Self Directed IRA: Pros and Cons of using the money flip houses

[Esha Addy]

I just resigned from my job and have a sizeable amount in my 401. What are some of the pros and cons of transferring the money into a self-directed IRA and then using that money loaning that money to your own company to start flipping properties?

[Brian Eastman]

@Carol Bloom

The IRA owned LLC does not change the tax rules, it simply allows you to directly administer investments through the vehicle of the LLC. You can direct the affairs of the LLC, but may not benefit personally through doing so (other than growing the value of your IRA, of course) nor may you inject value into the IRA through the provision of goods or services.

There is no black and white rule as to when an IRA crosses the line from passive investing to "engaging in a trade or business on a regular or repeated basis". The IRS has the leeway to review the facts and circumstances and make a judgement. The bottom line is that if the tax exempt entity is engaging in a business in a manner that it is competing with tax-paying businesses, then UBIT applies. See IRS publication 598 and discuss with your licensed tax advisor.

With real estate, the thing to understand is the difference in the nature of a transaction.  Passive income such as rent from real property, interest, dividends, royalties or the sale of an asset that has been held over time to produce passive income is not subject to UBIT.  Flipping houses does not fit any of those exemptions.  The real property itself is "inventory in the course of a sales business".  Buying and selling houses is no different than buying or selling cars or computers.

So what is "regular or repeated"?  Tough to say.  If you are personally flipping houses for a living outside your plan, even 1 per year inside the plan could cross that threshold.  You may be able to get away with 2 per year.  Did you buy the house with intention to flip, or were you listing it for rental when someone came along and asked to buy it off market?  If you hold a property with a tenant in it for some time (at least a year), when you sell that is not likely to be considered a flip.

It is easy to put on the internet or in marketing materials "you can flip up to 3 houses a year" and not have exposure to UBIT.  Is that the truth?  ... not exactly.  Be careful what you read.  Again, a consultation with your licensed tax advisor is the best source of real information on this topic.

Our general guidance - admittedly conservative - is that if you will be flipping more than one property per year, expect to file a 990-T and pay UBIT.  The risk of being too aggressive is that the IRS finds you (based on all those 1099-S records) and determines you were subject to UBIT and have not been paying.  The UBIT tax bill goes WAY up in that situation thanks to failure to file penalties, late fees, etc.