Why 99 Percent of SDIRA Investors Miss Out on Tax-Free Wealth | Ep 84

James: Do you think simply opening a self-directed IRA is enough? Well, it's not. That's where most investors lose the game because they stop there, and we're gonna talk about that today on the Furlo Capital Real Estate Podcast, where we dive into the intricacies of passive real estate investing, even with a self-directed IRA account.

And our mission is to equip people to invest wisely in both property and people so that together we can build wealth, ideally tax free while improving housing. I'm James and this is my wife Jessi.

Jessi: Nice. I was thinking, I dunno, you were just talking about money and saving and that's what happens. Maybe it made me think of inflation.

Oh, okay. I had this conversation. So our son lost a tooth recently. Ah, yes. And I, I, we were negotiating, you know, like, how much do you think the tooth Fair should give you? You know, that sort of thing. Oh yeah. And he was like, oh, I definitely deserve $10. $10. Oh yeah. Because it was wiggly on a camping trip.

Yeah. Which was. Like cause turmoil. Mm. And so there was dis, dis emotional back pay. Yeah. Yeah. Interesting. So interesting ing. So I owed him, I was just like I don't know about that man. So I gave him three bucks, but even still, I'm like three bucks. I used to get like a quarter, like, come on, teeth are not that expensive.

No, they're not. I mean, they

James: grow bad. They

Jessi: are 'cause orthodontia and all things. Oh my gosh, my,

James: yeah. Anyways,

Jessi: that's why, that's why you save.

James: That's why you save and invest, I guess. Yeah. Ideally in a tax free vehicle to make that happen. Yeah. And I do wanna talk about self-directed IRAs, and I know we talked about it like once, briefly a long time ago, but I think it's re worth revisiting and like, how do you take it to that next level?

Because most people right, they get into a self-directed because they're just tired of like the ups and downs of the stock market. Mm-hmm. Being locked in with some sort of index fund or whatever. Yeah. They wanna take a little bit more control and at the very least just make it more interesting.

Yeah. And self-directed is relatively easy to get started, to be honest. But there's things you can do to really kind of take it to the next level. And so I want to talk about that. And I got a lot of these ideas. I was, I'm, I'm a weirdo and I subscribe to different IRA and self-directed IRA, like websites and blogs and stuff.

Yeah. And so so I got this one from one of 'em and pieced together a few of 'em, just kinda like, all right, all right, here's how you take it to the next step. Interesting. Yeah. And so the, the big thing that differentiates people, and we'll get into more specifics of this, is to do well with the self-directed IRA.

It's not enough just to go off and now buy assets. You actually wanna have a strategy with how you're using it. Okay.

Jessi: Okay. So I feel like you need to take a step back. If anybody missed the previous one, just give a rundown of Yeah, I'm

James: sure everyone caught it. We're good.

Jessi: Yeah, yeah, yeah. Give us like a brief description.

Of what is a self-directed IRA?

James: Yeah. So it's kind of self describes, right? So you are able to say, I want to buy this thing and this thing, and it's not necessarily stock market related. Mm-hmm. It could be all sorts of stuff. It can be real estates, it can be businesses it can be commodities it can be all sorts of stuff.

There's a, actually, the list of what it can invest in is smaller than the list of things that it can. The list of things they can't invest in, they can't, smaller than the things that it can invest in. Mm-hmm. All like, you can't do art for some reason or jewelry. Yeah. There's a few other things there, but the general idea is you can direct it and the big one is it lets you invest in both real estate and businesses.

Cool. It's like what most people pay for. So

Jessi: it's, it's like another savings account in the sense that you. You open it, you put money into it each year. There's limits as to what you can put in, but the benefit is that you get to decide where the money's being invested.

James: Correct? Yes. It's like a retirement account.

It's a retirement account is what it is. Yeah, and they're, but not all retirement accounts are created equal. So the very first thing that people do is they prioritize the Roth. Retirement account over the standard. Mm-hmm. So the Roth grows tax free. So you pay taxes on money you put in, and then, but whatever the growth is, is totally tax free.

Jessi: Okay.

James: What the, what the, like the smart, so essentially you

Jessi: don't get taxed when you take it out.

James: Correct. Yeah. Yes, yes, yes. As opposed to the standard, you put money in tax free, but once it's grown and big mm-hmm. Then you get taxed on the other side of it. And furthermore, there are adminis, minimal minimum distribution requirements in the, in the normal retirement account.

And that's because government, they want their tax money. Yeah. Whereas with the IRA with a Roth, you, there are no minimums and you can pass it down to heirs, which are also, by the way, tax

Speaker 3: free.

James: And so super powerful. Hmm. So what people do is if you, let's say you have like a normal IRA, and even if you convert it into a self-directed one, you then convert that into a Roth.

Which means you pay the taxes in the moment.

