This is episode #370, and my guest today is Dmitriy Fomichenko – a self directed retirement account expert.

If you’re listening or watching right now, I know you’re passionate about real estate investing, and have an interest in building wealth, using real estate as a vehicle. Many of us start out that way, but end up getting so caught up in the day to day that we don’t focus on sheltering as much of our income as we otherwise could, or focus enough on building for the long term.

In today’s episode, we talk all about the Ultimate Retirement Plan for real estate investors, and a little known (to most), but super powerful way to build long term wealth as a real estate professional.

Get a pen or pencil ready…you’re going to want to take some notes today!

Please help me welcome Dmitriy to the show.

Highlights of this show

  • Meet Dmitriy Fomichenko – self directed account expert and founder of Sense Financial Services.
  • Learn about a powerful tool that allows you to contribute almost 10X the normal amount into your retirement accounts (if you’re self-employed).
  • Join the conversation on the benefits of self-directed investing, and how to use leverage to magnify your returns.
  • Learn how to build massive wealth to help pave your way to retirement.

Resources and Links from this show:

Listen to the Audio Version of this Episode

FlipNerd Show Transcript:

Mike: This is the Expert Real Estate Investing Show, the show for real estate investors, whether you’re a veteran or brand new. I’m your host, Mike Hambright and each week I bring you a new expert guest that will share their knowledge and lessons with you. If you’re excited about real estate investing, believe in personal responsibility and taking control of your life and financial destiny, you’re in the right place.
This is episode number 370 and my guest today is Dmitriy Fomichenko, a self-directed retirement account expert. Now, if you’re listening or watching this show right now, I know you’re passionate about real estate investing. I know you have an interest, if you’re not already, in building wealth using real estate as a vehicle. We all start out that way.
A lot of times we get into real estate to build long-term wealth, but we end up getting so caught up in the day to day that we don’t focus enough on sheltering as much of our income as we otherwise could, sheltering from taxes, that is, or focusing enough on building our long-term wealth consistently over time.
Well, in today’s episode, we talk all about the ultimate retirement plan for real estate investors and a little known to most but super-powerful way to build long-term wealth as a real estate professional. Get a pen or a pencil ready, you’re going to want to take some notes today, for sure. Please help me welcome Dmitry to the show. Dmitry, welcome to the show.
Dmitriy: Thank you, Mike. It’s great to be back.
Mike: Yeah, good to see you. It’s funny. I have a lot of . . . this is actually episode number 370.
Dmitriy: Wow.
Mike: So we’ve done a lot of episodes of this show over the past three and a half years. For those that don’t know the history, for about a year and a half, the show was three episodes a week. It was a lot of content. Since that time, for a short period of time, we went down to two shows and really for the past two years or so, we’ve been at one show a week.
But when I think back about doing three shows a week, it was a lot of work to kind of keep that going. What starts to happen after 370 episodes is this is more of an expert show. I’m talking to people that have a lot of experience. It turns out that it’s a pretty small world. We have some repeat guests back on now and truthfully, with people like you, we could record ten episodes and talk about different topics and have that still be great content.
So I’ve kind of lost . . . I really don’t focus so much on trying to always find new people now as much as I want people that have great content and it turns out that I already know the majority of the people in this industry that have great content to share and are willing to come back and share. So appreciate you coming back.
Dmitriy: Yeah. It’s great to be back.
Mike: Oddly enough, I was telling you beforehand we run in the same circles, I see you posting stuff. We don’t necessarily talk all the time, but the last time you were on the show was actually a little over three years ago. It’s hard to believe that it’s been that long.
Dmitriy: Wow. Time . . .
Mike: It does. Yeah. Dmitry, before we get started here, we’re going to be talking about the ultimate retirement plan for real estate investors. As you know and as I know and if people that are listening right now don’t know this, you definitely want to listen up, there’s probably no better vehicle for building wealth and kind of your ultimately retirement plan than real estate. There’s just a whole lot of opportunities and advantages that a lot of real estate investors historically have not used yet. A lot of real estate investors haven’t. So, I’m excited to talk about that today with you.
Dmitriy: Yeah. It’s definitely . . . another thing is that there’s many aspects of real estate. Real estate investing doesn’t . . . it’s not limited to just being a landlord. There are many aspects of that.
Mike: Absolutely. Before we get started, maybe you can give us a bit of an intro for those that aren’t familiar with you and kind of how you got started and how you got into the business you have now.
Dmitriy: Well, first of all, as you can hear and your listeners can hear from my accent, I’m not from Southern California. I’m from Kansas City originally. Just kidding. I actually immigrated here from Russia back in 2001. So, I can’t believe it’s been . . . sorry, 1996. 2001 was the year that I got married. I messed that up.
