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Note Investing With An IRA
We’re going to be talking about notes. In our last episode, we gave an introduction to investing with an IRA, IRA Note Investing 101. We talked a lot about what you can do, what you can’t do and what you shouldn’t do. Now, we’re going to tell notes stories that will show you some of the things you can do and the funny and often surprising things that happen along the way. I wanted to start by talking about a man that I remembered after thinking about this. This was a gentleman in my city in Philadelphia who has built a large portfolio of rental properties by buying properties and fixing them up with his IRA and then refinancing them to get his money out and then rinsing and repeating. You probably see the problem with that right away, Chris. Do you?
Yes, I do. If he is refinancing them out, what is he taking the loan in? If he’s taking them in his personal name versus the name of his IRA, that is a very big no-no.
That’s a prohibited transaction. Your IRA is not allowed to sell a property to you. You’re not allowed to sell one to your IRA. You can’t transact with any prohibited person either which as we may recall from our last session is anyone in your up and down family tree. Your parents, your grandparents, your kids, your grand kids, all cannot be transacted with your IRA. This guy is teaching this process to people like how to operate 101 and how to get away with it.
How to get a very big tax bill when you’re caught by the IRS doing these transactions? It’s interesting because if he’s refinancing them, that gets recorded. There’s going to be a clear chain that if anyone ever looks into that or he has to file his yearly statements, they’re going to see that money coming in and out and they’re going to see that John Doe IRA own the property and sold it to John Doe and refinance it out. That’s not good. That’s why you should always talk to your tax professional before you do anything with your IRA. Just talk to whoever assists you set up and run the deal that you’re doing with them. Run it by them and say, “Here’s what I’m looking at doing. Are there any issues with that?” It’s a five-minute phone call that at the end of the day could save you thousands or tens of thousands of dollars.
Sadly, he’s a pretty old guy so if he gets caught now, it’s going to be bad. There’s only time to rebound from that and then rebuild. If there’s a takeaway, maybe it’s that the IRS is a little overburdened. They’re not getting around to everyone, but I don’t think you can count on that. We always suggest doing things the right way then you can sit easily at night and you don’t have to worry about anything.
Gail, I want you to tell us about one of the deals you did in your IRA.
A lot of people know me talking endlessly about it that when I was a new node investor, I did all my deals in my IRA. My plan was to fail with my own money if I was going to fail before I started using investor funds. Strangely, I haven’t had any failures in my IRA. It’s been all rainbows and unicorns. The fans of Scott Carson’s Note CAMP, which is highly recommended, may have heard this story already. I bought a contract for deed in Birmingham, Alabama. For everyone who’s not familiar with it, there are two kinds of loan instruments. There’s your conventional note and mortgage, which most of us have on our houses. Then there’s a contract for deed, which is a house payment that’s like a car payment in the sense that you have to pay the entire thing before you own the house. You don’t get the deed until the very end.
If you, as a lender, own contracts for deed, you own the houses themselves and the borrower has a contract that entitles them to buy the house from you over time by making their payments. I had an instance in Birmingham. Birmingham’s a very tough town when it comes to property taxes. The taxes are not high compared to the Northeast, but they are incredibly strict. You have until the last day of the year to pay your taxes. If you don’t, in May of the following year, they sell your taxes and you have three years to redeem, which means go pay the taxes and get your house technically back or you’ll lose it after three years to whoever bought the taxes from you.
They can be sold at tax sales. If people hear that word of investors who invest in tax sales or tax deeds, that’s typically when your taxes get sold as if you don’t pay them. A jurisdiction will sell them to collect the money and then you get priority on that, which supersedes a mortgage or a contract for deed. They collect an interest rate depending on the jurisdiction. It varies.
In Alabama, if you go to a tax sale and you buy somebody’s taxes, you just sit tight while you wait out the three years and wait to see if the borrower is going to come back. If the homeowners don’t come back to pay the taxes, in which case they’ll just give you your money back with interest. If three years passed and the homeowner doesn’t come in and pay the taxes and redeem the house, they send you a tax deed saying, “You own the house now.” I bought this in October of 2017 and her taxes have been sold in May of 2017. That’s when the three-year clock started. I had no concerns when I was buying it. I thought I have lots of time to either help this lady pay her taxes or I pay the taxes. I was unconcerned. What happened was when the servicing transferred to my servicer, a whole bunch of money came with it that had been kept aside for the taxes. $2,500 in a place where the taxes are like $800 a year. What is all this and why did this servicing company collect all this money? Weren’t they supposed to pay it for their taxes?