Jessi: Okay?

James: Right. So if you've got a hundred thousand dollars and you wanna roll that in, you do it great. You, you, it's now as if you had a hundred thousand dollars worth of income that you gotta pay taxes on.

Speaker 3: Mm-hmm.

James: And the wealthy do it, they don't care. They're like, yep.

Because I know they're not playing for, let's say 2025. They're playing for 20 45, 20 55, way down the line. So they would much rather do stuff with the Roth. And I think that's one that. You know, it's kinda a big one.

Jessi: So the returns on this particular investment type or this particular account, I guess is the, is the word for it.

They are, depend, they're not dependent on like stock market returns. 'cause that's not where you're investing. They're dependent on whatever you're investing in. So if real estate is getting a 16% return, that's the return that you're getting. Yeah. Okay. Which. If that kinda makes sense. That it's a benefit and, yeah.

And by the way,

James: you can invest in the stock market. You're not, not allowed to. Sure. You can still invest in index funds. Sure. You can still invest in specific stocks. Like,

Jessi: so that's not, is the downside then that you have to do a little bit more work upfront to know what you're investing in? Or can you be like, I have a self-directed IRA that I'm giving to this broker or this person.

Oh, and they're gonna manage it for me.

James: No, that's not a thing. I don't, that's a good question. I don't know the answer to that. I am, I don't think it's a thing. It might be a thing, but most people who are self-directing it are because, well, they want to, they to direct it with themselves. Sure. Yeah. I could see in theory where they could say, Hey, I wanna self direct it, and I am, I have a financial manager and they're finding stuff for me.

Mm-hmm. I just, I don't see that happening. Honestly, if you, if you are busy, here's what I would say. If you're too busy to do the work yourself to find the investments, dude, just keep it in a normal account. Invest in a stock market. Don't, yeah. Why add all the complications? That's great. You'll, it's not worth it.

Jessi: You'll get plenty of return. Yeah, pick. It'll be fine. It's low risk. Yes. Yeah, yeah,

James: yeah. If you're not willing to get the financial IQ to find it, don't do it. Yeah, that

Jessi: makes sense.

James: Yeah. Alright. Next one is they stack strategies, not just assets. Okay. So again, you might have what? It's like, oh, I'm investing here, investing here, investing here instead.

What that, what those one percenters do, the really, you know, the, the wealthy folks is they, they stack things. So like for example, they don't just open one up, but they open one up with checkbook control. So what that does is it essentially. If you don't have it. So this normal process is you open up an account, you find an investment, you go, awesome, I wanna invest.

And then you call up that custodian, that company who you open the standard, the the self-directed IRA with. Mm-hmm. And you go, Hey guys, I wanna buy this thing. Can you send in the money please? And they go, sure, fill out this form. There's a little bit of a fees, whatever, blah, blah, blah. Like it's done. Or what you do is you open one up that has checkbook control and instead of the funds sitting in that custodian account, it sits in a checking account.

You have a checkbook for

Jessi: weird,

James: and then if you find, you don't

Jessi: even have to go through a third party to

James: Yeah, there's no paperwork, there's no expense. It's just go. Now there's also no double checking that you're doing everything right. So once you send

Jessi: your check, that is it.

James: Yeah. And there are certain transactions, and that'll actually be the the next one that we'll talk about that you cannot, should not, never do really.

And. If you have a custodian acting as an inter intermediary, yeah, they'll stop you. They'll go, they'll be, dude, you can't do this. They'll like, don't do this. But if you have checkbook control, you can move super fast. 'cause that's literally as fast as writing a check uhhuh, but you could potentially do a prohibitive transaction.

Okay,

Jessi: now I'm intrigued. What are these No-nos. Yeah. Yeah. We'll get that supposed to do. So other

James: strategies that you can stack on top of that is like, you can consider opening up a solo 401k instead of an IRA because there's higher balances. There's other mm-hmm. There's other benefits that you can get to it, assuming that you qualify for it.

One of the nice parts about that is you eliminate the, the UDFI which is a type of tax that gets applied to. IRAs.

Speaker 3: Hmm.

James: So there's a benefits there. They can also combine accounts. So you might have an hsa mm-hmm. Which you make self-directed. Yeah. You might have an Roth IRA that you make self-directed and you might have a solo 401k that you make self-directed.

And then what you can do is you can have all three accounts invest in a thing.

Jessi: That's interesting.

James: Yeah. So you don't necessarily have to have, so it's

Jessi: not necessarily a self-directed IRA. Is not the only thing that can be self-directed.

James: Correct. Pretty much any type of retirement account can be self-directed.

Jessi: How do you convert it?

James: So if you have whatever it's with. You then call up one of these custodians. You direct is the one who I, I like. But there's a bunch of 'em out there. And you go, Hey, I wanna convert this thing. You go, cool. There's some paperwork. And it's as if you're rolling over to you, like transfer funds.