Mike: 1996.
Dmitriy: Yeah. It’s been 21 years.
Mike: That’s awesome.
Dmitriy: I didn’t speak any English. I didn’t have any money at that time. My background is in electromechanical engineering. That’s what I went to school for. I went to school more here to study English and got my degree in electromechanical engineering. I had a job just working in the corporate and then the recession hit and I got laid off. I was looking for alternatives and got into financial services and got into real estate investing.
When I was working for a local company here in Southern California, basically, I got introduced to the concept of self-directed retirement accounts and because of my background and because of lack of finding a good company, a reliable company, I was given a project to basically start that as a department within the company. I did that successfully and then within a few months, I branched out on my own and I started Sense Financial. That’s pretty much all we do right now. We help people gain access to their retirement accounts so that they can invest in alternative assets.
Mike: That’s great. One of the things I love about this show is that, again, 370 episodes, there are maybe a couple people but not very many that grew up in real estate, that started right out of the gate in real estate. It’s always people that came from some other background and saw an opportunity, whether they’re an investor or whether they’re a kind of service provider helping investors, so it’s always fascinating to hear other people’s backgrounds. And hopefully, for people that are listening, inspirational because there’s a lot of people that are probably listening to this show that have not started investing yet or they’re dabbling and want to move forward.
So, hopefully, there’s some inspiration in the fact that people don’t have to say, “I’ve never done that before.” It’s like okay, I had never done it before at one point either. I was a corporate guy for a long time. So there’s a lot of people that most people that get into this space started without knowing anything. A lot of people we’ve had on this show obviously have become very successful even though they started with zero experience in that space.
Dmitriy: That’s so true. Americans are still land of opportunities and not everything perfect here but hey, you don’t know how bad it is in other parts of the world. So definitely I was able to, again, come with nothing, but learned how to become a real estate investor. I made my mistakes. I lost money, but that did not stop me. I basically got up and moved forward and was able to start the business and also basically from my real estate investments and my business, I achieved financial independence. I don’t have to work now. I can do things that I want to do, which is I enjoy helping people.
Mike: Yeah. That’s great. Honestly, that’s why I was thinking about this . . . preparing a presentation for something and I was thinking about that with FlipNerd. Truth be told, I’ve made way more money investing in real estate than FlipNerd or anything like that, actually doing deals. But doing those deals is what’s allowed me the freedom to pursue other things and try to give back and spend time networking and meeting people and all the things I do here. It’s kind of given me that flexibility or freedom to be able to do some things outside of what I have to do because I don’t really have to worry about my next meal or paying my mortgage or any of those things anymore.
Dmitriy: Yeah.
Mike: Well, today we’re going to talk about financial freedom for other people, like how to start building that nest egg through a unique retirement vehicle called a solo 401(k). So, a lot of people that are in real estate, if they’re familiar with the benefits, some of the benefits of self-directing, they typically are more familiar with a self-directed IRA, right?
But there’s another vehicle that has a lot of similarities but some other benefits as well called a solo 401(k), right? You’re the solo 401(k) guy, right? Why don’t you maybe share with us a little bit about what that is? Even though we’re not going to talk about self-directed RIAs, specifically, more on the 401(k) side today, maybe give a little context as to how they’re different.
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Maybe give a little context as to how they’re different.
Dmitriy: Sure. Well, let me start off by explaining what the self-directed IRA is. You’re right. Most people, if they’re familiar with the concept of self-directing the retirement account, they know about self-directed IRA, which is, again, an IRA with a custodian. Remember, the custodian is required for an IRA. You have to have a custodian. Most people are familiar with custodians like Schwab or Fidelity. Those custodians, they basically hold in your funds and they allow you to make the investments that you want to make.
Traditional custodians, they limit your investments just to the stock market . . . mutual funds, stocks, bonds, that’s it. So, in order to take control and basically have access to the alternative assets such as real estate, you need a self-directed custodian. It’s a company that, again, they’re holding on to your money, but they don’t limit your investment options.
Now, the advantage, obviously, is that you have a whole world of investment options available to you. You can invest in real estate, precious metals, in private businesses, you name it. But the disadvantage of that is those people who want to be a little bit more hands on with their investments, they want to maybe have broader investment options and they want to have more choices, they find it a little bit difficult dealing with the custodian because the custodian is kind of like a middle man.
You have to go through the custodian each time you do a transaction. So there can be a lot of red tape depending on the custodian and you lose the speed. Sometimes, especially talking to your audience, FlipNerd, you guys focus in on deals that may be potentially flipping, acquiring a deal that maybe is out there here today, but if you don’t act on it, it might be gone tomorrow.
With a custodial account, it might be difficult to exercise that deal immediately because you’ve got to go through the process, which might take a few days, so you can lose that deal. So, that’s kind of the self-directed IRA piece.