That’s the first thing that popped in my head is they’re collecting the money but not paying the taxes on behalf of the prior owner.In many places, you can get exemptions that lower your property taxes for a number of reasons. Click To Tweet
We have borrowers who own rentals, who collect rents but don’t pay us their mortgage. It’s certainly not something we haven’t seen before. Normally, servicing companies are held to a very high standard. They hold people’s fate in their hands and this lady’s house went to a tax sale because they didn’t pay her taxes. I began the process of redeeming the house. I thought, “Let me go ahead and do that. The borrower can pay me back but meanwhile, let’s get it done.” The first thing you have to do is send a form to the person who bought the taxes saying, “I’m going to pay the money. You’ll be getting a check with interest.” I send it off. Probably a week later, I’m sitting at 8:00 in the morning, in a complete fog in the wintertime in the Northeast. My phone rings and I picked it up and someone is screaming at the top of their lungs. I barely even said hello. My eyes weren’t even open. It was the man who had bought the taxes. He was telling me that he owned the house already because he had paid for four years of taxes when he paid for the taxes.
In his mind, that three years, even though it just started in May, was over already. He paid the 2014 taxes so that had expired away, the three-year grace period. He’s ranting and raving. There was a lot of threatening going on like, “You better not try to take this house from me. I own the houses on either side of this house and this house is mine already. I’m just waiting for the state to send me the deed.” I thought, “Let me play along.” He’s like, “I realized you have put money into this so I’m willing to give you some money. What do you want for it?” I thought of a giant number just to see what he would say. We settled on a number. I thought let me keep him busy with that while I go investigate. I went and called attorneys and I was like, “Is this true? Does that happen? Does he own the property and I don’t own the property?” I have an attorney agreed to investigate it for me for $2,000. I kept fretting. I was like, “How can I figure this out? I have this crazy man saying one thing.”
Did you call the county?
I did and they were like, “We don’t understand why he would say that. You can redeem this property.” I finally realized that I don’t need to hire anyone to tell me if I could redeem it. I thought let me just try to redeem that and see what happens. I sent him the money and sure enough, they redeemed the property. Then it was my absolutely sublime obligation to call the gentleman and let him know that we’re getting the house anyway.
How did that conversation go?
That was fun. I’m not normally someone who gets a lot of pleasure out of other people’s anguish, but he had gone over to the house and threatened the borrower. Threatened that he was going to throw her out in 22 days. That’s what it takes to evict a tenant in Birmingham. He was like, “I’m going to throw your ass out on the street.” He got her very upset and then she called me, which was the beginning of a beautiful friendship. She’s like, “I don’t understand what happened because I’ve been paying my taxes this whole time.” Then I remembered that $2,500 that came with me. I thought that rings true. She probably did pay taxes and they didn’t pay their taxes. When I spoke to the man, he was quite livid and sounded vengeful like you might give her or me trouble. I warned him. I said, “She’s got a massive lawsuit against that servicing company for not paying her taxes. If I were you, I would get away, stay away and just be glad you didn’t get involved.”
Did you not charge the borrower any of the late fees or anything that was associated with the taxes?
I did not consider her like a victim. I would say a lot of our borrowers are not savvy people who stand up for themselves. I was happy to be her champion. As soon as I heard that guy threatened her, I resolved in my heart. I’m getting this house for her. I don’t care what it takes. I would have paid anything to take it from him. I know that’s not a good investing practice.
I believe in karma. If you’ve got a property that the borrower wants to stay, the borrower is making a commitment to try and get on a payment plan and they have been paying their taxes and it wasn’t flowing all the way down, that component you can’t blame the borrower and I do the same thing. I wouldn’t charge any late fees or anything to the borrower because the money was there. It just wasn’t getting implemented properly. Sometimes when you’re dealing with very difficult neighbors, you always focus on trying and doing the right thing as well. Like any business, there’s the cost of doing business and you have to make sure you’re doing the right thing at the same time.
