Overcoming Hurdles & Helping Investors

Overcoming Hurdles & Helping Investors
Tim Berry is a Self-Directed Investor's Safe Haven

When Tim Berry (pictured above), one of the country's premier self-directed IRA and 401(k) attorneys, founder of the Tax Academy, and SDI legal counsel, was in law school, he had a very difficult hurdle to clear: "Everyone wants the tax code to be logical, but there is no logic in the tax code," he said.

"One of my very first days in law school, my tax professor started off the class by telling us there is no such thing as logic in tax law. It is 100 percent special interests."

"The sooner people get over the hurdle of looking for logic in this area, the better things are for their retirement planning."

Berry cleared that hurdle, and the result has been some of the most creative, pragmatic, and actionable work on self-directed investors' retirement accounts ever to go on the books. In fact, many of Berry's strategies have had direct effect on tax code and retirement accounting practices during a career that has spanned nearly three decades.

Throughout it all, he has retained a sense of humor to accompany the necessary gravitas associated with helping his clients through some of the most difficult times in their financial lives. "In a nutshell, what I do is work with investors who have decided to self-direct their retirement plans," he explained. "My professional life is devoted to helping those investors build up those retirement plans in a tax-free manner and not run afoul of the various IRS rules governing self-directed accounts."

Then, the humor shines through: "As I sit at my computer reading the tax code, I'm constantly amazed at just how crazy it is. I have to chuckle anytime someone tells me the tax code doesn't make sense to them because it was never intended to make sense!"

"The History of the Tax Code" According to Berry

Berry's irreverence serves him well when it comes to working with investors who may have made mistakes in the past in their retirement accounts and with those who simply seek to prevent errors in the future. "A lot of people get really confused by the rules about IRAs and 401(k)s. There are so many caveats and loopholes," he explained. "In my view, it is my job to help them navigate this tricky territory and, furthermore, to never talk down to them because the truth is that nearly no one understands this stuff."

"A lot of people get really confused by the rules about IRAs and 401(k)s. There are so many caveats and loopholes. It is my job to help them navigate this tricky territory and, furthermore, to never talk down to them. The truth is that nearly no one understands this stuff!"

Berry's rule of "never talking down" has made him a favorite with self-directed investors across the country. "It is refreshing to speak with a lawyer with our best interests in mind," explained one client who consulted with Tim prior to purchasing some properties in his self-directed IRA.

"Tim is thorough, accessible, and, most importantly, effective," added another, who once moved IRA funds incorrectly and opened himself up to taxes on his account. Berry was able to "penetrate the bureaucratic wall at the IRS...and the initial IRS ruling was reversed," the client concluded.

It is a good thing Berry is accessible, because, as most self-directed investors know, the tax code certainly is not. "I have something of a jaded view when it comes to government," he admitted. "My view is that there is very little logic when it comes to legislation in Washington. What it all comes down to is what special interest is most persuasive and how much can a policy-maker get for giving them what they want. Unfortunately, that is the history of the tax code. You can see why it looks illogical to the rest of us!"

As an example, Berry cited a crucial difference between using debt to fund real estate investments in a self-directed IRA compared to using debt to fund real estate investments in a self-directed 401(k). In both cases, when the project yields positive results, the account holds debt-financed income proportionally to the volume of the project that was initially financed.

The account holder has done nothing wrong in either scenario, but only the IRA investor owes taxes. On the other hand, the 401(k) investor does not.

"The debt-financed income rule simply does not apply to 401(k)s," Berry said. "Why not? Because the real estate developer community, which is a powerful interest from a powerful business sector, gets a lot of money from 401(k)s and not much from IRAs. Years ago, that community demanded a loophole for 401(k)s and got one. They left out the individual investors because, bluntly, those investors weren't on the developers' radar."

Fortunately for self-directed investors using 401(k)s to invest in real estate, the loophole does not specify the amount of capital that must be in the 401(k). "This exemption applies across the board, whether you have $100 million or $100 in your 401(k)," Berry said.

"If you have $100 in your 401(k) and you go into a no-money-down transaction with leverage and make your fortune, your profits are not taxed in that account even though if you did the same thing in your Roth IRA or other IRA, you would pay taxes on those profits."

Finding the Right Opportunities for Your Self-Directed Account

One of the biggest hurdles facing self-directed investors once they have set up a self-directed account is that the options for investing are simply overwhelming. This can lead to their investing trajectory "stalling out" just when they expected things to really take off. Berry said in his experience, the most successful investors are those who identify what makes a potential investment a good one for them, then just focus on finding those deals.