Let me switch to the solo 401(k) and specifically to the self-directed solo 401(k). Solo 401(k) can be a conventional account as well with the brokerage, with the custodian. But first of all, solo 401(k) is a qualified retirement plan that’s designed specifically for people who work for themselves, for self-employed people or small business owners who do not have full-time employees working for them. In the IRS’s eyes, full-time is 1,000 hours or less per year. So, about 20 hours a week, you can actually have part-time assistants, but not a full-time staff.
Now, keep in mind that yourself, the business owner and your spouse are not considered employees. So you obviously can own a business. You can own a company, corporation and you can be on the payroll, your spouse can be on the payroll, but you’re considered owner employee. So, it’s other employees who are not owners. You cannot have worked more than 1,000 hours.
Mike: It turns out most real estate investors are kind of owner/operators, especially as you’re getting started, you might be a lot of times truthfully, I don’t have any statistics on this, but most real estate investors, especially as they start out and probably for several years don’t have employees or at least full-time employees. More and more, people are using virtual assistants and people that would, I guess, be considered independent contractors.
Dmitriy: Yes. And I can speak from just talking to people and knowing who are clients are, we have a lot of clients who are real estate agents. We have a lot of clients who are real estate investors and they might even have a still full-time job working for somebody else, but they might flip a few properties on the side, a few properties a year.
That makes them self-employed. They might be doing some wholesale deals. They might be generating additional funds that way. It can be a full-time self-employment or it can be part-time self-employment. So, if you do it on the side, you still qualify. Having a full-time does not disqualify you.
Mike: Okay. I know we’re going to talk a little bit about the benefits because one of the best benefits is you can actually . . . a lot of times people think of an IRA and I can contribute $5,000 a year, whatever the amount is, but with a solo 401(k), you can actually put much, much more away. Before you tell us about that, talk about the requirement, kind of the eligibility for how much you can put away based on how much you make. Obviously, you have to have revenue in your business to be able to contribute, but maybe share that kind of requirement.
Dmitriy: Well, again, the self-directed or the solo 401(k) was designed for those people who are self-employed. The main benefit of the solo 401(k) plan besides that it can be self-directed and invested in alternative assets, it is a great tax sheltering vehicle.
The contribution limits for the solo 401(k) comparing to a traditional IRA, nearly ten times higher. With a traditional IRA, you’re allowed to put $5,500 in a year if you’re under 50. If you’re over 50, you’ve got an additional $1,000. So, $5,500 for a traditional IRA. For the solo 401(k), the limit is $54,000.
Now, that’s per participant. So think about this. If you’re a husband and wife business, if you work in your business together with your spouse, you can potentially double that. You can contribute or shelter over $100,000 of your income from taxes. Now, obviously, you do have to have income. You have to make money.
Mike: Right. What is the requirement though? You have to at least make that much? Could you contribute 100% of it or are there some limitations there.
Dmitriy: Yeah. Basically, there are two components when it comes to contributions into the solo 401(k), two components. Again, its’ a qualified plan designed for business owners. So there has to be a sponsor, an employer that sponsors the plan, which can be a sole proprietor. So you have to have a company.
Speaking of that, let me also mention or clarify to the listeners that it can be any type of legal business. It can be corporation. It can be an S-corp or C-corp, an LLC, it can be a partnership or again, for someone who just flips one or two properties a year, they might not have an LLC for that. So they might just do that in their name. They’re considered a sole proprietor, which again, the IRS recognized legal business type that can adopt a 401(k). So you can basically do it under your own name as long as you have self-employment income and self-employment activity.
Mike: Okay. Great.
Dmitriy: Now, once you do that and establish the plan, you basically are wearing two hats. You’re wearing the hat of an employee because you’re doing the work and you’re wearing the hat of an employer because you also own a business. So the IRS allows you to contribute in both capacities. As an employee, you can contribute up to $18,000, which can be 100% of your earnings. So, if you flipped one property a year and you made $20,000 just on that flip, most of it can go into a solo 401(k).
Now, if you’re doing full-time business and you’re doing well, you’re making good income, then you can also take advantage of the second component, which is a profit sharing. So, as an employee, you contribute up to $18,000, which by the way, can go into either a pre-tax or can go into a post-tax bracket because solo 401(k) has a Roth component allowing you to contribute post-tax. You don’t get the tax benefit now, but you get to grow those investments tax-free for the rest of your life.
Mike: Yeah. That’s so powerful.
Dmitriy: That’s the first component. The second component as a company or as an employer, you can contribute up to 25% of your compensation for a combined total which is $54,000. So, first $18,000 up to 100% and then in addition to that, if you’re a sole proprietor, 20%, if you’re a corporation, up to 25% of your compensation.