I have a funny little postscript to that story too. I was in Birmingham several months later and I found myself a couple streets away. I asked my friend, “Let’s go buy that house.” Her door was open. I hopped out of the car and I went and knocked on the door. When I introduced myself, it was like I gave her a kidney. It felt like we went through something together.
These are the stories that we want to share with people because we’re doing more than just collecting somebody’s mortgage. A lot of these people have gone through some hard times and we try and keep them in their houses and give them some hope and not be a large institutional lender where you have to go through 50 people to get somebody on the phone, “What’s your ID number in the system?” It’s a 400-digit ID that nobody ever remembers and they never tell you. You get caught in the parallel of another universe trying to deal with some of those people.
This very human business. I know people who don’t like it because of that. They prefer something that’s less messy. Particularly a parent or someone who is used to taking care of people and cleaning up messes, this could be a very sweet business to be in. It’s very gratifying.
My first note with my IRA was not as adventurous as yours. One of my first was I followed it this time. I call it the Adam Adams method of investing, which is buying an asset where you find later on that the borrower is deceased. I had a note in Baltimore, Maryland. Baltimore can be a very tough city to deal with and Maryland as a state can be difficult with foreclosure and going through the process. When I was doing my due diligence, I knew the property was vacant. In the notes that I got, there was a phone number for a local real estate agent. After I got my bid accepted, I was talking to the real estate agent about the property and she mentioned the inside. The kitchen is not bad. The appliances were still there. There was water damage on the bathroom, but she said it was five-square feet. It was more of a cosmetic carpet and paint-type scenario.
It was a decent area and I’m in the Washington, DC area. I had somebody I know go by as well, take a look at the property. The borrower hadn’t paid in several years because they were deceased. The biggest challenge we had was it was a mother and son who were on the title to the property. All the history for the son was there because there was information. There was also probate, which we had to go back and open up but the mother we couldn’t find. There was thought that she had passed. We were running searches on her. We couldn’t find anything and the process servicer doing all this research finally after 90 days went to the court and said, “We can’t find this woman. Here’s what’s happened. We have to publish in all the local newspapers.” A niece saw it in the paper and called the attorney and said, “Yes, she passed away and so forth at this point in time.”
Didn’t the skip trace show that she was deceased? That seems like a no-brainer.
No, it didn’t. We won’t get into that because there may have been Social Security checks still getting mailed to a certain residence. It was interesting because it was also one of my first foreclosures. One of the things I’ll tell if you’re a note investor or any type of own any debt, whatever they tell you for foreclosure timeline, take it and usually double it. There’s documentation out there that says everything takes this long and that is if it isn’t the perfect storm situation. When all the moons align at once is when that occurs. In Maryland, the biggest challenge is typically the courts. The courts take a long period of time from when you submit the case. For them to actually give you a date may take up to 90 days. You submit the paperwork saying after a 30-day demand, you submit. Here’s a foreclosure file that gets recorded. Then you’re waiting for the date from the courts that took several months. The foreclosure occurs at that point in time. At this point, we sold the property at foreclosure because we had set our bid price that what we want to accept. Interesting to know, the foreclosure sale occurred in April and the court finally ratified and approved the case in August.Invest people's money the way you invest your own money because every loan counts. Click To Tweet
Did somebody buy it or did you keep it?
Somebody bought it at auction.
It took until August to transfer title to them?
Yes, and it was nothing that they or I can control because what happens is after the auction, the court has to ratify to confirm that all the proper paperwork was submitted. The right amount of money is owed to each individual. The money goes to the court and it’s like a regular closing where the HUD form has to get filled out and so forth. To know whatever that auction price is and where that money goes, that process took four months.
I should make a note here that I never knew until I got into this business how foreclosures work. All cases work the same way in the sense that you notify the borrower that a legal process is underway. They have time to respond. Eventually, there is a hearing where the case gets decided. A foreclosure culminates in a sheriff’s sale. Chris got the right to foreclose and order a sheriff’s sale and then you, as the lender, also get to set the minimum amount that you will accept for your mortgage. I currently am foreclosing on a guy who has a $50,000 mortgage because he hasn’t made any payments since 2012. There have been a lot of lots of insurance costs and lots of legal costs and things going on. The man has declared bankruptcy seven times in six years. We were almost out the foreclosure sale. The point is that the property has to go up for sale because there is a chance that the property will sell for more than we are owed. If that happens the homeowner is allowed to have that extra money so basically, if they have equity in their house. They’re allowed to get it back.