It's as if you're transferring from like say Charles Schwab to Vanguard. It's, it's interesting. There's paperwork. Yeah. And you just go through it and they work you out through it. You essentially just

Jessi: move your money to a different spot.

James: Yep, yep. Other thing they'll do is, they'll also pool their money with other things, like, like doing it in a syndication or something like that, where they can actually go after bigger deals mm-hmm.

Where they potentially get bigger returns and they don't have to worry about spon, you know, doing all the management stuff for mm-hmm. Which can cause some potential issues, which is, by the way, the next one is they avoid prohibitive transactions like the plague. Okay. So the the number one rule is you cannot personally benefit.

From the retirement accounts investment or anyone related to you account and vice versa, that seems kind

Jessi: of counter to what you're trying to do. Well,

James: no, like for example my retirement account cannot buy a house and then I rent it from it.

Jessi: Oh, you can't get like material benefits? Well,

James: my retirement, you

Jessi: can get, you can get financial, like pay.

James: What do you mean?

Jessi: Well, like if you invest in the property and then they sell it and you get paid. Like

James: what do you mean they sell it?

Jessi: Well, like you give your money to an investor, Uhhuh, the investor, like

James: Uhhuh

Jessi: gets a return. Okay. And then they pay, pay you? No,

James: they don't pay me. They pay the retirement account.

Jessi: Oh, you don't get money? I don't say

James: anything and then I just do a distribution from the retirement account.

Jessi: Okay. So the money just goes back and forth into the retirement account. But again,

James: like, so let's go with this example. Like, so one of the things I can't do is say, oh, my retirement account's gonna buy this property and then I'm gonna manage the property, thereby saving money on a property manager.

Right now I'm benefiting. But you're, yeah, 'cause you're getting paid to manage it. Or actually in that case it's the retirement account is benefiting, right? 'cause it doesn't have this expense anymore 'cause it's getting it from me. Or if I do work. I'm gonna replace the roof and I'm just gonna pay myself for fixing the roof.

No go. Can't pay me. I can't even say, well, I'll do the work for free again. No, go. 'cause now that's a benefit to the retirement account because it would've had this expense that I just saved it. I essentially donated my time.

Jessi: Weird. And

James: by the way, neither can you. Neither can our kids. Neither can our parents.

Jessi: Weird. Nobody in our family can work on

James: it. My brother. You can do it. That's allowed what? He's not in my direct lineage.

Jessi: That's weird.

James: Yeah. Cool. You cannot so like, let's say you're gonna flip a house. You, you can't use the IRA to fix a hou to to buy the house, to pay for all the materials. And then I do the flip.

Like it has to be like off, you have to pay contractors hands. Like, I can't even manage the project. Yeah. Let's see.

Jessi: So you would, if you were doing this self-directed. IRA investment in real estate, you would have to have a sponsor.

James: Mm-hmm. Mm-hmm. That you're

Jessi: hands off. They're doing all the things.

They're doing all the work.

James: Or I could buy a house, have it be a rental, and then there's a property manager who does who this retirement account hires. Right, right. I'm not hiring them. The retirement account is, I might be. I am the I'm the representative for the retirement account, but ultimately it's pretend the retirement account is a third party person, like someone totally different and pretend that it's not someone who you particularly like and you don't want them to get any benefit.

Weird. Like that's how, like, that's how you have to think about it.

Jessi: It's kind of a strange concept 'cause it's like,

James: I know it's your money, but it's your

Jessi: money and, but if you benefit like.

James: So the problem if, if you do any of this, the government goes, oh, this actually isn't a retirement account. Pay up the taxes for everything.

I guess that

Jessi: makes sense. 'cause it's like you're, you're getting income,

James: correct. Essentially. Yeah. Yeah, yeah. And they, they want it to be a distribution officially.

Jessi: So you

James: gotta document everything. That's another big one. Document everything, work with pros, document everything.

Jessi: How does the government, I mean,

James: okay.

It's,

Jessi: it's tricky 'cause it's like you, if you don't get, you're investing, you could be away with it. But, and then. You're getting a return back into the retirement account? Like are you paying taxes on that before it goes into your retirement account? Nope. Well, like, probably not. That's so income. That's the answer.

James: Correct. But it grows tax free income. That's the thing. Strange, I, that's mostly true. That's not a hundred percent true, but that's mostly true. Hmm.

Jessi: It seems like weirdly nuanced to me. It's like, okay, so I can't manage the place and the income. Well, it's the same way. Imagine you have a retirement, I can invest.

If you have a

James: retirement account that is invested in the stock market, when the stock price goes up and maybe it sells those shares, reinvest, it does whatever, like you don't pay any taxes on that.

Speaker 3: Mm-hmm.

