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Tips to Self-Directed IRA Landlords for 2023 – Episode 369

Adam Talks

In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses some helpful tips that real estate investors, especially landlords, need to consider for 2023 based off the macro-economic conditions that are impacting us.

Tips for Self-Directed IRA Real Estate Landlords 2023

Hey everyone, Adam Bergman here, tax attorney and founder of IRA Financial. On today’s podcast, I want to review and actually dive into some very important tips that real estate investors, especially landlords, need to consider for 2023, based off the macro-economic conditions that are impacting us today and that will likely continue for the coming year.

So, we all know what’s happening end of 2022. We’re in a period of high inflation, high interest rates, and an investment market that has been depressed to say the least, right? Almost every asset class has gone down this year, from traditional equity indexes S&P 500, down around 18 or so percent; NASDAQ stock exchange; Russell 2000; cryptos, Bitcoin, Ethereum, all down 60+%. Gold, silver, even down. Tech stocks getting crushed. Really the only things that are doing well are commodity stocks, like oil and other commodity stocks. Everything is getting crushed. But real estate is held up relatively well. Yes, prices have gone down. There’s still some inventory, not as many real estate deals, but prices have not come down nearly as much as equities, cryptos, and other alts. Plus, obviously, real estate investors have a pretty big cushion since there’s been such immense real estate asset growth in the last two to three years, right? So, we definitely have a way bigger cushion today than we did back in ’08. So, I don’t expect that we’re going to go into a real estate tailwind and have a crash like ’08. Just people, investors, whether it’s residential, commercial, too much built up equity into their assets.

But, landlords, there are things that we all need to consider. I’m a real estate landlord. I have a Self-Directed IRA asset, real estate asset, that I own, that I rent out, and these are things that I’m starting to see that I’m sure all of you are as well. Number one, obviously expenses are going up, right? Taxes, we all know. Maintenance, right? Repairs gone up considerably, 30% to 40%, I’d say, in the last couple of years, right? Just finding someone that’s willing to, you know, do electrician work or plumbing work or just general basic improvement work has been tough; hard for them to show up and then their fees have been outlandish. I mean, really, 30% to 40% more than I paid two to three years ago. Okay?

So, that’s kind of really the topic of today’s podcast is, hey, you’re a lender, you’re looking to buy real estate in an IRA. Here are some tips to consider before doing so. So, number one, why do you want to buy real estate in an IRA? Well, it comes down to deferral/compounding return, right? When you buy real estate in an IRA, you don’t pay tax on any of the income, the rental income, or on any of the gains that you would make when you sell the asset. Whereas, if you use personal funds, you would pay tax on any rental income, ordinary income tax and either short-term or long-term capital gains on any sale of the underlying real estate plus the potential for depreciation recapture, which is taxed at a higher capital gains tax rate.

So yes, you do not get deductions when you buy real estate in an IRA, right, because you’re using tax-exempt funds. So, of course the IRS is not going to give you a corresponding deduction when you’re not paying tax. So, that probably is the detriment, or I would say the downside of using an IRA or 401(k) to buy real estate is you’re not getting the deductions or other pass-through deductions from your real estate, assuming they’re active and they’d be able to offset other income.

But overall, what people want to do is they want to use their retirement funds to diversify. They want to invest in hard assets, hedge against inflation and obviously they want to invest in assets they know and trust like real estate. That’s why it’s become probably the most popular alternative asset.

So, obviously you can use cash to buy real estate which is, in a retirement space, probably very common. Why? Because if you use leverage, meaning a loan to buy real estate using an IRA or 401(k), there’s two things to consider. Number one, the loan must be nonrecourse. That’s a loan you do not personally guarantee. Why? Internal Revenue Code section 4975(c) does not allow a retirement account holder to personally guarantee an obligation of the IRA, meaning you cannot take a recourse mortgage where you’re personally guaranteeing a loan. Hence the loan must be nonrecourse, which brings in obviously more risk to the lender; means you have to put down more than 20%, generally 30% to 40% and generally higher interest rates because the lender is taking more risk.

The second item to consider, if you’re using a non recourse loan by real estate, is this ugly four letter word which you’ve heard me talk about if you’ve listened to any podcast or videos over the years, is UBTI or UBIT, UBIT, UBTI, unrelated business taxable income, unrelated business income tax which is an ugly, ugly tax that rears its ugly head and triggers a potentially maximum 37% tax rate when an IRA uses a nonrecourse loan to buy real estate. So, simple example, you have $100K in your IRA and you buy an asset worth $200K, a real estate asset. You borrow the additional $100K from a non-disqualified person, a non-parent, non-child, non-spouse, non-daughter-in-law, son-in-law, not yourself, like a bank, friend, hard money lender, neighbor, brother, sister aunt, uncle, cousin. And now you have $100K debt, $100K equity, just 50/50 death to equity ratio, meaning if your property generates $20,000 in net income, $10,000, which is attributable to the debt, the 50/50 debt to equity ratio would be subject to the UBTI tax, which can go as high as 37% at approximately $15,000 to $17,000; so it’s a very low threshold.

