The New Tax Law: Self-Directed Real Estate and Note IRA's and Keogh's


By Hugh Bromma

The New Tax law, also known as the Economic Growth and Tax Relief Reconciliation Act of 2001, expands opportunities to make larger investments in IRAs and Keoghs and offers possibilities for your plan not available before.

Creative New Possibilities

Let's take a look some of the major advantages just for year 2002:
  • The contribution limits, levels or indexes have changed for all plans.
  • The IRA goes to $3,000 in 2002
  • If you reach age 50 in 2002, you also get to make an additional IRA contribution of $500. The average age of and IRA account holder is 50.
  • Education IRA limits increase to $2,000 (qualification indexes for joint filers is increased to $190,00 for 2002, up from $160,000). Entities other than individuals may also contribute to Education IRAs.
  • SIMPLE IRA contributions have increased to $7,000 for an individual and the employer may contribute a like amount.
  • Elective deferrals (401(k) deferrals) are not counted as employer contributions when determining the employer's maximum deductible contribution of 25% adjusted to a maximum of $40,000 to a profit sharing plan.
  • Catch up contributions for 401(k) and Salary Reduction SEP-IRAs of $1,000 for person age 50 and over in 2002 will also be permitted.
  • Plans and IRAs are generally portable among each other, except for after tax contributions held in accounts.
The most beneficial plans are for the self-employed: The Profit Sharing plan with the 401(k) feature permits a 100% employee contribution of up to $11,000 in 2002, and the employer contribution based on 25% of compensation can make up to the remaining $29,000.

When this is coupled with an "in-service withdrawal" capability in the plan, after two years, a fully vested plan can be rolled to an IRA and converted to a Roth. This works particularly well for the self employed with spouses and partners.

How Does This Work in Reality?

Plans generally must have the investments contained in them for two years after the contributions are made before they are eligible for distribution as an in-service withdrawal. In other words, you must still be employed by the company that offers the plan (your company). You have made investments of various kinds during this time period, such as real estate, private placements, Limited Liability Corporations, publicly traded stock, mutual funds and Certificates of Deposit.

After two years in the plan (you have selected 100% vesting of the employee (you) of the investments in the plan accounts), you decide that you want to have certain of the investments grow tax free, or be part of a Roth IRA. If you selected Real Property, you would need to arrive at a fair market value of the Real Property. An assessor's valuation is acceptable. This amount is distributed to you from your plan. The real estate could be held in your profit sharing portion or your 401(k) portion, or both.

Within 60 days, you roll the property to your IRA. You then convert this IRA to a Roth IRA by paying tax on the value of the Real Property (the distribution amount is included as part of your taxable income for the year in which you do the rollover, so pick a low income year), and then convert to the Roth. The actual Roth conversion process takes a written form for you to complete and a few keystrokes by your IRA custodian.

What you have done is take a retirement plan vehicle which permits you to make large contributions and convert some or all of the assets in the plan you directed to be purchased to a status which renders the resulting income, future sales and purchase exempt from income taxation forever.

This example is used for the plan that permits the maximum contribution and allows conversion to an eventual Roth IRA, which is tax-free. Of course, your income level during the conversion year (or years) must be under $100,000, so this requires planning.

Education IRAs

By the way, the education IRA isn't called an Education IRA anymore; it is now the Coverdell Education Savings Accounts, or CESAs. The contribution amount did get changed but, better yet, if the beneficiary you first selected reaches age 30, you can transfer the account to another family member, rather than distribute the amount and pay tax.

So you can provide for future generations with whatever is left over. This is particularly good when you consider that you can self-direct the investments. With great planning, this tool is a great family education wealth builder. You can use these funds for accredited elementary, secondary and post secondary schools. There are maximum income limits which begin at a joint return of $190,000, and after $220,000, you can't fund the CESA.

As noted above, entities may also make contributions to CESAs, so the income limitation may be moot for those of you who are self-employed. You can, of course, also partner with your other accounts, plans and personal money for those non-standard investments, such as real estate, notes and private placements. Partnering also includes other people, their money and plans.

Tax-Deferred and Tax-Free Possibilities

As you can see, the "new" tax law has brought some new possibilities for creating additional tax-deferred and tax-free wealth accumulation. These are but a few that you can use easily.

Remember that self-directed plan owners have historically accumulated more than twice the dollar value of assets in their accounts than the standard stocks, bonds, mutual funds and CDs. Diversification can be a good thing, as long as you plan ahead early and put the energy into making your investments tax free and assets, not liabilities.