"Stand your ground. Do not fire unless you are fired upon, but if they mean war, let it begin here." 1775, Battle of Lexington and Concord, Captain Parker
Kelly Coughlin is CEO of BankBosun, a management consulting firm helping bank C Level Officers navigate risk and discover reward. He is the host of the syndicated audio podcast, BankBosun.com. Kelly brings over 25 years of experience with companies like PWC, Lloyds Bank, and Merrill Lynch. On the podcast, Kelly interviews key executives in the banking ecosystem to provide bank C-Suite officers risk management, technology, and investment ideas and solutions to help them navigate risks and discover reward. And now your host, Kelly Coughlin.
This is part-two of my interview with Kirk Chisholm, a wealth manager with innovativewealth.com and the Innovative Advisory Group in Lexington, Massachusetts. Kirk, are you still on the line?
I'm still here, Kelly.
Great. Kirk, let's talk about Lexington. That's a famous town in American early Republic history.
Yes, it is. We are surrounded by our country’s heritage. I'm actually surprised at how few people, where I say where I'm from, who actually point that out. I appreciate you pointing that out.
I love early Republic history and Revolutionary War stuff. I have since I was in fifth grade, I think.
We have a lot of that in Boston, too. It's all over the place. It's really interesting. I think living here, we don’t appreciate the heritage that surrounds us everywhere. I walk around the city and I see it, but I don’t always appreciate it, because we're surrounded by it every day. It's nice, especially times like the 4th of July, when they have the parades in Lexington. It's nice. Nice thing to bring you back to the way things used to be hundreds of years ago.
Well, Kirk, just to get caught up here. In our first interview, we talked about more of the mechanics of IRA custodians and trustees in the alternative space. While it's a topic that I think tends to be a bit of a boring topic, the work that you've done in this space is very impressive. Since our first interview, I've dug into more of what you've put out, and I would highly recommend that people that are interested in this space go in and get your publication, Ultimate Insider’s Guide to Self-Directed IRA Custodians and Administrators. If you're really bored with your life, go get that book, and you'll be an expert on it. It's quite impressive what you've done.
In part one, we talked about the “sausage” of these custodians and administrators, and the features and benefits that are required and customer service and a little bit on fees. Today, I thought we'd talk about some alternative investment choices and options that individuals can have in their IRA, and I want to start out with a discussion about holding real estate in an IRA. How does that work, and doesn't that present some problems? Unlike traditional securities, once you buy it, then there's really no ongoing cost to maintain the asset. Real estate is just the opposite of that.
You've got physical maintenance costs, insurance. You've got taxes. You've got all these costs related to just holding the asset. If it's a rental property, you've got to collect the rents. If you own this asset in your IRA, do all of the costs to hold the asset and to maintain the asset and the receipts on the asset, do all of those revenues and expenses have to go through the IRA? Or can you carve expenses out and deduct those? That kind of thing.
It's a really interesting topic. Real estate, while it is the most common alternative asset held in IRAs, it is also one of the more complicated ones. I always find this interesting that people want to invest in this complicated structure. This is just without an LLC. This is just straight real estate. The way it works is this. You cannot transact with your IRA. You cannot sell a piece of real estate to your IRA. Your IRA cannot sell a piece of real estate to you. You're a disqualified person as are some other people. There's a list of disqualified people. You cannot transact with yourself. Effectively—
With any asset, not just real estate. Is that correct?
Any asset, yes. Any asset. That's a clear rule in the Internal Revenue code. What's interesting is, you have to consider your IRA like one of the neighbors on your street that you really don’t like. You're not going to loan this guy money. You're not going to work for free on his house, help him out for free. You're not going to let him borrow your lawnmower. There's things that you don’t like the person, you're not going to do these things for them. You have to treat your IRA the same way. You can't loan your IRA money. You can't work on the real estate, because that would be called sweat equity. You're not going to give away your labor for free to some other person. There's many things you cannot do.
