I Want my IRA to Invest in “Green” Energy

Energy consumption is on the rise, both nationally and globally, and many new energy companies are popping up to fulfill the increased demand. Growth in the alternative energy industry has increased the number of wind turbines and solar panels that provide power to our homes. The oil and natural gas industry is also still booming, with technological advances in shale extraction leading to more opportunities for expansion. All this growth has caused many of our self-directed IRA holders to ask us how they can take advantage of this emerging industry as part of their retirement portfolio.

Whether the energy industry is something you have previous experience with or it is a new interest you have developed, the IRS allows SDIRA holders to pursue their interests and use their personal agenda or strategy when investing. Your IRA can invest in energy in a number of ways, including lending funds to an energy start-up through promissory notes, purchasing shares of private stock, or forming a limited partnership.

As the price of fossil fuels has increased, the popularity of renewable energy sources has soared. Wind and solar energy are becoming major players in the energy game, presenting investors with the opportunity to not only take advantage of an emerging industry, but also to invest in “green” energy sources. Those SDIRA holders who are concerned about making socially responsible investments can utilize these environmentally-friendly energy sources for their retirement portfolio.

Increases in the demand for energy are creating an emerging industry that could create an investment opportunity for self-directed IRA holders. As the account holder, it is important for you to perform thorough due diligence when choosing a new investment. Doing so will help you protect your retirement and allow you to find the right investment for you.

Retirement Plan Integration with Self Directed IRAs

Whether you’re getting close to retirement age or you’re just beginning to look into retirement planning, it is important to understand how each type of retirement account fits into your overall retirement plan. Common retirement accounts, such as the Traditional IRA, Roth IRA, and HSA, each play their own role in a well-rounded retirement strategy. Knowing how to utilize each type of account will allow you to develop the best retirement plan for your personal retirement goals.

Each plan type offers a different tax advantage. Traditional IRAs are traditionally thought of as providing tax advantages when funds are placed in the account, and Roth IRAs delay the advantages until funds are removed from the account. While this is generally true, there are many factors that can affect the personal advantages of any particular account. These factors can include the age at which you plan to retire, your current tax bracket, the tax bracket you will be in post-retirement, the cost of living where you plan to retire, and the performance of other investments outside of your retirement accounts. A study of each account’s tax advantages and how those advantages will interact with the factors above may help you to create a personalized retirement plan.

For self directed IRA account holders, determining which accounts will best suit your retirement goals can seem complex. Just because you have a self-directed account does not mean you are alone on your retirement journey. SDIRA account holders can utilize the services of Certified Public Accountants (CPAs), Certified Financial Planners (CFPs), RIAs, trusted friends, and others to form a financial team. This team can help you discover the right combination of retirement accounts for your goals while you maintain the independence that comes with self-direction.

One account to consider for your well-rounded retirement plan is a Health Savings Account. An HSA can help you plan for those medical bills that may be incurred after you retire, allowing you to use your IRA funds to pay for other things. Not only can your HSA help you save for future medical costs, but you may also invest your funds to help grow your account’s value. The HSA also provides another advantage. After the account is opened, any medical costs incurred and paid out-of-pocket may be reimbursed from the HSA at any time in the future. Your financial team can help you determine how best to utilize a HSA as part of your plan.

New Direction IRA is proud to be a part of your personalized retirement plan. The self directed IRAs and HSAs we provide allow you to diversify your retirement investments, use your personal expertise to invest in what you know, and adjust to changing market conditions. We offer education to account holders and non-account holders alike, as well as providing continuing education to CPAs, CFPs, and other members of your financial team so you can make the best decisions possible for your self-directed retirement plan.

IRS Explains Unrelated Business Income Tax (UBIT) and Unrelated Debt Financed Income (UDFI)

At New Direction IRA, a self-directed IRA and HSA provider, we hear a lot of questions about UBIT, or Unrelated Business Income Tax.

Many investors are afraid of acting on money-making opportunities because they think UBIT is a penalty or an excessive tax. However, UBIT typically means that—in the case of retirement accounts—the account is making money. It is not a penalty, just a way to even the playing field between tax-exempt and tax-deferred entities like a retirement account and other entities/people.

To get a basic understanding of UBIT and Unrelated Business Taxable Income (UBTI) and Unrelated Debt-Financed Income (UDFI), that two types of income that may be assessed UBIT, let’s go straight to the source: the IRS. The IRS Publication 598 outlines what these tax consequences are and how you’ll incur them.

