When you invest with leverage in your IRA, you pay tax on the income earned from that leverage. However, when you invest with leverage using an offshore IRA LLC, you can eliminate that tax. Here’s how to keep the IRS out of your retirement account when using leverage in your IRA offshore.
First, allow me to define a few terms.
Leverage in the context of an IRA is when you borrow money to increase the amount you can purchase or invest with your IRA. If you set up a currency trading account with 5 to 1 leverage, that’s a leveraged IRA account. If you buy gold and the broker gives you $200,000 in gold for $100,000 in cash, that’s a leveraged investment.
More common, if you buy real estate using your IRA and a mortgage, that’s a leveraged investment
When you invest using leverage in an IRA or other retirement account, it creates a lot of tax complications for you and your custodian. For this reason, the vast majority of brokerage firms in the US won’t allow you to use leverage on an IRA trading account.
This tax complexity is the reason most Americans think it’s improper to use leverage in an IRA. Their broker tells them it can’t be done and that’s the end of it.
When you borrow money for an IRA transaction, it must be non-recourse loan. You are not allowed to pledge your retirement account assets or provide a personal guarantee to secure the loan.
Now let’s talk about the tax implications of using leverage with your IRA.
Any income earned in the US from leverage will generate a category of taxable income referred to as Unrelated Business Income. Because the income from leverage generates UBI, the profits from that leverage are taxable (UBIT).
In most cases, UBI is taxed at the corporate rate of 35%, not the lower long term capital gains rate. The IRS is penalizing you for using leverage in your retirement account.
So, if you buy a rental property using $100,000 from your IRA and $100,000 from a non-recourse loan, 50% of the net profits from your rental income will be taxed at 35% before reaching your IRA.
Also, 50% of the capital gains earned when you sell the property will be taxed at the corporate rate. These profits won’t flow into your account tax deferred or tax free as would a typical IRA investment.
The same goes for leveraged brokerage accounts. If you have 10 to 1 leverage on your FX account, only 1/10th of your gains will flow into your retirement account tax deferred or tax free.
- I use tax free to refer to ROTH IRAs and tax deferred for a traditional retirement account.
Only the well informed and well connected know how to work around this UBIT. The most famous example was Mitt Romney back in 2012. His offshore IRA account grew to over $102 million… not bad considering the max amount he could contribute was about $5,500 per year.
And Mitt was not alone in structuring his IRA offshore to minimize US tax on leverage. A 2014 study by the Government Accountability Office found that just over 1,100 IRAs have account values greater than $10 million and 300 have account values greater than $25 million. So, while it’s relatively rare, there are some big players out there who know how to work the system.
Here’s how you can become a member of the offshore IRA investment club:
As I said above, when you invest with your IRA using leverage in the USA, you pay a 35% penalty. Income earned from that leverage is taxed at 35% before flowing up into your retirement account.
Take your IRA offshore, create a UBIT blocker corporation, and you can use all the leverage you like without paying a dollar in tax to the US. 100% of the profits from your offshore investments will flow into your retirement account tax free.
By moving your retirement account offshore, you can create a structure that eliminates UBIT from leverage in your IRA. First, we take your retirement account offshore. Then we create a second offshore corporation as a UBIT blocker. Your IRA invests into that corporation, which in turn, buys the real estate or opens the brokerage account.
When gains come back, they go first into the corporation. Then the corporation passes those profits up to the retirement account as a dividend. Dividends are not UBI and no tax is due. The offshore corporation has successfully changed the character of the money going into the IRA.
Yes, we can create a UBIT blocker in the US. In fact, these structures are often used in leveraged real estate to simplify the tax reporting of the retirement account. However, and this is a big HOWEVER, the income that flows into the US corporation is taxable at 35%. So, a UBIT blocker in a US transaction won’t cut your tax rate on leveraged transactions. It only simplifies your reporting requirements.
When we setup a leveraged investment through an offshore IRA LLC and an offshore UBIT blocker, we select a country that won’t tax your corporation or your IRA LLC. Because the tax rate of your UBIT blocker corporation is zero, compared to 35% had the transaction taken place in the US, we have eliminated US tax on leverage by investing offshore.
I hope this article on using leverage in your IRA offshore has been helpful. For more information and a quote to setup an offshore IRA LLC and UBIT blocker, please contact me at firstname.lastname@example.org or call (619) 550-2743. All consultations are confidential and we will be happy to work with you to structure your investments offshore.