Three Things You Need to Know About Fix and Flips Using Self Directed Retirement Funds

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“Humpty Dumpty sat on a wall,
Humpty Dumpty had a great fall.
All the king’s horses and all the king’s men
Couldn’t put Humpty together again “

Author unknown but probably a 18th century English tax lawyer?

Please allow me to share one of the worst stories I have ever heard in real estate. A Missouri seller convinces a California buyer to “use her retirement money” to buy several rental houses. The buyer failed to obtain outside advice, and simply withdrew the funds to purchase the properties.

Rumors, innuendo and speculation are very dangerous in this arena and as a result the buyer was subject to all of the applicable penalties associated with withdrawals from her 401k. If I remember correctly it was about a $40,000 tax bill.

The worst part about tax planning is it looks like humpty dumpty some times… all the king’s horses could not unwind the transaction.

The teaching point from this outrage of a result: ALWAYS consult tax and legal counsel before acting to self direct your retirement funds.

That caution aside, I am a huge proponent of self directing retirement funds. I believe that Wall Streets capabilities are largely in marketing. Their financial acumen in general…ehhhh. Don’t even get me started on their transparency. You’re as good as they are.

So, as you can imagine I think self-directed retirement funding is very wise. As you know I am a staunch proponent of the wealth creation effects of real estate, because when done right – they are in many ways superior to stock investing.
The key competitive advantages in my mind are:

  • Less volatility
  • Opportunity to force appreciation
  • Easier to find an information advantage

So having said that its important to talk about one of the hidden boogie men…errr provision in the retirement realm. The opportunity to tax defer or in the case of using after tax dollars of the beautiful ROTH provisions tax-free growth is greatly affected by this concept.

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1. What the heck is UBIT?

Unrelated Business Income Tax as defined by the IRS:

“For most organizations, an activity is an unrelated business (and subject to unrelated business income tax) if it meets three requirements:

  1. It is a trade or business,
  2. It is regularly carried on, and
  3. It is not substantially related to furthering the exempt purpose of the organization.

There are, however, a number of modifications, exclusions, and exceptions to the general definition of unrelated business income.”

2. Fix and Flips are NOT a good fit for SDIRA’s because of UBIT

The problem with self-directed IRAs and the fix and flip strategy lies in the UBIT.  Word on the street is 1 to 3 flips a year are “probably” okay but I urge caution. If you want to go full “J Scott” and flip 20 or more houses in one year the UBIT boogeyman suggest it MUST be outside of your retirement fund.

Perhaps fix rent then flip may work…but how far will that take us?

3. Hard money loans to flippers are great alternative?

From every source I have read making a hard money loan is the best way to play in the fix and flip space with regard to your retirement funds. The only true limit is how fast your money churns it seems.

I am not a professional tax adviser so take my word with a grain of salt but so far my research suggest that this strategy is available “all day long”.

In conclusion the opportunity to self direct and invest in real estate is way too sweet to pass up. However to avoid the tragedy that befallen humpty dumpty and her family…please engage professional advisers.
Photo Credit: thetalesend

About Author

Douglas Dowell

Douglas Dowell J.D. is a commercial and multifamily investor. His blog will focus on legally raising private money, risk mitigation with due diligence and management science. He is also an avid student of success principles with a focus on modeling success factors.


    • Douglas Dowell

      Hello Dennis,

      I have seen alot of different deals in life, business and real estate. To me it seems you have to know what the prevailing market price is, and how much value you bring to the table. That formula will likely vary widely over time. If its your first deal and your personal resources are limited the lender is taking more risk and could fairly price higher for it.

      I would ask around to see how else is taking this deal in your market. Sometimes not playing is winning. The flip side if it add’s one more source of profit you would not otherwise have, it might be worth it.

    • Douglas,

      Your advice “ALWAYS consult tax and legal counsel before acting to self direct your retirement funds.” is sound advice but unfortunately all too many people think that seeking such advice equates to asking their Financial Planner, Stock Broker or Mutual Fund Salesperson.

      Most “Financial Planners, Stock Brokers or Mutual Fund Salespeople” are not “Experts on the various types of Retirement Plans or the concomitant tax consequences.

      Often, if you go to a CPA or Lawyer the clock begins to run and you are billed accordingly even when many CPAs, Accountants and Lawyers are also not “Experts” but in reality seek advice from the Experts.

      Here’s a novel idea, why not contact the “Experts” like a law firm that specializes in the Self-Directed IRA with Checkbook Control and the Individual 401(k) that does not incur U.B.I.T for debt leveraged real estate. Why not talk to on a gratis basis (free) Lawyers who have worked for ERISA that regulates IRAs and DOL (Department of Labor) that regulates the Individual 401(k) ).

      If you want more information I welcome your emails.

  1. Douglas, you are walking on thin ice bringing up the stock market vs real estate. But I completely agree with you! I have never done anything with self directed IRAs, mostly because I am 34 and don’t want to wait 30 years to use that money.

    • I am curious, why is comparing “Real estate” v. “stock market” walking on thin ice?

      They are two very different things and putting the IRA aside for a moment with real estate you can avoid taxes indefinitely on your profits something you cannot do with stocks and Mutual Funds.

    • Douglas Dowell

      Hello Mark,

      I seem to like thin ice in that my suit is neoprene and I take my skates everywhere….hahaha
      I think you may find a way to integrate tax free and tax deferred growth into your mix and still use the money in a way YOU have control over. Check book control.

  2. My question is not so much about tax implications in regards to SDIRA’s but is related to the topic. I have funds in a SDIRA I would like to use to partner with someone on long term hold rental properties. There may be occasion that one of the rentals get sold…not sure. I am assuming the properties would be held in an LLC. I know from past discussions with my IRA administrator that if I buy a property with 100% IRA funds, all revenue and expenses must flow through the IRA. At least I think so. How would one structure a partnership with a property and one partner’s contribution is IRA funds? The partner not using IRA funds will also need to be paid property management fees. I am thinking I need to buy shares of a company?? I would appreciate any input.

  3. Dmitriy Fomichenko

    That’s a sound piece of advice. SDIRAs are not the best option for fix-and-flips, but they can be effective in a buy-and-hold strategy. One can buy the property, fix it, rent it, and sell it after a year or more. It will drive rental income, appreciation, and tax benefits.

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