There is an important exemption if you’re a Solo 401(k) or 401(k) under Section 514(c)(9), there is an exemption to the UBTI tax if a 401(k) uses a nonrecourse loan to acquire real estate. So, a very important exception that applies if you get into a Solo K or a 401(k). How do you get into a Solo K? You don’t need a full-time business. You just need side gig, Uber, DoorDash, selling shoes on eBay, whatever it is, whether you follow schedule C or you have a C or an S corp, just need to earn a little bit of income and then you could establish a plan for that side business and buy real estate by a rollover. And then if the real estate is acquired by a 401(k) using a nonrecourse loan, there is no UBTI tax, where that tax would apply to IRA. So, obviously that’s super important.

So, let me just kind of expand on where we are from a leverage standpoint. Obviously in December ’22, it’s not where it was in January 2022, right? The mortgage rates for a 30-year loan, they’ve gone up from like 4% to 7%; investor loans, definitely more expensive, you’re looking 10% to 12%, up from about 7% to 9%. So obviously, when money gets expensive, it’s much harder to make money. We’ve been really blessed, I mean, we’ve lived on a low-interest gravy train, but really, since, ’08, we had some increases in rates, you know, periodically towards, before COVID a little bit, ’19-’20, then again, ’14, a little bit ’12, but very mildly. We’ve really been on a rocket ship of very low-cost fuel and low-cost interest rates, and it’s been a boom time, right?

A lot of real estate investors I talked to, colleagues and my friends, they’ve never experienced an environment of higher interest rates. Never. So, it’s going to be interesting how they play their game, right? They just have never really had to address expensive money. Money has always been cheap. Maybe not as cheap as COVID, but cheap, really. Zero interest rate. So, if you’re a real estate developer and you can borrow tons of money at like 3% or 4%, a lot easier to make money than if you’re borrowing at 10% or 12%, okay? And that’s what’s going on now. But on top of that, landlords, you and me, we have added costs, right? We have inflation, we have costs, repairs, maintenance. We have all that stuff that we never really had to deal with, you know, pre-COVID and really pre2022. COVID, we had difficulty maybe capturing certain types of hard materials or even potentially finding people to work. But, now prices are just skyrocketing and a lot of businesses are just saying, well, there’s inflation, so I’m just going to raise my prices. But in reality, labor costs have gone up, basic materials have gone up, even though we’re not in any type of, maybe not as significant, shortages of materials, but it’s more of a labor crunch, which is causing contractors and repair-type businesses to increase their fees because they’re paying more.

So, you got to do the math on the rental income. That’s really super important. We all have to be better real estate investors today than we were over the last ten years, right? You really have to pay attention to your business. I think the goal is to kind of try to generate about a 4% return. So, if you’re paying $500,000 for the asset, you want to try to generate $20,000 net after expenses. It’s kind of the goal, right? So, you need to really focus and try not to overestimate the benefits, right? Really consider potential unexpected vacancy, right? Assuming increased costs for repairs, maybe you got to fix the plumbing or the pool, or you need a new roof or whatever it is. Those costs are more than they were three, four, five years ago, okay? It’s not like a few hundred bucks is going to cover each month. You can’t expect that.

So, we all need to be smarter landlords. We need to plan for vacancies, plan for higher costs. Now, again, why am I in real estate with my IRA is because I think it’s the best hedge against inflation. Why? I can always raise my rent next year, right? I have a one-year lease with my tenant, not a five-year lease, one-year lease. So unfortunately, if my costs go up 7-8%, I can raise the rent 5%, 6%, 7%. Assuming it’s still a very strong labor market, which it is today, and there’s plenty of opportunities to acquire a new tenant.