Below are some excerpts from the IRS that may help an IRA holder to understand the parameters.

Unrelated business income - Unrelated business income is the income from a trade or business regularly conducted by an exempt organization and not substantially related to the performance by the organization of its exempt purpose or function, except that the organization uses the profits derived from this activity.

Income - Generally, unrelated business income is taxable, but there are exclusions and special rules that must be considered when figuring the income.

Exclusions  - The following types of income (and deductions directly connected with the income) are generally excluded when figuring unrelated business taxable income.

• Dividends, interest, annuities and other investment income - All dividends, interest, annuities, payments with respect to securities loans, income from notional principal contracts, and other income from an exempt organization's ordinary and routine investments that the IRS determines are substantially similar to these types of income are excluded in computing unrelated business taxable income.
• Royalties - Royalties, including overriding royalties, are excluded in computing unrelated business taxable income.
• Rents - Rents from real property, including elevators and escalators, are excluded in computing unrelated business taxable income.
• Exception for rents based on net profit - The exclusion for rents does not apply if the amount of the rent depends on the income or profits derived by any person from the leased property, other than an amount based on a fixed percentage of the gross receipts or sales.

Gains and losses from disposition of property - Also excluded from unrelated business taxable income are gains or losses from the sale, exchange, or other disposition of property.

Unrelated Debt-Finance Income

Income From Debt-Financed Property

Investment income that would otherwise be excluded from an exempt organization's unrelated business taxable income (see Exclusions under Income earlier) must be included to the extent it is derived from debt-financed property. The amount of income included is proportionate to the debt on the property.

Debt-Financed Property

In general, the term “debt-financed property” means any property held to produce income (including gain from its disposition) for which there is an acquisition indebtedness at any time during the tax year (or during the 12-month period before the date of the property's disposal, if it was disposed of during the tax year). It includes rental real estate, tangible personal property, and corporate stock.

If you have any questions about UBIT, UBTI or UDFI, feel free to contact us at NDIRA by visiting www.ndira.com and giving us a call, email or chatting online with an IRA expert.

(Information provided by the IRS publication 598.)

IRA Valutions: Who Cares What It's Worth?

Not all IRAs are created equal (when it comes to providing an annual valuation, at least).

Consider the case of “Berks vs Commissioner of Internal Revenue.” In the case, Bernard and Claire Berks invested in notes with their IRAs but the borrowers either defaulted or their collateral did not adequately secure the debt. This resulted in the notes being worth zero. The IRA provider, over a period of several years, requested that the Berks provide an annual valuation. The Berks referred these queries to the investment provider who, allegedly, called the provider and told them that “the notes are worth zero.” No documentation supporting this assertion was provided. The Berks requested that the assets be valued at zero and that the provider terminate their accounts. In accordance with the provider’s policy, the assets were distributed from the IRA holder’s account to the IRA holder at the last recorded book value of the asset. In other words, the IRA holder received a 1099-R (form for reporting distributions from pension plans) for the full amount of the account using the original face value of the notes.

The Berks took the case to tax court challenging the valuation of the IRA at the time of distribution. The IRS did not see this situation the same way as the Berks did.  Not only would the IRS not accept the opinion of the Berks that the IRA was worth zero, they penalized them 20 percent of the account value for their “negligence” in failing to make a reasonable attempt to comply with tax laws, maintain adequate books and records or to substantiate items properly. They were also cited with the intentional “disregard” for rules and regulations. 

As is usual in tax cases, the burden of proof falls on the taxpayer. The Berks’ tax return claimed the IRA distributions were not taxable and therefore paid no taxes on the reported distribution. They blamed the preparer for this “oversight.” They blamed the IRA Provider for distributing the account at full value. In short, they took no responsibility for their account or their tax preparation and the court was not sympathetic.  In fact, the court found that these arguments actually proved the Berks’ negligence.

The case brings up a greater issue about the importance of valuations.

IRA holders whose accounts have alternative assets in them receive a request from their IRA providers every year to provide fair market value for their IRA’s assets. For most IRA holders, these annual valuations are of little importance because their IRAs are invested in publicly traded securities and their IRA providers will often prepare valuations for their clients at a fee. For reference, about 97 percent of IRAs are invested in publicly traded securities.

For the $126 billion invested in self-directed IRAs (SDIRA) however, valuations matter a great deal. The account holder, not the provider, is responsible for providing valuations every year on their assets.

This issue of determining fair market values for hard-to-value assets in SDIRAs has become a focal point for the IRS. The IRS is now paying attention to the fact that with many SDIRA assets, there is a wealth of taxes to either be reaped or avoided. 