Mike: Okay. Wow. And then if your spouse works in the company . . . with a lot of real estate investors, their spouse has some role in the company as well, then they’re treated the same, so you can effectively double those amounts you just mentioned.
Dmitriy: Exactly. Yeah. So think about the . . . put aside the self-directed aspect and ability to invest those funds. Think about the immediate effect that this can have on your bottom line, the tax bottom line.
If you’re in business, most of us real estate investors and self-employed people, entrepreneurs, we are dealing with the taxes. We’re always concerned with that. So it’s important to plan for it, but think about the bottom line, how much taxes you’re going to save if you’re able to shelter $100,000+ from your income. It’s significant.
Mike: Absolutely. Yeah. Not to mention that, I don’t know how much time we’re going to have to even get into this today, maybe we’ll have to have part two of this show, is what you can do once it’s inside your account in terms of lending or buying and selling properties, all the things you can use to grow your accounts pretty dramatically.
Dmitriy: Yeah. And just to very quickly mention on that, the beauty, again, of the self-directed solo 401(k) is that you’re not limited to buying certain stocks that Fidelity offers you, right? The truth is, Mike, you and I and probably most of our listeners have no control over what the stock market is going to do tomorrow.
Mike: Absolutely.
Dmitriy: We have no control. Now, we can hope and pray it will do well and we don’t lose a lot of money, but the truth is, we can’t control it. Now, with alternative investments, like I’m doing a lot of private lending. So, basically, I use my retirement account and my savings as a bank, so I lend money to other people and I check the deal, I work with only a few borrowers. I know up front what my return on investment is going to be and my risk is very minimal.
Recently, I did a deal. I did a second trust deed, but the CLTV, combined long-term value, was 29%. It’s a property in California. So, there’s hundreds and hundreds of thousands of equity protecting my interest. So, it’s very low-risk. So, comparing that with the stock market, there’s no way I could get something like that, even close.
Mike: For sure. Yeah.
Dmitriy: I’m getting 10% return on my money with very low risk.
Mike: That’s awesome. So you just talked about how you lend your money. Let’s talk about in your experience, because obviously you know lots of investors, you work with them through your company, all the things that people do with that, they obviously can lend to other investors, but they can fix and flip deals themselves. Maybe just kind of go through a list of the most common things that you see and then maybe even share a couple of things that aren’t as common, but are still like powerful kind of case studies.
Dmitriy: Well, I won’t be able to give you a statistical data because again, what we do is we do self-directed plans and we basically empower our clients, give them the control to invest. So I don’t necessarily have the data of what every single of my clients do, but as you said, I do talk to people and they consult with me. So, I know some of the deals that my clients do. Real estate is obviously very common.
But like I said, there are many aspects of real estate. I think one of the common ones is just buying rental properties, long-term rental properties. This is a proven way to achieve wealth, to achieve financial security is just buying a rental property, let the tenant pay off the mortgage because you can leverage it and then eventually, you own this asset free and clear and you enjoy long-term passive income. That’s one aspect.
Another aspect is private lending. That’s something that I learned or got into myself over the last few years. I started as a landlord initially, but because I run a business and that requires my time and my attention, I don’t have as much time, nor do I wish to spend much time on my rentals. So, actually, over a period of the last few years, I transitioned my portfolio into passive investments such as being a private lender. So I invest in trust deeds.
I do a combination. I have long-term and short-term, so are my clients. This is something that I learned from my clients, how to become a private lender. So, that’s also popular. So you use your 401(k) as a bank. If you’ve got $100,000 in your 401(k), you can lend it to someone else, whether it’s a flip or a buy and hold or a combination, it could be even a syndication and basically, you’re acting as a bank, you’re lending to them. You might not know how to flip, but you can lend to somebody else who knows and they need the funds to do it, so you can be the bank for them. Like I said, I really like this model.
Mike: Yeah. There’s ways to . . . we’re going to talk a little bit about some prohibited transactions, things that you can’t do. So, maybe with that in mind, starting to mix in some conversation there, talk about . . . when you have the funds, you’re a dealmaker. Whatever you can imagine, you can do if somebody else agrees to it. There’s obviously some limitations on some prohibited transactions.
But for example, as a lender, you don’t necessarily have to say, “I’ll charge you 10% and two points.” You could say, “I want a portion of the deal,” right? “I want profits split,” or anything you can imagine that you can negotiate with the person that wants to use that money, aside from prohibited transactions, which I know we’re going to talk about you can do, right? So you’ve seen people get creative in that regard as well, I expect.
Dmitriy: Yeah. It’s a good question that you brought up as far as flipping, we can talk specifically about that or we can talk about splitting the profit. Now, if you’re a lender, the terms of the loan are basically spelled out in the promissory note. There is a promissory note. You might charge the borrower some points, a couple of points up front. Then you charge interest that is set in the promissory note.