You have to look at your IRA as completely separate entity, in that if you own a piece of real estate, you're going to have a broken toilet. You're going to have to fix the roof. All of these different things are part of owning rental property. In the case of real estate, you have to hire somebody to do these things. You cannot fix your own toilets, and I know the landlords out there listening to this are going to cringe at the idea of hiring somebody to do something they can do themselves. It's hard, but you cannot do it yourself. If you think you're trying to get around the rules, I can assure you, you won't. The IRS is much smarter than you.
You can't set up an LLC management company to do that on your behalf?
Who’s the owner of the LLC? You? Then, no. Owned by some other third person at arm’s length? Then, maybe. You have to hire somebody else. You can do the hiring. You just can't do the work. You could do administrative functions. You can pay the bills. You can hire people, but you can't do the work yourself. You basically have to find a property manager to do it for you. It's the easier way to do it. Through this process, your IRA has to pay for these fixes.
If they have a new roof, you have to make sure you have enough money in your IRA to pay for that roof. Effectively, that's one of the problems with real estate is that you might buy it for $100,000, but you need to have an extra $20,000 or $50,000 sitting around for expenses, for other things, just to make sure that you don’t run out of cash. Or, you have a good line of credit somewhere. Then, when you borrow money, that brings up another level of this, which makes it more complicated. Your IRA, like yourself, potentially can file a tax return.
You might think, you own real estate in an IRA. I don’t have to pay taxes. Maybe. If you're buying it just straight out for all cash, then probably not, but if you have a mortgage on it, you may have to pay taxes. Look at it this way. If you buy a property for $200,000 and you put $100,000 into it, because that's all you have in your IRA, and you borrow the other $100,000, your equity is still $100,000. You don’t pay taxes on your equity. You pay taxes on the asset amount that you don’t have. You have $100,000 of assets that is backed by debt, you have to pay taxes on the levered amount. Effectively, 50% of your income is taxable, potentially. Now, that being said, you would have to file a tax return on your IRA, which of course, you also get the deductions of real estate, so you may not have to pay taxes. The levered amount would be treated as if it was an individual.
You get the amortization. You get depreciation, the deductions, all of that. You do get all the benefits. You don’t lose those, but potentially, you would have to pay taxes on that. It does bring in a level of complication that many people are not aware of. Real estate is, on many levels, can be complex and in some ways, harder to deal with. If you own an LLC, that can make it easier for the custodian and for you, but it still has to go through the LLC. The process is the same. In some ways, it can be simpler, but in other ways, it can also raise more issue. Real estate is not simple. Other assets are generally simpler. You buy it and then it does what it does, but real estate tends to be a little bit more complicated because of all the moving parts.
In addition to real estate, talk about other investments. What are you seeing out there? What are some of the most interesting choices that you see investors have made over the years that you've put into this business?
We've got a lot of stories. I don’t where to begin, but I'll tell you a few of them. One of my all-time favorite assets to invest in, which actually is one of the earliest assets that I was looking at when I started this journey into self-directed IRAs was tax liens. The reason I love tax liens is because you're effectively getting essentially really high rate of interest. In the state of Florida, you can get 18% interest. You have a superior position to any mortgage or lien on the property. You're almost guaranteed to get paid off the money owed, or you would own the property. I look at it as a great asset that so few people know about, and it's such a great asset.
I believe a few years ago, there were six banks that had $200 to $300 million portfolios of tax liens. It was just a phenomenal money maker for some of these firms. Certainly, the institutional demand has driven the rates down a lot, but you can still find good rates in some of these states.
That's one of my favorites. Some of the other interesting ones was, I had a client who invested in a payday lending business in the state of Missouri. The state of Mass, I believe, the most you can charge interest without it being usury, I believe, is 20 percent. I think it's 20%, 25%, or something like that. Anything over that is usury. In the state of Missouri, you can charge 30% a month on some of these loans. I don’t think this individual is doing God’s work. He's really, I don’t want to say preying on the people, the underprivileged. Charging 30% a month, getting 360% a year on somebody who, it's basically on payday loans. They need money today, but they don’t get paid until Friday. They're borrowing at that rate. I don’t see that as a great business, but if you take out the moral implications and just look at it from the financial perspective, that's a pretty darn good business. Even if you have losses, you're still getting 100 to 200% returns, which is pretty fantastic.
