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Author: BruceCM Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76420  
Subject: Re: self-directed IRA custodian Date: 4/11/2011 3:14 PM
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Canuck104
Sorry, but I have to disagree with most of what you've outlined.

1. You may not personally mange the IRA. Actually, you can

No, you may not. From §4975(c)(1)(c) "For purposes of this section, the term “prohibited transaction” means any direct or indirect—"...
"furnishing of goods, services, or facilities between a plan and a disqualified person; "

Now, comes the issue of creating an LLC to hold 100% of the IRA assets, with the IRA owner the only shareholder of the LLC, hence a work-around to the custodial limitation and direct IRA control by the owner. Proponents of this approach point to the 1996 Swanson VS Commissioner case where the court found that there was nothing in the current code to classify this arrangement as a prohibited transaction. However, most legal opinions outside of this growing industry, that I've read, have reservations about this ruling and its application to IRAs. Most agree that this is an area which the IRS has not spent time clarifying complex issues, but clearly direct ownership and control of investment property by a fiduciary is self-dealing, whatever smoke and mirrors are being used to work around this basic tenet of tax deferred plans, and it is, in my opinion, just a matter of time before the IRS/Congress clarifies and clamps down. Take a look at Groom Law's opinion on this topic at

http://www.groom.com/media/publication/441_IRA%20Myth%20Arti...

For investment purposesIRA custodians have two investment constraints: statutory and policy directives required of each custodian. The former comes from restrictions on investing in collectables (§408(m)(1)) or life insurance contracts (§408(a)(3)), while the latter is the limitation set by each custodian. For example, most custodians will not allow margin accounts within an IRA, although this is theoretically possible. In either case, it is the custodian who determines investment alternatives, not the IRA holder. For a self-directed custodian, you, the IRA holder, may recommend renters, but it is the custodian's decision. For example, the custodian could be held liable if the renter you choose is a disqualified person.

You can not use it as loan security. Not quite accurate
No, exactly accurate. You restate what I have already said about non-recourse loans.

The right custodian will not charge any closing costs
There will certainly be tens of thousands of dollars in closing costs when procuring and disposing of RE property. The custodian will not throw this in for free...you will pay for it. Thinking you're getting this for free is a bit naive, it is most likely a case that you don't know you're paying for it. There is no free lunch.

Exchange traded REITs offer full liquidity and flexibility. Information is readily available to those who wish to do the research. Investment RE held through a self-directed custodian is illiquid and inflexible...and expensive. Like time shares, unlisted REITs, private limited partnerships and cash value life insurance, once you're in, you're pretty much stuck and run a high risk of coming up against expenses that you had not originally anticipated. When the investor finally realizes this, an exit is either not possible, is limited or is available but very costly.

I've held multiple rental properties over my lifetime, and I am the first to say that this can be a great long-term investment for those who:
1. Know how to select the right rental property
2. Know how to select the right renter
3. Can do most of the maintentance and repairs themselves, at least in the early years (capitalize their labor)
4. Use the maximum amount of low cost leverage available

Even with this approach, it takes many years to generate appreciable assets net of all costs (NOT gross assets or gross cash flow, which is what the salesman and unsophisticated investor will tend to focus on). Adding a custodian's constraints (#3 and 4) and added costs, including converting capital gains into ordinary income in an IRA, make profitability difficult at best.

In my travels, I work with some very smart investment managers and self-made personal investors. Not one of them has ever invested in income RE using their IRAs as a path to wealth accumulation, any more than they would use cash accumulation in life insurance. It is simply too expensive, too constraining and too risky for the possible returns....

....although I'm sure it is quite profitable to the self-directed custodians.

BruceM
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