So the Berks case offers several learning points. First, provide an annual valuation, with documentation, when the IRA provider requests it.  If the asset is worth zero, provide proof that the asset is worth zero. For those with publically traded IRA investments, much of the work is done for them by the IRA investment provider, usually at a fee (we don’t charge a valuation fee at New Direction IRA.)  SDIRAs give IRA holders entrance to every investment allowed by law, but the account holder must find and manage the investment and provide the value annually.  Those are the rules. With SDIRAs, investors receive unlimited possibilities but they are also expected to know and understand the rules.   

What's Better: An HSA or a PPO?

With the Affordable Health Care Act (Obamacare) taking effect, health insurance has risen to the national spotlight in the last few months. Americans have more choices than ever on how to be covered for medical expenses, so I thought it might be good to highlight the differences between two very different, but very popular insurance types: High Deductible Health Plans (HDHPs) with Health Savings Accounts (HSAs) and PPOs (preferred provider organization).

First, the PPO. Like other insurance plans, it enables the account holder to choose his doctors and hospitals based on who will accept the insurance. PPOs will often have networks of doctors, specialists and doctors that the plan holder can work within or out of. If the plan holder visits out of network doctors or facilities, he’ll often have to pay a higher cost.

PPOs require premiums to be paid. Premiums are the cost of the plan and are typically (but not always) split between the employer and the employee in company situations. PPOs also have varying deductibles (the amount the plan holder pays in a given year) and lower deductibles typically indicate higher premiums. Deductibles range anywhere from $200 to $5,000 for PPOs.

The HSA operates differently. The HSA itself is not an insurance plan, therefore HSAs are couple with High Deductible Health Plans (HDHPs). The HSA is the pool of funds, then, that pays off medical expenses incurred in the HDHP.

HDHPs have little to no premium if offered by your employer and often the employer will contribute money to the HSA on top of that. Medical expenses incurred by the plan holder until the deductible is reach is paid by the account holder—typically via HSA funds. So if the HDHP’s deductible is $5,000 and the plan holder gets a blood test for $230, the plan holder would pay the full price. In the case of a bad medical year, the HDHP prevents against colossal medical costs by covering just about everything above the deductible limit.

What makes HSAs unique is how you can use the funds. First, any medical expenses incurred don’t need to be paid right away. You can actually pay those expenses out of pocket, keep money in your HSA and then reimburse yourself anytime in the future (as long as the expense is a “qualified medical expense” and you have the receipt.) Plus, when you use HSA funds for qualified medical expenses, you are achieving a discount on those expenses because it is not taxed.

And while those funds stay in the HSA, you can invest them in everything from stocks and bonds to real estate and precious metals. The flexibility of this account and the potential for massive growth attracts many people. It’s a great way to save on medical expenses and grow funds that can help in your retirement! If you still have funds in your HSA by the time you reach retirement age, you can distribute them like a normal Traditional IRA and use them for whatever you’d like.

For more information on HSAs or how they compare to other health insurance plans, visit www.NewDirectionIRA.com.

How Do I Find Self-Directed IRA Investments?

Self-directed IRAs, or SDIRAs, are becoming increasingly popular because they allow account holders to choose from a world of investments. At New Direction IRA we’ve seen IRAs invest in everything from trailer parks to oil fields to Middle Eastern currency and more.

The sheer number of investments could seem daunting, but many investors view this as an opportunity to invest in what they know and trust. Here, we’ll go through the main alternative asset types and share how you might begin looking for investments.

Note that all due diligence is your responsibility and not the responsibility of the IRA provider, like New Direction IRA. (At NDIRA, we do not offer financial advice; we only service the investment that you choose.)

Real Estate

Real Estate investments come in all shapes and sizes. You can invest your IRA in commercial or residential real estate, fix and flips, rental properties, raw land and everything in between.

There are many options for real estate IRA investing

You may find it beneficial to search for investment property by contacting a realtor, driving around the area you in which you want to invest or attending real estate investment groups. What’s important to remember is that you can invest in nearly any real estate as long as it follows disqualified persons rules.

Disqualified persons to an IRA include the IRA holder, his spouse, his parents and grandparents, his children and grandchildren, their spouses, certain fiduciaries and any entity owned or operated by a disqualified person. So, for instance, you couldn’t buy a rental property or vacation property and let your kids live in it.