The only problem is, you've got to pay Tony Soprano, put him on the payroll, to collect for you.
Oh, no. No, no, no. Not in the state of Missouri. On title loans, yes. You have to find a repo guy to repo the car. In payday loans, this is something that blows my mind. If I get a payday loan from you and I don’t pay you, the constable throws me in jail until I can pay. Now, how that is even remotely logical is beyond my comprehension. You're saying if I don’t pay, you're going to put me in jail until I can pay? How’s that going to work? How am I ever going to get out of jail? The process of some of these things is completely absurd, but the reality is, the laws in place support this activity.
If you remove the moral implications, effectively it's a pretty strong way to collect. Like you said, Tony Soprano to collect for you, you don’t have to. The state is doing your job for you by putting these people in jail. The point I'm making is, it's an interesting asset class that I'm sure some people will find interesting, but it's one of many. We have another client who invested in a horse, a dressage horse. This I found extremely interesting. I knew nothing about dressage horses before this. My business partner did the due diligence. He became an expert on dressage horses. There are a lot of rules that you have to abide by with IRAs and 401ks, and there are a lot of exceptions to those rules, and there are some exceptions to those exceptions.
Generally speaking, you cannot do the work on the asset. Once it gets funded, you've got to keep an arm’s length or relationship with that asset. Correct?
Yes. I'll close up this little topic with this. Let's say you want to buy a business and you want to run that business and get paid for running that business. You cannot do that in your IRA, but you potentially can do it inside of a 401k. There are ways to do things. You just have to understand what the rules are and follow them. If there's exceptions, you can take advantage of those exceptions. There are ways to do things. Part of what we do in this process is working with our clients to help them facilitate the transaction so that it's not become a prohibited transaction, because we as a registered investment advisor are fiduciary.
We're liable if we mess something up. We make sure that things are done absolutely correctly and there's no room for error. There are gray areas, because certain standards haven’t been defined by court cases or what have you, but we're not putting ourselves on the line. We're making sure that whatever we do is okay. When we do these things, we're definitely not playing in the charcoal part of the gray, if you know what I mean.
Is that your sweet spot at Innovative Advisory Group? Helping clients that have these nuanced alternative investments they want to do? Whether it be they want to do something unique in their IRAs or their 401k? Is that your sweet spot? Or is your sweet spot investing in portfolio management, overall wealth management generally speaking?
The way I would characterize it is this. We have a lot of clients who don’t work with alternatives, and that's fine. We're actually agnostic when it comes to asset classes or investments. We have our theories, as most people do. Everybody’s got a theory as to what works best, but in general, I don’t look at it and say, stocks are better than bonds or horses are better than cows or real estate is better than stocks. I don’t really care. I look at each investment individually, and I look at it and say, given the broad scope of what we have to work with, what is the best way to invest? And is this investment itself a good investment?
We do a lot of traditional portfolio management, but when it comes to alternatives, there are really two types of clients that come to us. One type comes to us and says, I want to buy a horse in my IRA. Can you help me do this? Which we will. We have a lot of people come to us with very specific investments that they need help with, and that's a big part of what we do.
We have another part of business where clients come to us and say, I just want to invest in alternative assets. I don’t like the stock market. It scares me. I don’t want any part of it. Can you please find me something that's alternative that makes sense? For those people, we have built up a network of investment sponsors that we do work with to help fulfill that need in the portfolio. We do have clients that have really interesting stuff. We don’t generally offer that to most of our clients, because it's very niche, and it's not what we do. We have found ways to be able to find, in our opinion, good alternative investments that are really lower risk and do provide consistent returns and things like that. We do have areas that we look at, and we're constantly expanding that. I know one area that we do actually a lot of work with is private mortgages. One of the reasons we like private mortgages is, both my partner and I love real estate.