"Don't allow yourself to become overwhelmed or make things more complicated than they need to be," he explained. "Find your deals the exact same way you did before you had a self-directed account. If you used online platforms to find your deals before, then use them now. If you used lead-generation techniques to turn up good potential opportunities before, then use those techniques now. Just be sure to run the actual deals by your trusted attorney before you do them!"

The crucial difference between investing successfully outside of a self-directed retirement account and investing successfully within a self-directed retirement account lies in making sure your transaction adheres to the regulations governing these special accounts. These regulations deal with the very few prohibited assets and prohibited transactions the IRS clearly delineates for self-directed accounts (read more about prohibited transactions).

Naturally, Berry said, the right time to vet an investment with your attorney is before you make it. Fail in this, and you can cost yourself and your retirement capital a hefty sum. He recalled one client who had been doing two deals each month for nearly a year and making about $20,000 on each deal.

"It was a pretty good rate of return, but he did not factor in that debt-financed income," Berry said. "He called me after doing 18 of those deals and finding out from the IRS they were looking for the $100,000 in taxes on that $360,000 of income in his IRA. He had to pay a good piece of it because he had invested without knowing the rules or how to mitigate his tax burden."

"The best time for people to call me is before they are going to do a deal," Berry concluded. "That way we can figure out the most tax-efficient way to do it. If that investor had been my client from the start, I would have recommended some different strategies for those great opportunities!"

"The best time for people to call me is before they are going to do a deal. That way, we can figure out the most tax-efficient way to do it."

Catching On to the IRS "Catch-All"

Because Berry specializes in self-directed IRAs and 401(k)s and the issues that come with them, it comes as no surprise that he has a nearly infinite number of case studies to reference for any topic related to self-directed retirement.

"There are a lot of things that an investor can do in these accounts that are not clear-cut," he said. "That is on purpose. Do not ever think that you can do something just because the IRS has not addressed it specifically and be very cautious about working with any professional who tells you that a strategy is okay just because the IRS has not dealt with it directly in the tax code."

Berry explained that many investors believe that there are a set number of prohibited transactions that can place their accounts at risk. This belief leads those investors to invest aggressively in "gray areas," confident they are safe because they are avoiding everything on "the list" of prohibited transactions.

"Unfortunately, no one mentions a certain little 'catch-all' in the code dealing with prohibited transactions," Berry warned. "That catch-all essentially says that doing a transaction with anyone who might cloud your best judgment as a fiduciary is prohibited. That's a really wide net. It's an extremely large gray area where you can run afoul of the rules. You have to understand how the catch-all works in order to work within it."

Berry explained that most transactions that are not blatant violations of the prohibited transaction rules are not likely to be judged in violation using the catch-all clause either. However, he said, wise investors err on the side of caution. "That means working with an attorney who is a true expert in this field of law, not thinking you are smarter than the IRS, and being prepared to defend your actions in the event the issue comes up," he said.

Logic Triumphs After All

Given that the IRS does not have to provide any reason for auditing your personal, professional, or retirement accounts, it just makes sense to be careful when dealing with your retirement savings. "I have seen investors lose a lot of money in these types of audits because they made a single, relatively minor mistake early on in their investing," Berry said.

"Once the IRS starts an audit, they do not want to have wasted their time and money. They will find your mistakes if you made them. That is why you need to avoid making mistakes and, if you have already made some, work with your attorney to make sure you are prepared in the event that you do end up in an audit."

Fortunately for self-directed investors reading (and sweating bullets) right now, you do have options if you fear you have committed a prohibited transaction. One option is to continue on as if nothing has changed. "Move forward, because in the eyes of the IRS, the account is totally blown up at this point. You can't go back in time," Berry explained. "We stay quiet until the IRS shows up because there is no reason to kick a sleeping dog. There might not even be a problem! The window in which you think you've made a mistake and the IRS has not audited you yet is a gift to be used for preparation."

Berry added, "Take the time you have now, while you are aware and the IRS is not, to come up with a game plan for how you are going to defend yourself if the IRS does make a move against you. Everything you did after the point of the prohibited transaction has tax ramifications. Accept that, but whatever you do, do not move that account to a different custodian or try to transfer assets out of it and into a new account."