Now, if you’re agreeing to some kind of deal split, then I don’t know how you can . . . I haven’t exactly seen any particular deal structure that way. I hear people talk about this, but I have not seen it in the paper. I don’t know if you can actually do that without taking the ownership. You’ve got to have some kind of possibly an ownership.
Here is the thing that people need to be aware of. When you enter into a partnership, let’s say you provide the capital, let’s say you form an LLC and you’re a passive investor, you just provide the capital and then another partner just does all the work. They do all the work. They’re the expert.
Now, if your investment, actually a flip, we just consider it an active business. If you start doing an active business or running an active business out of your 401(k), there are some consequences to that. That’s where UBIT comes into play and UBIT stands for unrelated business income tax. Basically, the IRS says that if you’re running an active business like flipping out of your retirement account, then they want to make the field level to everyone.
So, because you’re using a tax-exempt entity like a 401(k) or maybe another example, if it’s a nonprofit organization, working with like a charity and they end up getting into flipping, does that mean that they’re not going to be taxed on that? Well, no. They say your main activity is not going to be taxed. If you’re a church and you’re getting donations from your congregation, you’re not going to be taxed on that, but if the church flips a property, then there’s going to be tax consequences, same thing here.
If you invest passively, retirement accounts designed to be invested passively for retirement, so if you invest passively such as being a private lender or owning a rental property, which is passive, 100% of the income or gains will be sheltered, but if you start running a business such as you buy a franchise, now your 401(k) owns a franchise, which is an active business, income from that will be subject to UBIT and the same thing, if you start running flips, you’re likely to deal with the UBIT.
There is, again, it’s a complex situation. So, if you just do one flip and you do maybe ten lawns out of your 401(k), your activity is still passive for the most part. You just happened to do a flip. You’ll probably be okay. It’s more of a tax question, which is not my expertise. Experts seem to disagree on that, where is the line? Is one flip or three flips okay or maybe ten? I don’t know.
The way I see it is basically the intent. Was your intent when you entered into the transaction, was your intent to flip it for a short-term profit? Well, then you’re running an active business. If your intent was you acquired this property, you wanted to hold on to it for long-term, then your neighbor to that property, he always wanted to get that particular property, so he made you an offer that you couldn’t refuse. You actually flip the property in a month, but that was not your intent. Then it’s passive.
Mike: Okay. Those aren’t necessarily prohibitive. They’re just some more tax consequences. Let’s talk about a few examples of prohibited transactions, things that you just can’t do.
Dmitriy: Well, the IRS has that . . . basically, there is no list of things that you can invest in or do with your retirement account. This or such list does not exist. Instead, what they do is they give you a list of things that are prohibited transactions. There are certain things that you cannot do. First of all, as far as the investments, the only investment that is disallowed with the solo 401(k) is collectables.
You can basically invest into anything except collectibles. Collectibles can be collectible coins, it can be collectible art work, collectible rugs, whatever item if it’s considered collectible, collectible automobile, you can’t invest in collectibles with your retirement account. That’s one no-no. Then on top of that, IRS says that there are certain people in your life who are considered to be disqualified persons to your 401(k).
Your 401(k) is prohibited from engaging in a transaction or conducting any business with such person and disqualified person . . . it’s kind of very easy to remember. I always illustrate this. It’s a vertical line, right? So, basically, it’s your parents and grandparents. Your kids and grandkids and your spouse. You may think your spouse is on the side, but your spouse is not to decide. When you got married to your spouse, you became one. Two shall become one, right? So your spouse, your kids, grandkids, their spouses, your parents and grandparents, those are immediate family that your retirement account and yourself, I don’t know if I mentioned that.
Sideways is okay, which is your brother, your cousin, your nephew, your niece. You can deal or enter into transactions with those extended family members, but not immediate family members. Let me just illustrate some of the examples of what the violation can take place. Well, if you have a 401(k) and your spouse is a real estate agent, you may think, “I’m going to have my spouse find a deal.” So, she gets commissions on the deal and then I buy it inside of my 401(k).
Guess what? That will not be allowed because your spouse is a disqualified person and you cannot enter into contract or your spouse cannot provide any services to the 401(k). Being an agent represents providing a service. She gets compensation for that. That’s disallowed.
Mike: Sure. Let me ask you, is it the act of providing a service or the act of getting financial compensation for that?
Dmitriy: It is both. Obviously, the fact that your spouse gets compensation makes it a prohibited transaction, but also providing a service at the same time. So, if you’re a contractor and you fix homes, you cannot do the work on property that is owned in your 401(k). Now, you can control it, you can supervise it, but you cannot physically go into the property and fix that up without being compensated.