You bring up a good point because a lot of people I talked to when they asked the question, “What is a note investor or what do we do?” I tell them we buy distressed debt and try and help people into homes and share some stories. When people hear stories that someone hasn’t paid their mortgage in five years or three years, the reaction I get from people is almost always the same. They look at you like you have six heads like, “Are you serious? Someone hasn’t paid their mortgage in four years?” I’m like, “Yes.” Typically, the banks don’t do much because when you look at it, they’ve got tens of thousands of loans and little John and Jane Doe who owe $50,000 they’re spending their money having somebody chase a $500,000 loan, not something that is only $50,000. Jane and John may try and get the loan reworked or try some type of program the institutional lender has, but they get nowhere because there’s nobody there to deal with them unfortunately.
People who stay inside the lines and follow the rules would be very shocked to find out. Most people who are very conscientious about paying their mortgages would be very surprised to find out that nothing will happen, except your FICO score. I used to think I’d be homeless if I missed one or two house payments. I would be sitting out front with a bucket of my toys and that would be it. We have people who have lived for years and years while their loans get sold from one bank to the next hedge fund to another hedge fund or another hedge fund.
One thing I’ll mention on that deal that I did in Baltimore because we talked about not dealing with family members. I’ll throw the curveball in that you can JV if a deal is upfront with a family member. In this deal, I JV’d with a family member’s IRA but the rules are we both had 50/50 ownership in the deal. The invoices, the bills and everything got split and nobody was gaining any benefit from it. As long as it’s done upfront when you’re going to acquire that asset, it can be done. If the deal costs $20,000, I can’t have $12,000 and somebody have $100. You both have to have enough to be able to afford that loan and the JV is there as a 50/50 and nobody is gaining a benefit. Where if somebody only had $10,000 or $12,000 and somebody had a $100, now the person with $10,000 or $12,000 is getting the benefit of a $20,000 asset.
Even now there are very strict rules with IRAs about not doing deals with prohibited people. You can’t do deals with your parents or grandparents, your kids, your grandkids but you can do the kind of deal that Chris was describing where you put in money and one of your relative’s IRAs put in money. What you can’t do is say we are 50/50 partners in this, but your mom’s IRA is putting in a $100,000 and you’re putting in $2,000. You are getting 50% of the profits when the whole thing is done. The IRS is looking for situations where you’re bending to the breaking point rules in order to unfairly enrich either yourself or the IRA or whatever. It has to be kosher as we Jewish folk would say. I understood this. People hammered into me at the beginning because I manage my own IRA funds in a checkbook IRA. I am the captain of my ship and I am the one who can drive it on to the rocks. I’ve been extremely cautious about what I do.
Let me jump into another story. The fact that it was an IRA is particularly relevant, but this is just a story that I like. The first two loans I bought in my IRA. One is a house that burned down in Flint. The other was a cute little old lady in Georgia, in a suburb of Atlanta. This lady has a house that’s probably worth about $65,000. Her mortgage is about $70,000 or something. She had been paying sporadically, which is what we call a sub-performing mortgage. It’s non-performing and it’s not performing. It’s something in between. When we reached out to her initially to find out whether there was a way to have her be more consistent in her payments, it turned out that she had a car. She had a car loan where her car loan and her car insurance equaled her mortgage payment. She was making a decision. She was paying me sometimes and paying her car other times. This is not uncommon that people will pay their car loan and not you because the repo man can drive the car away. No one is going to put up a winch to the house and drag it down the street. They feel like that’s a reasonable decision to make.
The laws are much more protective on your property than a vehicle with average foreclosure times across the country at about two years. Even if you foreclosed, you have to still evict them as a tenant, which can take a very long period of time. If you look at it and do the math, people will pay the price before their mortgages.
