Self Directed IRA for wholesaling

[William Luke Laity]

I recently heard on a podcast that you could use money from a self directed IRA as earnest money for a wholesale deal, and then when you flip or assign the contract, the money you make from it would be tax free apparently. It was a podcast from awhile ago so I'm not sure if that still works today, but if it does, how does that work, or what are the steps to do that?

[Brian Eastman]

@William Luke Laity

It is possible to flip/wholesale properties using a self-directed IRA, but there are challenges to executing such transactions inside the IRS rules. The main take away is that the occasional transaction of that sort would be OK, while a focused strategy of using your IRA in that manner on a repeated basis will not likely work out.

The first issue is involvement. Wholesaling takes a lot of hustle. You, as a disqualified person to your IRA cannot benefit from or provide benefit to the IRA.  If you are putting hours of your own time into marketing and digging up deals, you could be viewed as providing services to your IRA.   If you go to an auction and buy a house using the IRA, or have someone bird dogging properties and occasionally your IRA decides to pick up a deal that can be quick-turned, that is a less involved approach.

The second issue is that when an IRA engages in a trade or business on a regular or repeated basis, the gains are taxed as Unrelated Business Taxable Income (UBTI). This tax is designed to protect tax-paying businesses from unfair competition. Quick turning properties is a dealer activity and considered a trade or business if it is done with frequency.

Better strategies for an IRA will be more passive, both in terms of your involvement making deals happen and in the type of income produced. Buying a property at discount and holding it for rental at least a year before selling produces passive rental income and a passive capital gain, both of which are fully tax sheltered to the IRA. Being a transactional lender to wholesalers or a rehab lender to flippers both produce passive interest income.

There are plenty of ways your IRA can invest in real estate without running afoul of IRS rules. It just takes some education to hone in on the right strategies for the network and opportunities you may have.