That’s the labor that somebody else should have been compensated. You actually go in and are doing that yourself and that’s equal to or considered illegal contribution. You’re contributing your labor to the retirement account.
Mike: You’re kind of comingling your personal self with your retirement account, right?
Dmitriy: Yeah. Now, here’s one thing that I also use as an illustration to help people understand what it is that they can and cannot do. That illustration is a difference between a white-collar worker and a blue-collar worker, right? So, white collar is somebody who’s working in the office in a shirt and a tie. They’re on the phone talking with the customer. They’re doing the paperwork, talking with their colleagues and so forth. You can do those kinds of things.
A blue-collar worker is somebody who is actually on the factory floor working with their hands. You can oversee the management. You can manage the deal, manage your investments, but you cannot provide any physical labor.
Mike: Okay. Awesome. That’s good. If you need more . . . if you’re listening to this and you have questions, you can contact Dmitry to explore that more. One of the challenges with real estate investors is I was kind of making this joke before we even started the show today, Dmitry. We’re always kind of in the gray zone, like, “What if this? What if that? Can I do that?” So we tend to be creative creatures because we’re entrepreneurs trying to make things happen.
So I know that a lot of times if your deal is pretty cut and dry, you’ll know it, but if it’s in a gray zone, ask Dmitry. Be like, “What if I do this? How can I do that?” Sometimes it’s not necessarily, “Can I?” It’s like, “How can I do that? How can I make this work and still be in the safe zone?”
Dmitriy: You’re right, Mike. There are certain things that kind of fall into a gray area, certain things that are pretty obvious. When it comes to retirement accounts, what I’ve seen in my experience, just looking at, again, potential deals, for the most part, most of the time, it’s pretty black and white. I have not seen a gray area often. I’ve seen some deals like that, but it’s . . . for the most part, they’re pretty obvious, “Yes, you can do that, no, you cannot do that because disqualified person is involved in the transaction.” It’s very obvious. So, if you’re considering getting into self-directed investing, you’ve got to understand the rules. Again, they’re not rocket science.
They’re straightforward. They’re very easy to understand. What I tell people, listen, the best way to avoid a prohibited transaction is to ask questions before you enter into a transaction. Let me use this illustration, which is a little bit funny, but I had a call from a client of mine. This lady, she’s been a client for a few years. She left me a voice message some months ago. It was about noon time and she said, “Hey, Dmitry, give me a call back. I’m closing escrow on this deal today. I want to make sure it’s allowed,” or something like that.
So I’m calling her back a couple house later, maybe 2:00 in the afternoon. She’s about to close escrow at 4:00 p.m. Talking with her, it was obviously that it was a prohibited transaction because she was comingling her personal money with her 401(k) money. I don’t know where it ended up. I told her, “You cannot do that.”
I didn’t think there was a way to actually stop that because the money would already be in play and so forth. Again, that’s a classical illustration of a prohibited transaction and just not being wise. And she probably had a feeling she wasn’t doing something that was right because she ended up calling me eventually.
Mike: Just too late, it sounds like. Yeah.
Dmitriy: She probably had that feeling from the beginning. Don’t do that. It’s not worth it. There are so many ways to make money legally and without risking your entire retirement portfolio, just don’t do that. If you’re not sure, ask.
Mike: Sure. One of the benefits, not that you should go do transactions that are prohibited or that are not allowed, just to clarify, correct me if I’m wrong, Dmitry, specifically with a solo 401(k) versus an IRA, if you do a prohibited transaction, then it’s limited to that transaction, not your entire account.
So, with a self-directed IRA, the IRS could blow up your entire account and take your account and probably tax you to death and all sorts of stuff, charge a bunch of penalties, but on a solo 401(k), am I saying that right? That it’s limited to that transaction. They may fine you or tax you on that transaction, but it doesn’t blow up your entire account. Am I saying that right?
Dmitriy: That’s a very good point that you’re bringing up because you’re right. First of all, let’s focus on an IRA. If you do that inside of . . . if you make a prohibited transaction or commit a prohibited transaction, entire IRA, entire account, maybe you have $1 million in your IRA and you do the prohibited transaction with $50,000. Well, guess what, the day you did that, the whole IRA, $1 million considered to be distributed.
So you’re taking an early distribution from your retirement account with consequences which is taxes and penalties. If it’s a larger account like this, it’s going to be huge numbers as far as the penalty. IRS may even penalize you. The penalties can be up to 100%. You can lose all of it. That’s why it’s not worth it.
Now, you’re right. With the solo 401(k), there are two differences. Number one, if you enter it into a prohibited transaction kind of unknowingly and you discover that you did that, you can actually reverse it. The IRS gives you an opportunity to actually correct the prohibited transaction. You can actually reverse it. The way to do it is basically restore your account to the way it was before you entered into a transaction. So there is a way to fix that.
