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BE CAREFUL DOING WHAT GURUS RECOMMEND! Wholesaling in your self-directed Roth IRA

We are bombarded in Emails and on the news by a mixture of the truth, half-truths, untruths and some misinformation that is downright dangerous. I got an E-mail from a reputable real estate guru this month about wholesaling in a self-directed Roth IRA (described below) that worried me so much, I decided to write this article.

Much of the time we can’t even tell the difference between truth and untruth, even when communicated by figures of seeming-authority. In most cases, the authority figures actually believe what they say is true which is why they are so sincere and convincing.

What should we do when we hear strong recommendations from gurus and other authority figures?

The answer is to do due diligence before taking action on the recommendations.

Challenge everything you hear from everyone, including from me. What if I am wrong? What if a guru is wrong? If something sounds wrong, follow up and find out what is right.

I received an Email this month that contained an extremely enticing recommendation that was sent by one of the leading real estate gurus in the nation. Chances are that most of you reading the guru’s pitch will not immediately recognize the potential for creating tens of thousands of dollars of tax liability and possibly penalties if you follow the strongly implied suggestion to wholesale 10 deals in your self-directed Roth IRA to create $100,000/yr that is "tax free and no risk."

Following is a directly quoted excerpt from this Email:

"Imagine, how fast you can grow your retirement account with real estate.

In fact, the average real estate wholesale deal will yield a $10,000 profit (when you do them my way). So, let’s say you did 10 deals a year. That’s $100,000/yr in your IRA (Tax Free and No Risk)."

The interesting phrase is "no risk." Is the guru sure there is no risk?

I'm not an accountant, so I am not qualified to determine what is the level of risk. I do have a self-directed Roth 401k that I started in 2007. Since I am a conservative investor who strives for compliance, I did not feel comfortable to make certain investments in my Roth until I read relevant IRS publications and even certain portions of the IRS code that I thought might be relevant to my investment activities in my Roth.

One of the items I found in the IRS code appears to my novice understanding to suggest that we are not allowed to conduct certain types of business on a "regular" basis in a retirement fund. According to my admittedly novice understanding, there is a non-negligible probability that the IRS may likely consider the execution of 10 wholesale deals in a year to be doing "regular" business. If true (check with your licensed professional to confirm or refute), this might have serious ramifications on the tax-free status of those 10 transactions, and worse yet, potentially jeopardize the tax-free status of your entire Roth retirement account.

If that happens, the taxes due in one shot and potential penalties could be huge depending on your specific situation.

For example, if the IRS challenges these 10 wholesale deal transactions in someone's SD Roth IRA and if the IRS won their case, then the IRS may find that the beneficiary of the SD Roth IRA may have to pay either unrelated business income tax (UBIT), or worse yet, potentially pay federal tax on the $100,000 gain, possibly short term capital gains at the beneficiary's marginal tax rate, state taxes on the gain, perhaps the 15.3% self-employment tax. The IRS may think that wholesale deals are not real estate deals since the wholesaler is selling contracts, not real estate. If the beneficiary is younger than 59 1/2, there may be a 10% penalty on top of all that, depending on what the IRS finds.

In the worst-case scenario, which we don’t know will happen, if the beneficiary has more money in his/her SD Roth IRA (for example, another $200,000 after doing this for two years), there is the possibility that the IRS may disqualify the tax-free status of the entire SD Roth IRA and levy the same taxes and penalties on the all the rest of the balance of that account that was not Roth contributions. Imagine being surprised by a $100,000+ unexpected tax bill!

Could this happen? I don’t know. But I am concerned enough to raise the question and strongly recommend that before you follow this guru’s recommendation, you consult with a qualified licensed tax attorney who specializes in retirement plan law to learn of the ramifications.

Again, I am not an accountant, lawyer or tax attorney (I am only a chemist!), so nothing written above is qualified information. All I am doing is raising some concerns based on my novice totally non-qualified understanding of sections of code I have read with the purpose of being conservative in my decisions in what to invest and what to avoid in my own SD Roth 401k.

You must ALWAYS be aware that anything said by a guru (or by me) might be flawed and the consequences can be very significant.

If you are investing SDIRA funds, SD 401k funds or their Roth analogs, in real estate, you should watch the lecture "Advantages and Disadvantages of Self-Directed IRA's Versus Self-Directed 401k's." While no legal advice or tax advice is given in that presentation, there is information of which investors should be aware before investing hundreds of thousands of dollars.


Biography: Marc Halpern is a successful part-time investor who has achieved financial freedom in terms of passive income and net worth mostly through rentals and flips using “regular” money and self-directed 401(k) funds.

E-mail Marc Halpern directly if you want to learn more about part-time investing or improve your profits through coaching by a local expert in South Jersey/Philadelphia with track record.

Do not take any action or make any decisions based in whole or in part on the content of this article. ALWAYS consult with licensed professionals in YOUR state before making any investment.

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