Self Directeed IRA Myths Busted: Part 1
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
About the author:
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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