Now, sometimes it can too late to fix it. you just cannot fix it soon enough or you discover it after the fact and you cannot fix that, then you’re right. Only the amount that wasn’t involved in the prohibited transaction will be considered distributed and you’ll be penalized only on that amount. But your entire 401(k) will not be jeopardized. That’s not a major benefit of a 401(k) or an IRA.
Mike: Yeah. Well, Dmitry, I know we’ve missed one thing I want to make sure we talk about before we end the show. That is the opportunity to use leverage, another big benefit of a solo 401(k) account is right now, if I have a 401(k) account or an IRA that’s in E-Trade or somewhere else, I’m restricted from the amount of funds I have in there and I can invest them.
But with self-directed accounts, you can use leverage. I can actually borrow money just like we do in other areas of real estate, obviously, and lever that up. So I can turn my $100,000 into something much more than that by actually my account borrowing money. So maybe talk about that a little bit and share some of the details.
Dmitriy: Sure. Again, let me compare an IRA with the solo 401(k) as far as using leverage. Sometimes people, they have a misconception that if they set up a self-directed IRA and they’re buying a property for $100,000 they have to have $100,000 cash to buy that property. That’s not true. You can use leverage, but it has to be non-recourse because IRS rules do not allow you to be personally involved in the deal, so you cannot provide a personal guarantee. Therefore, conventional financing will not work. You have to use what’s known as a non-recourse law.
Mike: As a traditional lender, you’re kind of personally guaranteeing something, so therefore you have to take the house back and that wasn’t enough, they can come after you personally.
Dmitriy: Exactly.
Mike: But in a self-directed account . . .
Dmitriy: You cannot be part of that. So, therefore, it’s a non-recourse loan. Non-recourse simply means that the lender who lends the money, the only security they have is the property itself. You personally are not responsible for that loan and they cannot touch your other IRA assets. It’s the only property. So, it’s a higher risk to the lender. They may not recover all of the investment for them.
So, typically, you do need a larger down payment for that. It’s somewhere between 20 and 50% depending on the property, depending on the deal. Now, you can use institutions, like you can use lenders who specialize in these types of laws. There is a handful of lenders. By the way, you cannot go to Bank of America or Chase and get a loan like this. There’s only a few lenders and we do list them on our website. So, if you need that list, you can find it on
So, typically, those major lenders, they do need 30 to 50%. But sometimes, you can be creative, like you said, and you can find a deal maybe that is way below market value and you can actually use some private lenders who can lend you money and sometimes you can get up to 100% of the purchase price. So there is some flexibility there.
Mike: When you talk about non-recourse lenders, I know you have some on your site that you recommend, those are probably more institutional-type lenders that basically they have rules that say we’ll lend up to 70% or some percentage. Those are kind of, they’re rules, but anybody could be a non-recourse lender, other than somebody that would be a prohibited transaction like a parent or grandparent or spouse.
If I found somebody that was a wealthy person, I could say, “Will you give me a non-recourse loan? By the way, I want to put one percent down,” if they agree to it, “And I want to leverage up 99% of the deal so it cash flows and everything.” So you could have a very, very small amount that you can actually buy rental properties as long as you can find somebody to give you a non-recourse loan that is kind of non-conventional from the institutional lender standpoint, right?
Dmitriy: Yeah. It’s exactly right. What we talked about earlier, I was using my own resources and my own retirement funds as a bank. So I’m that non-recourse lender to actually . . . most of my loans that I’ve done, they’re recourse because the borrower is responsible. So I can come after borrower if I don’t recover my investment. But when it comes to retirement account, the loan has to be non-recourse. But anybody can be a lender to you.
Mike: That’s awesome.
Dmitriy: Now, switching or digging a little bit deeper on that, when you use an IRA and buy a property with leverage, let’s say you buy a property for $100,000, you put $50,000 down and you finance $50,000, you get a loan for $50,000. Well, half of the income that comes from the property is considered from the financed portion of the property.
So it actually will be taxed. It will be subject to UDFI tax because it’s unrelated debt finance income. There’s leverage on that portion of the income. So, that portion of the income, you can deduct still half of the expenses, half of the property taxes, half of the mortgage payments and so forth. But half of the income from that property will be subject to UBIT tax.
When you do the same thing inside of a solo 401(k), it’s not subject to UBIT tax and leveraged real estate. So, you can finance the property inside of your solo 401(k) and none of that income will be subject to any taxation.
Mike: Oh, wow. So that’s restricted to an IRA and not a 401(k)?
Dmitriy: Yeah.
Mike: Wow.