While you are coming up with your plan of action, you also could "start over" with new capital in a new account. This way, at least your new account is protected from the mistakes of the past.

"If you have the option, I might tell you to start making new contributions in a new IRA as long as you do not move any of your 'toxic' assets out of the old IRA and into the new one," Berry said. "Do not move a single dime of those old assets into that new account, though."

Finally, you can take a great deal of comfort in the fact that although the tax code may not have been created with logic and reason (as we know them) at the forefront, the audit side of the IRS process does proceed with a little more rationality.

"You may think you have done something horrible, but an expert in this field will quite likely be able to tell you that there is something in the hundreds of thousands of pages of IRS legal interpretations and precedents that indicates the IRS has stated outright it will ignore your mistake," Berry said. "The IRS may actually be on record saying it makes a practice of ignoring what you did. You just have to find out whether that is the case, and unless you have personally read all the tax code, you need to find an attorney that has done so and can find and document this information," he added.

Berry noted that even when his clients have committed prohibited transactions and do owe money, sometimes the tax debt can be mitigated. "Auditors are not graded by how much money they collect; they are evaluated by how fast they move their cases," Berry explained. "Investors and attorneys who try to make things complicated just bog down the auditor and make their situations worse. Investors and attorneys who offer clear reasons to close the case along with a clear, concise, valid explanation will often find themselves with far better results."

He described a recent case with a client whose CPA tried to defend an audit on her retirement account. When Berry came on board, the client had paperwork saying she owed about $100,000 despite her CPA's best efforts to dispute the debt.

"CPAs generally should not try to defend audits on self-directed retirement plans because their attempts to do so end up being too long and convoluted," Berry said. "They go on the offense and drag all sorts of things that have nothing to do with the audit into the mix. When I took this case, the IRS had responded to the CPA's long, drawn-out defense with a repeat of their initial request for $100,000. It was probably in large part because the defense just did not make sense in context of the account audit!"

Berry was able to issue a one-page letter showing exactly why the account holder had made the decisions in question. He included a mere 10 pages of additional backup documents. The client received a response from the IRS accepting her defense, and she did not have to pay the $100,000.

"You want to provide a simple, clear-cut reason for closing the case. Tell them why you did whatever you did and provide the rationale and evidence. The IRS does not back down from obfuscation, but it does accept rational arguments even in cases where it would not have to do so," Berry said. "Keep it simple, and work with a lawyer who knows how to keep it simple as well."

Self-Directed Retirement is Not for Everyone, But It Probably is for You

The concept of self-directed investing can be intimidating, and Berry admitted that it is not for everyone. "I used to think everyone should self-direct," he said. "I felt like it was their right and they were wasting it if they did not exercise it. However, the more I've worked with people, the more I realize there are some people who really should steer clear of this option when it comes to their retirement accounts."

Berry said that successful self-directed investors are willing to dedicate time to educating themselves about their options and finding experts in self-directed accounts and in the sectors in which they want to invest. "If you are not willing to learn what self-directed investing is, then you probably are going to cost yourself and your family a lot of money," he warned. "You have to be responsible and willing to learn from and work with experts who know more than you do about it."

Berry cited a little-known IRS practice of investigating 401(k) accounts to make sure they are up-to-date. "There are certain amendments that must be filed, and if you fail to do this, then your 401(k) is no longer up-to-date," he explained. "If you let your account lapse, the IRS can come in, invalidate that account, and tally up the taxes that you now owe as a result. That should never happen. It's wholly unnecessary, but it does because people do not work with the experts they should and they do not educate themselves on self-directing."

If self-directed investing is sounding pretty intimidating to you at this point, Berry does have a solution. "You do not have to be perfect at this. You just have insulate yourself from your personal weaknesses," he said. "Work with people who know what they are doing, ask them good questions, and take their advice. Just because you are self-directing does not mean you have to go it alone."

"You do not have to be perfect to self-direct your retirement investing. You just have to insulate yourself from your personal weaknesses. Just because you are self-directing does not mean you have to go it alone."

Feature: Tim Berry
Tim Berry, J.D., is a lawyer focused on self-directed retirement accounts and high-net-worth asset protection strategies. Learn more about Tim and the strategies described in this article at IRAIdeas.com or email Tim at [email protected]
written by Carole VanSickle Ellis

Carole VanSickle Ellis is the editor-in chief of Self-Directed Investor Magazine. Read more about self-directed investing at SDIMagazine.com or email Carole directly at [email protected].

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