We all stared in wonderment at that piece of information like, “What’s the plan? Is she going to live in the car?” Then I thought, “What kind of a car does she have?” I’ve gotten to know this lady over the years. One thing I respect a lot about her, she is of a generation that believes in paying their bills. I’ve even offered to ease up in some respects and give her more time or whatever and she’ll be like, “No, this is my responsibility and I have to take care of it.” She got into a jam and this was one of our experiences that I don’t know if it’s the same for you. I appreciate some of my borrowers without even intending it. You get to know them. I get involved with them a little bit. She got to the end of the year and had a large property tax bill. She had a $2,000 tax bill. Her normal taxes are $1,800 but with late fees and stuff, it easily gotten to $2,100. She was horrified and she couldn’t pay it. She was all in a dither about it. I ended up having to pay it, which is not a big deal.
Whenever you end up paying for stuff on the behalf of your borrowers that they’re supposed to pay for, you can always add it into their loan not into the balance itself. It becomes like a charge against the loan that if the house ever gets sold, you get back. I found out after looking at it a little bit that even though she was on disability, in Georgia like in many places, you can get exemptions that lower your property taxes for a number of reasons. If you’re a senior citizen, a lot of places have it. If you are disabled, if you are the homeowner as opposed to it being a rental property, an investment property with renters in it, you get a homeowner’s exemption. For that, it’s got a homestead exemption. Most people can get that all over the country. She’s not yet old enough for the senior exemption, but she was entitled to a homestead exemption and a disability exemption.
I discussed this with her in December and she was all excited about that. Then literally it was mid-March, I woke up out of a deep sleep with one thought in my mind. Did she ever go apply? I bet the deadline is soon. I contacted the county. It was April 1st and this was March 23rd. I was just like, “Oh my God.” I called her up and I told her the deadline was sooner than it was because I did not want any dithering. I got her to go down there and her taxes were reduced from $1,800 a year to $600 a year. When she’s old enough in two years to get the senior exemption, they’re going to get lowered even more. I can’t even imagine what would they be? That was the basis on which I paid her taxes. I was like, “I’m paying them this time but you need to save the $50 a month from now on and pay them.” You can do that and she did.
That will be a topic I’m sure for another show where we start talking about taxes and other charges and things because that is a very common element of the business during those phases of when you’re doing your due diligence in buying a property. Making sure what the tax balance is because when you acquired it, the note or a contract for deed carries along with you. That’s one thing you definitely want to pay attention to. As well as making sure that the county has a proper location to where to send tax bills or start calling twice a year to make sure taxes are being paid. There is nothing better than picking up the phone and calling the tax company or the county tax collector and tell you, “There’s $3,000 due.
I hate this time of year because all the contracts for deed are in our company names and I get a tax bill every single day. I have such a floppy stomach from this.
It is still the borrower’s responsibility to pay it. If you’re buying a distressed debt that they’re making partial payments on the note, the escrow isn’t getting fully collected. In many instances, you may have to put some money out as well.Know the rules and follow them. Click To Tweet
Do you want to tell us another note’s tale?
What I’ll tell you rolls into taxes and a mixture of both stories. I have a borrower in Ohio that thought he was paying the taxes and the tax balance at that time was $9,000.
The house is worth how much?
The house is worth about $80,000. The borrower who isn’t in there was a contract for deed and the payout he owes was about $25,000 to $30,000. He abandoned the property for about eight years. He went through a modification back three or four years ago. He thought that the modification includes the taxes. Unfortunately, it didn’t. This was I’ll say one of the unusual borrowers where he would respond to the servicer. When they would call, he periodically would respond. The servicer through communications with me, I asked him, “Go down and talk to the county and see if we can get on a payment plan because of two things. One is I don’t feel like cutting a check for $10,000 right now and see if you can get on a plan with them and you start working the payments back up.” He went down and the county agreed to put them on a payment plan so he can pay it off over the next five years. They’re pretty flexible, which I was pleasantly surprised.
The other component to that was he had missed a few payments. We had the attorney send a demand letter to note that we are going to start the legal process. They came to the door and handed him the notice that you potentially could lose your house. He called the attorney and spoke to an attorney that we use in Indiana and Ohio, Franco. He goes to me, “You might want to talk to this guy.” I’m like, “Okay, Franco.” He’s like, “He seems like a decent guy.” I got the guy on the phone and the guy did not make one excuse. I was shocked because I figured the dog ate the paycheck. The car broke down, the roof had a leak or his hours got cut. Everybody always has some story. They had to go to a wedding in the Caribbean. I had that as an excuse on why they couldn’t pay their mortgage.