Dmitriy: Now, just again, to comment, there is still UBIT tax on unrelated business such as flipping or owning a franchise or something else, like if you run a business out of your 401(k), there’s still UBIT tax, but a solo 401(k) exempt from UBIT tax and leveraged real estate specifically. That’s a major advantage over an IRA.
Mike: Yeah. Awesome. Well, there’s so much that we didn’t talk about today, such as even talking about the pros and cons of a Roth versus a traditional and all that. We may have to have you back on, Dmitry, to talk about some of those things sometimes soon. But if folks listen to this, my guess is folks are listening to this, some people see the power of this and they’re like, “Oh my goodness, I need to learn more.” If they wanted to reach out to you or Sense Financial, where should they go to learn more about your service and if they have questions and things like that?
Dmitriy: Well, it’s very easy to get ahold of me. They can go on our website, which is and Sense is like common sense, Sense, or they can call our number, office number, which is 949-228-9394 and I do offer a complementary 15-minute consultation to anybody. So, we can talk about your specifics, just I can help you brainstorm and see if it makes sense for you and answer any questions.
Mike: And one thing that we talked about at the very beginning was contributions. So you can contribute if you have a business, obviously you contribute. But talk about maybe real fast one thing that we didn’t really cover is if you’ve left a job and you have a 401(k) that you need to roll over or you even have an IRA that’s in E-Trade or one of those places, you can roll that over to basically a self-directed account. Do you want to maybe take just a moment and kind of talk about that?
Dmitriy: Sure. That’s true. Any retirement accounts that you have can be rolled over into solo 401(k). So any qualified plans, it can be individual accounts like an IRA or could be an employer-sponsored plan like a 401(k) or a pension or 403(b). Now, with the employer-sponsored plan, if you’re bringing it from the employer, it has to be from the past employer because if you currently are working for a company, you have a 401(k) there, it’s not that solo 401(k) will not accept it, it will, but your employer, they will not allow you to.
Mike: Right. Until you leave.
Dmitriy: They’ll leave or reach retirement age. Sometimes there are exceptions. I’ve seen a few exceptions when they allow you to move it while you’re still employed. It’s possible . . . so, the best way to find out is to contact your plan administrator, maybe HR department and check with them.
Mike: Yeah. I think if most people don’t stay at their jobs for their whole career anymore. They leave every few years to pursue something else. In my experience, when I was in corporate America, that’s how it was. I’ve been gone for almost ten years and I’m never going back. When I left jobs, I usually had some period of time where I had to roll that out of my company’s plan into somewhere else. What happens is some people have an IRA at E-Trade or somewhere else and they leave this job. When we roll that money over into this one, if you go to another job for three, four, five years and you may roll it over into your personal account, it just starts to build up over time.
Dmitriy: Yes. They might have multiple accounts out there. All of them can be combined. One thing that I did not mention is one exception. That is a Roth IRA. Roth IRA, IRA does not allow you to move it into a solo 401(k), even though there is a Roth component in the solo 401(k). But the rules for the Roth IRA, certain rules on the distributions, they’re different for a Roth IRA versus Roth 401(k). So you cannot move a Roth IRA specifically. That’s the single exception.
Now, if you have a 401(k) at your job and there is a Roth component in there, you can move it to a solo 401(k). So Roth 401(k) can be moved . . . a Roth 403(b), I’ve seen those, can be moved also. But Roth IRA is an exception.
Mike: Great. If you have any questions, just contact Dmitry at We’ll add a link below the video here. So, Dmitry, thanks for spending some time with us today. Great to see you.
Dmitriy: Yeah. It’s been great. I know it’s been a good discussion and we ran out of time, but it’s a great topic. There’s a lot to discuss. So, hopefully, you guys find it beneficial.
Mike: Yeah. Everybody that’s listening to this, you’re either an active real estate investor or you want to be an active real estate investor, active in the sense that you’re doing deals to pursue financial freedom. So, if you’re just doing deals and you’re not focused on some tax shelter opportunities and some vehicles like what we talked about today, you’re really missing out on a lot of the benefits that real estate investing offers. So I think that for that reason, I’m sure the people listening today got a lot of value out of this. Thanks for sharing with us.
Dmitriy: Sure. You’re welcome.
Mike: Awesome. Everybody that’s listening, this is episode number 370 of the FlipNerd Expert Interview Show. We appreciate you guys. We have tons and tons of other shows out there. If you could, do us a favor, if you watch it on iTunes or Stitcher Radio, Google Play, there’s a million different places where we syndicate to, if you could go out and give us a positive rating if you love the show, we’d appreciate it.
That is kind of the fuel that keeps us going here that helps us show up higher in the rankings so more people find our show and that makes me want to keep doing more and more shows. So I appreciate all of you. We’ll see you on another upcoming episode. Have a great day.
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