add those labels to your pluses and minuses, then it gets scary. But if you just do the math and forget the labels and just everything’s plus and minus, then you can make a more unemotional decision.
Matt: I love it. Alrighty, so whenever you’re ready to have Tim crush your dreams … No, whenever you’re ready to have Tim help you do it the right way so you don’t have your dreams crushed by the IRS, you can go to taxhacker.com, download Tim’s free book to help you navigate the new tax plan. And after that, if you have something special, you’ll have the opportunity to schedule some time with Tim. And either he or one of his team members will get on the phone with you for a short five to 10 minute call just to assess your situation, see if they can help.
And if they can, they’ll connect you with Tim. If they can’t, then they’ll give you some resources that might work better for you. And if you’d like to take advantage of Tim’s Tax Hacker Blueprint, it’s a 3,000 dollar value. And that’s what I mean, if you knock on Tim’s door right now as a stranger, that’s what he’ll charge you for this. But right now, it’s half off. And if he can’t save you at least double that, then you pay him absolutely nothing. And if you want to look into that, go to Tax Hacker Blueprint … Excuse me, ask them for … No, tell them that you want your Tax Hacker Blueprint and they’ll take it from there. Alrighty? So much for my improv lessons.
Alrighty Tim, it’s been a pleasure. I’ll see you next week.
Tim: Yes sir, I appreciate it man, thank you.
Matt: Okay. And we’ll see you next week for another episode of Tax Hacker Tuesday on the Epic Real Estate Investing show.
Speaker 1: That’s it for today. As we dream of a tax system that works just for you. But until then, you have Tim Berry. See you next Tuesday for another episode of Tax Hacker Tuesday.