I call this gentleman. I had a conversation with him. The guy was very sincere and then I point blank asked the guy, “Nobody has ever asked you this question before I’m sure. How can I as your lender help you?” The guy I believe started crying. He was so emotionally like, “Oh my god.” I said, “How can I help you? Do we need to adjust the payment? He told me the story. He had been in the house for eight years ago, about a tree in the house that his kids built the tree house in. You hear this story and like, “I really don’t like to throw this guy out of the house.” This guy was so sincere. When he came back he’s like, I just need until Thanksgiving.” I said, “What if I give you until the end of the year? I can give you until the end of the year, but I’ll tell you if we can’t get it cleaned up by the end of the year, I’ve got investors and partners that it will be a problem. If something comes up, pick up the phone and give me a call. Reach out to the servicer. We need to work together on this.” He was just so thankful because he had talked his wife was unable to sleep because they would have to find a place to live and so forth. The heartwarming side of this were there’s the financial side, which this is a note that is going to provide positive income and then providing that positive story on the backend. This is the first borrower I actually ever talked with.
As a matter of routine, we do not call borrowers. We usually have someone else reach out and hear their stories and find out what’s going on. It’s inevitable particularly because I don’t know about your servicer, but mine gives out my phone number. It’s their revenge if you don’t hire them to manage everything for you. I get these calls out of the blue from borrowers. People are very cool most of the time. It’s always been helpful to talk to borrowers so far.
Typically, if somebody is calling you, they’re calling you to try and work it out. Most of the time, if you’re not hearing from somebody, they’ve gone dark because they could be embarrassed. There are a million reasons. Typically if somebody is calling you, it’s because they’re ready to step up to the plate. Possibly see what can be done or how can you work out a situation. I give credit for people to do that because a lot of times you may feel embarrassed or you do not feel like you have the fortitude to pick up the phone and just talk to somebody. Most people think that everybody is this big institutional lender that they’re big and intimidating. Let’s be honest, we’re all humans. We all put our socks on before we put our shoes on. We’re all the same and in that instance. I don’t think a lot of borrowers understand that in a sense. When you start dealing with private firms like ours versus large institutional lenders, there is definitely a management style that varies.
Most people feel annoyed and rightly so when their loans get sold, even performing loans tend to be sold. They’re constantly getting notices, “We’re not your lender anymore. Talk to these people now.” For everyone, until their loan ends up in the hands of people who will care enough to call them up and find out what caused them to default to begin with and find what the current situation is. Try to tailor the loan to their current situation so they can be successful again. It’s actually a blessing when the loan falls into the hands of smaller entrepreneurial investors who will treat it like a big B because it is to us. It’s not about shuffling paper. We invest people’s money. We invest our own money. Every loan counts. There aren’t any throwaways.
For this episode, we talked about some IRA investing. If you were to give two to three takeaways of IRA investing in notes, what would those two or three items be?
Don’t do what the guy in Philadelphia does where he buys and fixes properties with his IRA and then refinances it in his own name. That’s a big no-no. The big thing with IRAs is they are very flexible in a sense. You just have to really know the rules because you can get into trouble. People get away with things because they haven’t been audited yet. Don’t be afraid to use your IRA. It gives you unbelievable flexibility and if it’s a Roth IRA, the gains are untaxed and unbelievable. Don’t be afraid but know the rules and follow them.
If you don’t then partner with somebody. That’s the one thing I think of. If you’re not comfortable with the rules, then partner with somebody who’s experienced. If they’re not a family member, you partner with them, give them the money to invest and work out a deal with them for their time and their management. To have them invest for you and keep you informed in what is ongoing. Then they can manage the whole process for you. You just sit home and manage over that person. It’s an arm’s length transaction where it pretty much should alleviate most of the fear or risk that somebody has.
Watch what they’re doing and then learn it so you can do your own investing in the future.
It’s been a pleasure as always, Gail. If you want more information about us, you can visit us on www.GoodDeedsNoteInvesting.com as well as reach out to us. Our links and email are on the website as well. We look forward to providing more episodes. If any of you have any ideas or things, you’d like us to talk about in a future episode, please feel free to reach out to us. In the meantime, go out and do some good deeds.