SD IRA why not for flippers?

Question

Hey guys;

I have seen a good amount of posts on the subject of buying rental/long term properties with a SD IRA. I apologize if this has already been covered (deployed right now and internet is slow, so I havent been able to open all the pages) but it seems to me that using an SD IRA is best suited for investing strategies that produce short term gains, i.e. flipping etc. As has been discussed in other threads, landlording, buy and hold all already have tax benefits associated i.e. depreciation, long term cap gains, etc etc. Am I missing something, or why arent people people writing about using SD IRAs for flipping?

In my mind here is how it would play out;
Due to the fact that I am late 20s with the $5k cap per year, my IRA doesnt have enough to purchase a home outright (well maybe in Detroit, not in SoCal). Therefore I gain the deed through sub2 or a lease option. 100k house, I pay the lessor 10k for the option. Turn around and list it for 130k. That profit returns to my roth account, thereby increasing it by 20k of tax free gains.

Am I missing something or doesnt it make more sense to use SD IRA for short term type purchases?

Thanks

Will Barnard · Answer

Flipping in an IRA or any qualified retirement plan is certainly possible and is actively completed by investors. The key factor you need to realize is that flipping, as like with any other competing business such as a donut shop, income is subject to UBIT which is a very complicated form of taxation on retirement accounts. The tax was implemented to "level the playing field" so that the tax advantaged company would not have advantages over non tax advantaged companies. For instance, if your IRA owns a donut shop and does not have to pay income tax, that shop could sell donuts for slightly less than all the competition who does have to pay income tax, thus placing the IRA business at an advantage. If you flip in an IRA, you will incur UBIT. However, paying this tax may or may not be the worst thing in the world. In an example where an IRA had only $10k in it and those funds were used to flip or wholesale a deal, it is very possible that $10k could be made on that $10k investment, tus returning 100% gross profit. After paying UBIT, the return would still be very high, so while you must conuslt with your CPA regarding UBIT implications, if you must pay them, simply make sure the net profit is worth it to the tax advantaged account.

Loren Whitney · Answer

I'm a Business Development Coordinator for a National SDIRA provider.

Loren Whitney · Answer

@ Samuel, Glad to see you're still thinking about this. I've been away from the BP board this weekend and a little late joining in. While I can't give tax or legal advice, I can highlight that the Solo 401k can help you avoid UBIT in many scenarios. Do some research and I think you'll be pretty happy with what you find. I enjoy seeing the wheels turn in your initial post. I work in the SDIRA industry so seeing that excitement is definitely motivating.

Andy M. · Answer

Find your flip property, have a good friend purchase it (who is in the business). Loan him the money through your SDIRA and have a participation agreement that gets you interest plus a share of the profits (50%?). You find deals and lend money, and you could do the same for them. Grow that Roth!

Samuel Ksiazkieicz · Answer

Loren Whitney, what do you do in the industry?

Samuel Ksiazkieicz · Answer

Hmmm, some good responses, thanks guys. I guess I naively didnt realize all the issues there were with using SD IRA funds. Although really I dont see any that affect my initial thinking of purchasing via lease option or sub2, paying from the IRA and flipping, as long as I ensure all payments are done from the IRA and I dont personally make any improvements. I have not looked into a solo401k roth, so I dont know anything about their benefits vs regular sd ira. I guess that will be my next study session.

Jon Klaus · Answer

linked http://www.biggerpockets.com/renewsblog/2012/10/11/your-retirement-income-news-flash-youll-only-be-spending-after-tax-income Brown's postings on gutting your IRAs and 401k made an impression on me, too. At the BP Summit in Denver I asked him about it. He said the same thing he said in his blog, "The numbers don't lie." More recently he and his contributers have been writing more about self directing retirement accounts rather than gutting them.

Dave Savage · Answer

@David Beard Hadn't considered the collusion aspect of that approach but it definitely could show up on their radar. Thanks for the heads up, not a path that I am interested in travelling down This goes back to the difficulties in dealing with IRAs/401ks and why for active investors it may make more sense to take the tax hit and penalty for fewer restrictions on the money . I have been reading and re-reading @Jeff Brown's blog post http://www.biggerpockets.com/renewsblog/2012/10/11/your-retirement-income-news-flash-youll-only-be-spending-after-tax-income/ and it makes it clearer that the initial penalty may not be that difficult to swallow with a long term view.

David Beard · Answer

Just to clarify here, Dave Savage, are you referring to a situation in which you and one or more associates, all having SDIRAs, would make loans to each other, which proceeds each would use to generate regular taxable income? If so, from something I read, this type of collusion is viewed by the IRS as no different than lending directly to yourself, as you are entering into an agreement with others that will have benefit you personally. I believe the instance I read about was one in which a circle of people were making loans to each other, and the IRA detected this arrangement (through 1098-INT filings?) and levied heavy tax penalties.

Brian Wall · Answer

Define "operating". If you are actively participating in the business, like in our example, if you are the one swinging the hammer on a rehab, then you are correct. But, you can manage your investments, e.g. you can direct the investment. People buy businesses, with their SDIRA all the time. For example, you could buy a website business, and hire someone to run the day to day stuff. But, like Will said there are potential tax implications that you need to be aware of. Brian