James: It's not until you do the distribution. 'cause you don't have any control over it. Technically it's not your money yet.

It's when you, it's when you do a distribution and you get the funds. That's when. If it's a standard account, you get taxed. If it's a Roth, you do not get taxed.

Jessi: I understand. Because if you were getting paid to do work, you would have control of the money, like it would be yours. Yeah.

James: And essentially this is the government trying to incentivize people to save for retirement.

Yeah. Right. So they go, Hey, if you save for retirement, we'll be really nice to you on a tax basis. Sure. You can either like, we'll let you grow Yeah.

Speaker 3: Without

James: paying taxes so it can grow faster. Like that's the whole idea. Makes sense. Then the self-directed was essentially, essentially rich people saying like, so we don't just wanna do the stock market like we wanna do other stuff and.

Yeah. And you can see crazy returns. Like can you imagine if there was someone who invested early on in Facebook with their self-directed retirement account, which they could totally have done. And they went, yeah. Threw $50,000 into it. 'cause I believed in Mark Zuckerberg and now I'm more than 50 billion.

Yeah. You know, but it's all, and depending on what it is, they're either a massive tax bill eventually. Yeah. Or it's, if it's in a Roth, like boom, their kids are set for life, which could probably be a bad thing, but, yeah. The next thing that they do is they do more due diligence than a sponsor does.

Right? So they don't just say, asset looks cool, go, right? Like, you gotta spend the time investing, making sure that it is, and this is, and this is not necessarily, not necessarily related to self-directed retirement accounts. It's just like, man, good investors. Like, do your due diligence, ask the questions, have the conversations, do those kind of things.

That's kind of what we were talking about.

Jessi: If, if you don't have the time to put into doing due diligence and knowing what you're investing in. Just do the simple like regular retirement stock market. Right. Hands off. Yep. Like that's fine. Yep. That's good. Exactly. You'll get a return. Exactly. It won't be quite as big, but, but it's okay.

Like,

James: you'll know what you're doing. You, you, the risk of a major loss is. Much, much lower, which is, which is nice. Other thing they'll do is they stay liquid enough to strike. So they don't necessarily place all of their capital out into the field. They have some leftover so that when a great deal hap maybe comes along, they can move fast and go, yep, I got the funds to do this.

Instead of being like, ah, man, I got it all placed. And there's a couple things that you can do to to make that work. A just straight up, have cash reserves. You can have a bunch of short term notes that turn quickly. So like we do flips. Right? And a lot of these are less than a year, so you might have a bunch that are in progress.

So you're like, yeah, every three months or so I've got something coming up that I could choose to, to place into something else. Or they've got like those, again, you can start with a regular retirement account and convert it into a Roth. Mm-hmm. And and so like, they may not do those all at once.

They may stage them out over time so that they've got the funds available, but they don't necessarily have a massive tax bill all at once. And so there's games that you can play with that. So those are things that they do. And again, it's not necessarily about like what makes, what makes the 1% special isn't that they have.

A bazillion dollars. It's just they have a strategy. Mm-hmm. They're thinking through how to do this. It's not just, oh, I transfer the money and now I go buy stuff. Mm-hmm. Like, they're really thinking through what's the, what does this whole plan look like? How do I structure this, that I can move fast, so that I can take advantage of things?

How do I make sure I'm buying good deals? Only? How do I avoid getting in trouble? Hmm. Like, it's just, it's, it's having a plan, doing the diligence. And I think it comes back to that, that comment that we keep going back to, right. Like. Do a self-directed, if you're willing to put in the time and effort mm-hmm.

To actually direct it yourself and to learn how the process works. Yeah. That sets you apart. It's not just, oh, yeah. It's another way to do it. Yeah. I don't think that's, I don't think that's how you want to go about it. Alright. So you go sub IRAs, that's how to be the top 1% and take advantage of this what is genuinely a really cool investment vehicle.

And as we talked about, you can't necessarily invest in your own deals because the temptation to self deal and benefit is way too high. So my recommendation is to check us out at furlo.com. We would happily. Take your self-directed funds? I actually, we've got some deals where that's the case. I'm thinking of one in particular where it's a person who used his self-directed IRA and or Yeah.

And invested in one of our deals as a lender even so it's not even an equity holder. So as a lender, 'cause that's an option. Cool. And and we actually didn't do the paperwork right. Right away. But we were able to go back afterwards and fix it. And so it wasn't ultimately not a big deal. But yeah, so it's relatively straightforward once you're all set up and going.

I mean, that would be my, my my suggestion too, if, if you're interested, like find that custodian you direct is one that I like, but there's a ton of them out there. Find that custodian, get that process started so that when the deal comes along, you can move. And if you have questions about that, I'm happy to help get you pointed in the right direction.

So again, you can check us out at furlo.com. And so with that, thanks for listening. Have a great day.