We think it's a great asset class for so many reasons. However, right now, I think real estate is expensive. I know that real estate is very closely tied with inflation. If we ever had deflation, real estate would be negatively impacted in ways that most people haven’t even thought of. I've written about this a few times. It's happening in Japan right now. In general, buying real estate long-term is great if you can find a great deal. When you have private mortgages, you more or less are investing in real estate. You get a yield that is reasonable to you. You know what that yield is. You don’t have to deal with tenants. You don’t have to deal with expenses. You don’t have to deal with all of the headaches that go along with real estate, but you still have a rate of return that's tied to real estate. You're getting your yield, whatever it is, 5, 10, 15%, whatever it might be, although I don’t advise finding a private mortgage for 5%, but some people do.
You find, let's say call it 10% for the sake of argument. You get that yield. If they ever don’t pay you, you foreclose on the property. You own the property. If you're okay owning the property, then it's basically for the price that you lend the money. Then, you really have a pretty good investment there. We look at it and say, it's light work for the investors. It's not light work for us. We do a lot of work on it, but we don’t have a lot of the headaches that go along with owning real estate, and you don’t have to own it for 10, 20 years.
Most of these private mortgages are one to two years. You have a very short maturity. You have a high rate of return, and if you do it right, you can do it relatively low-risk so that if the market turns sour and things get really bad out there, then these notes mature and you can use your cash to buy real estate or stocks at a discount. In our opinion, one of the better asset classes, given the current rate environment that we find ourselves in, we really like that asset class. There are some others, too, that we like, but that tends to be our most popular one at the moment.
You've done a significant amount of work in this space of the self-directed IRA market. You've seen a lot of the providers out there, and you've seen a lot of different deals, a lot of different alternative assets that have come through your desk. I guess my question to you is, since our audience for this series of podcasts with you is really community and regional banks who I think it's safe to say, are not specialists in alternative asset business. It might be that many of them simply say, no. We're not doing that. Would it be an accurate statement for me to say that your position would be that any financial institution that doesn't specialize in this or that hasn’t adequately and thoroughly resourced this business line should stay out it? Should not get into it at all? Is that an accurate statement?
Yeah. I would definitely agree with that. For the last 40 years with the IRAs have been in existence, some firms have come and gone from this part of the industry. I think that there are some banks on our list. They do this to a moderate degree, and there are some banks that provide custody for administrators and all they're doing is providing custody. They're not really doing anything else. The problem with the custodians, if you're doing that model is, you still have to provide oversight. You still have liability. Even though the administrators are doing all the legwork and the administration, as a bank you still have oversight. The administrators do something wrong, then you're ultimately liable.
The bank still has to provide compliance on these accounts, which means, obviously you have to hire a compliance person to deal with this. If you're doing it at scale, then it perspective makes sense. If you're not doing it at scale, then it doesn't, because why are you going to hire $100,000, $125,000 compliance person to do a handful of transactions? Probably not high on your list of things to do. It can make sense in some ways. I think a lot of the administrators have collectively focused on only a handful of custodians that do most of their work. They provide their oversight, but in general I would say, most firms should not do this kind of work unless they're actually going to specialize and decide that they want to do this as a business model. You can't do this with a kind of sort of thing. You really have to put your efforts in.
Okay. Then, the follow up to that would be this. We have a banker that listens to this. Let's say he's a CEO and he says, you know what? We're thinking about getting into this business. We're going to get out of it. Let's see if we can set up a relationship with Kirk and his group. Would you be willing to have a relationship with a community bank, whether it be in your footprint there or the state of Kansas or anywhere else where you would agree to help their customer that has an alternative asset, that needs some help, but you're not going to poach the relationship for the other part of the business? Are you open to that kind of relationship?