You can, however, partner with both disqualified and non-disqualified persons. You’ll have to be diligent about paperwork and incoming/outgoing funds but the flexibility afforded by the IRS to maximize your funds opens your investment options even further. You can even take out a non-recourse loan to mortgage investment property. For more information on funding, visit http://www.newdirectionira.com/real_estate_ira.html

Precious Metals

Your IRA can invest in gold, silver, platinum and palladium products. There are certain fineness requirements for each and you cannot invest in many collectible coins, but there are simply many options for a precious metals investment. For a full list of acceptable coins and metals, visit http://www.newdirectionira.com/gold_iras.html.

In an SDIRA, you find the dealer from which you want to buy metals and determine the terms of the deal with him. You send the terms over to your IRA provider and they will send money where needed. At New Direction IRA, you can then choose your depository (where your metals will be stored) and the dealer will ship the metals directly to the depository.

Performing due diligence is necessary for all investments, especially precious metals. Make sure you are comfortable with the dealer and depository and the terms of the sale.

Private Equity

Finding private equity investments often requires more leg work than real estate or precious metals investments.

Where you can often find listings of property or scores of dealers offering metals, private equity offerings require greater diligence. There are several website cropping off that seek to match investors to companies and individuals seeking investments.

You can also invest your IRA in entities that may be launching a new product or certain groups that are preparing to make large investments. As above, disqualified persons apply and full details can be found at http://www.newdirectionira.com/private-equity.html.

The best way to find private equity investments is to get involved. Visit investment groups, research companies, search for startups and find an investment opportunity that fits your IRA investment goals.

How does Unrelated Business Income Tax (UBIT) work?

Securities brokers and some accountants will be the first to tell you that you don’t want leveraged property in either a Traditional or a Roth IRA because you will have to pay additional taxes, specifically Unrelated Business Income Tax (UBIT).

How UBIT Works

UBIT was instituted as a way to level the playing field between non-profit and for-profit companies doing similar work.

For example: A Homeowners’ Association “Dairy Glen”, a non-profit corporation, has installed a pool and tennis courts for its residents. These facilities are supported by the HOA dues, paid by the residents of that neighborhood. At some point the HOA board decides that they are going to open the recreation facilities to the public and charge admission or offer memberships, all funds going back to the HOA accounts.

Down the road is “Muscle World, Inc.” a gym that offers similar facilities to their members. Muscle World pays taxes like any other corporation but has a tough time competing with Dairy Glen because they have to pay taxes. This is where UBIT enters. The government, in order to force fair competition levies UBIT on Dairy Glen because they are now in a business that is unrelated to the original business of maintaining neighborhood facilities.

So how does UBIT relate to IRAs?

The government will give you tax-deferred status on the income generated by whatever you have in the IRA. However, it is not willing to shelter the profits of the income generated by funds brought into the account in the form of a loan.

The IRA is treated like a non-profit but the additional funds brought in are not. This is because the IRS doesn’t allow unlimited ability to contribute to a tax-advantaged plan. The amount of money you can shelter within an IRA is limited by the annual contribution limits, so by taking out a mortgage, you are increasing the size of your IRA.

For example, if your IRA buys a home using a mortgage, UBIT will be assessed on the leveraged portion, not the portion that your IRA contributed. Thus as your IRA pays off the mortgage, the percentage that incurs UBIT will decrease.

UBIT is assessed at corporate tax rates.

Quick UBIT Facts

-          LLCs will not protect you from UBIT, it still applies

-          The IRA pays the tax, not you.

-          The IRA has its own tax return and this return does not affect your personal tax return

-          For most leveraged real estate deals, an IRA does not pay UBIT until somewhere between years 4 to 8 because of depreciation.

UBIT is generated by an IRA in three ways:

1.       The net income generated by the leveraged portion of an investment at trust rate.

2.       Proceeds of a sale taxed based on balance of debt at time of sale at capital gains rate (short term gains are taxed at the trust rate.)

3.       The IRA owns an operating business such as providing goods or services. Tax is on 100% of the net income using the trust rate. (This situation is not covered in this article.)

UBIT Illustrated

A good exercise is to take the same size IRA and calculate the gain on a property with zero leverage. Compare this property bought with varying degrees of leverage. Estimate the income generated by renting the property, and see what UBIT may be over the next 4 to 8 years.

Before someone talks you out of leveraging a property within an IRA, do the numbers and decide for yourself. It may or may not make sense to use a mortgage but at least you will understand the decisions you make when investing your IRA money.

Remember that a self-directed IRA is the only way you can purchase real estate AND have a mortgage on it.