So, I’m super, I could sleep at night, right? I have also equities and cryptos, and I’m very diversified. But my real estate investment is the one asset where I don’t worry about it. Of course, I don’t want anything tragic to happen, like a hurricane to hit the house and the roof to collapse or flooding, but the chances of that are so minute. The biggest obstacles I have are, like, the toilet overflows or the lights don’t work, or small stuff like that, which I have someone that handles that, and it’s just something I price in. But I’m telling you, when the lease is up early ’23, like, the rent is going up. And that’s the flexibility of being a landlord tenant. You’re not stuck into an investment generally for two, three, four years, just raise the rent right? Obviously, you don’t want to raise it 40% and risk not having a tenant in there. But your costs and expenses go up 7%, 8%, 10%, like, you can always raise the rent 7%, 8%, 9%, 10%. So you have that flexibility, which not a lot of investments and assets can provide.

So, that’s why, I think just ’23, I know I’m just super more focused on expenses as a landlord than I ever was. I’ve had this real estate in my IRA for many, many years, and it’s always made some money. I’ve done pretty well, but I’ve never really ran that investment like a business. Just been like, oh, okay, I got to pay this person to do that, or the tenant doesn’t want to pay a lot this year, maybe I’ll give them a break. Now it’s like, no, my expenses are up and I can’t lose money. So, I need to raise rent a little bit unfortunately. My tenants been in my space for a couple of years. I really like them, but like, hey, I’m going to have to raise rent because costs of servicing have gone up tremendously. I don’t have any leverage on it, so I don’t have to worry about UBIT. And obviously I’m not buying a house today, so I’m not really as focused on the cost of leverage, but especially for non-IRA investors or even IRA investors using leverage, that is obviously what’s slowing down in the real estate market.

And that’s what the Fed has been trying to do purposely, is to tame the real estate market, which they’re hoping will tame down inflation. They really believe that real estate is the heart of a lot of this price increase, so their goal is, hey, we increase interest rates; less free cash, going to be more expensive to transact real estate-wise, and home prices will drop and people will make less money and that’s going to kind of bring prices down across the board. But, really there’s still a lot of labor pressures, which I’m not sure the Fed is even trying to address. So, if labor markets still, there’s tightness in it, the shortages, people are still going to demand more money, and that’s going to just put pressure on inflation, and the one thing that could solve it, and is definitely a hot-button item, is immigration, right?

Not saying just let people jump over a wall and get into this country, but we need to come up a way to bring in smart, educated people; give them a green card, maybe forget about the voting issue right now, give them green cards. Countries like India, Ukraine, parts of South America that have very talented people, let’s bring them in. We lost 2 million people from COVID that just basically stopped working, got out of the economy. We need to replace them and that’s going to, I think, be the only thing that really dampens inflation is just bring more smart people into America that want to work and be productive and pay taxes. And I think that will take care of itself. But immigration is definitely a hot topic and everyone looks to the wall, the border, the South, which of course; I came to this country from Canada. I did it the right way. I applied. I got a visa; went to law school in the United States. I didn’t just hop a fence. So I agree, do it the right way, but let’s bring in some smart people that could really help the labor market and get things back to normal.

So all in all, I’m still super bullish on real estate. I think ’23 will be kind of up and down year, but if you are owning real estate in an IRA or thinking of buying it, definitely you’re going to need to be more focused on expenses in ’23. You have some flexibility in rent increases, but plan for maybe a couple of months not having a tenant, right, if you’re going to raise your rent. Plan on increased expenses and costs. If you’re trying to get a loan to buy real estate in an IRA, expect 30%, 40%, 50% down. If you’re not using an IRA, you can do 20%, but you’re really going to have to run the numbers because it’s not a 4% or 5% mortgage anymore. It’s like a 7%, 8%, 9% mortgage, which definitely is not as enjoyable to pay and doesn’t make a lot of real estate deals worthwhile, and that’s why a lot of people are just really on the sidelines today. So, I think that will change. I think by 2nd third quarter ’23, I think rates will pause, maybe, I don’t know, come down, but I think the Fed will stop increasing rates and I think the real estate market will stabilize. So, maybe just sit tight on the sidelines for a bit. But, if you are a current IRA landlord, then definitely focus. It’s going to be tougher to make money in ’23, so really pay attention to the bottom line.

And that’s today’s episode. So, I hope you guys enjoyed today’s podcast. I really appreciate you guys spending some time with me today. I know it’s Christmas, Hanukkah, New Year’s; lot of good stuff to do, but I think it’s an important topic because it is going to be harder to make money as a landlord, but there are ways, if you stay on top of your numbers and really treat it as a business, not just a casual hobby, I think that can make the difference to get you really at that 4% sweet spot where you want to net income 4% of what you paid for it and have that compound without tax.

So, want to wish everyone a Happy Holidays, Happy early New Year. Hope everyone has the opportunity to spend a lot up time with family and friends, relax. Looking forward to a great 2023. So, take care, be well and I’ll talk to everyone again next week. Take care.


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