Yeah. It's a great question. We have relationships with many different financial institutions. We as a firm, we will work with other financial institutions, because they don’t know what they're doing with self-directed IRAs. They don’t have the experience. They don’t have the background or the infrastructure. What they'll do is, they'll say, we have a client who wants to invest in this horse. Can you help us? We will work directly with them on that, and manage that asset. We don’t poach the relationship with the client. We just work directly with the advisor. It's the same way we're working with a bank or another financial institution. If they want to come to us for a very specific transaction, we will work with them directly and make sure it's done properly. If a bank wanted to offer these services and do that, we certainly offer consulting services.
Right. Your primary footprint is in Lexington. What county is Lexington in?
Lexington is in Middlesex County, but we actually have clients all over the world. We are not location specific in our firm. We have clients across the country. We have some international clients as well. We're not really location specific. As I'm sure your audience knows, in this environment, it's becoming more and more virtual. We actually have fewer and fewer people who want to come back, stop by the office anyway. Everything is virtual now.
Well, Kirk, I think you're doing some really terrific things. I keep picking on IRA custody as being kind of a boring sausage business, no sizzle, but you're doing some pretty interesting things with it. So, congratulations on that, and I know that you've got a business partner there who does a lot of the due diligence on deals. I looked at his resume. He seems like a pretty capable guy, too. So, congratulations on building a unique and high-value financial advisory wealth management practice. I think it's pretty cool. Kirk, why don’t you give us another plug for how listeners should get ahold of you if they wish?
The easiest way to reach us is at our website. It's innovativewealth.com. On our website, there are a lot of free resources that you can learn more about us, about me, about self-directed IRAs and alternatives. Also, we have a free gift for listeners of this show. If you go to innovativewealth.com\bankbosun-podcast, you can get a free gift for that.
Thank you for that. I want to put a plug in for this riveting publication. So exciting. A Quick Start Guide to Self-Directed IRAs.
Yeah, thanks, Kelly. I appreciate that. I almost forgot to mention that. We put together a few resources for self-directed IRA investors, or CPAs and attorneys or people who specialize in the self-directed IRA space. Really, anybody who’s interested in this space. We have resources for pretty much all comers. There is a quick start guide to self-directed IRAs for people who are just learning about them and want to know more. It provides a lot of great resources to get you started on your journey. We have the Ultimate Insider’s Guide to Self-Directed IRAs, which effectively includes the Quick Start Guide. It's really comprehensive. If you're looking for a custodian or administrator for your retirement account, you have to pick between one of 47 companies. This resource will help you make that decision in the best way possible.
We put together some really in-depth due diligence on each of these companies with over 100 data points in each one. We also have fee calculators for each of these companies, because even though there's a fee schedule, sometimes it's hard to figure out what you're actually going to pay. This fee calculator allows you to estimate what it would cost you to use this custodian based on your investment strategy. This is probably one of our more well sought-after resources. I can't tell you how many times people come to me and say, I'm just really unhappy with the fees I'm paying. I didn't know I was going to pay this much, but if you do all this research up front, you won't have that experience. The last one is really a comprehensive resource for people in the industry. It's really access to all of our research. You can get access through the website.
I appreciate your time, and I wish you luck going forward.
Thanks a lot, Kelly. Appreciate the opportunity to speak here. It was a lot of fun.
We want to thank you for listening to the syndicated audio program, BankBosun.com. The audio content is produced and syndicated by Seth Greene, Market Domination, with the help of Kevin Boyle. Video content is produced by the Guildmaster Studio, Keenan, Bobson Boyle. Voice introduction is me, Karim Kronfli. The program is hosted by Kelly Coughlin. If you like this program, please tell us. If you don’t please tell us how we can improve it. And now some disclaimers, Kelly is licensed with the Minnesota Board of Accountancy as a certified public accountant. The views expressed here are solely those of Kelly Coughlin and his guest in their private capacity and do not in any way represents the views of any other agent, principal, employee, vendor or supplier.