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?
Sounds like a prohibited transaction.
because you are considered to be a "disqualified person" to your IRA any transaction between you (or any entity you own) and your IRA is prohibited. Can not do it!
You can use self-directed IRA to make investments into real estate or any other alternative assets but you personally can not benefit from those investments. IRA is designed for your future benefits (at retirement).
But, I can use it to fund other people deals.
Within the space of a self-directed IRA what you propose would not work well. An IRA is designed for arm's length investments that generate passive income. As such, you could not be the flipper and benefit in any way personally. An IRA could partner with another investor to do flips, but in that case the income is still taxable to the IRA since the IRA is engaging in a business rather than passive investments. That generally does not make sense.
An IRA could be a lender to an unrelated party who is flipping houses. Points and interest on such loans would be passive and tax-sheltered to the IRA.
If you are looking to become a real estate developer personally, there is an alternate structure known as a Rollover as Business Startup. This allows you to be an owner-operator of an active business, and make your retirement plan a shareholder of that business. There are no taxes for using the retirement plan to fund the business initially. The business will operate in the normal taxable realm, however. You can draw a salary. This generally only makes sense in the real estate space if you are talking about more than $100,000 in IRA savings.
I just met someone who uses their SDIRA to fund liquor licenses. It's not flipping, but it's something else you could do with those funds.
I'm currently looking into this as well for myself. I have a background in small business financing and a company I used to work with offered a Business Directed Retirement Account program. They would basically help individuals set up an entity, create a custom 401k plan, issue private stock that allows you to invest in the corporation without any tax penalties. This gets around the fact that you are individually a "disqualified person." From my understanding, according to the ERISA (Employee Retirement Income Securities Act) this is perfectly legal.
I can send you my contact's information if you want to at least have a conversation about all the details. Let me know.
@Brian Eastman if I set up a LLC from my self directed acct I become the manager for the LLC. therefore it would not be considered "personal" is that correct? What happens if the LLC purchases a property with "cash" from the LLC and is not sure if I want to flip or buy and hold. I had thought I read somewhere as long as you don't have "inventory" you can do a few flips a year with an LLC with self directed funds? Can you please clarify if this is correct. Thank you!
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.
Thank you for a detailed explanation, very helpful. I would rather be on the conservative side of the equation, when calculating expenses, what is the UBIT tax rate I should include?
That is an analysis to perform with your CPA. The maximum federal trust tax rate hits 39.6% at about $13,400 of income.
Extremely high tax rate! I guess that's why the gov't doesn't want you to use your 401K money for flips.
The intent of the UBIT tax, which pre-dates IRA plans by about 30 years, is to prevent tax-exempt entities from driving tax-paying businesses out of business.
Interesting about liquor license. They must do it as promissory note investment.
Just got some info saying if I'm not the majority owner in the LLC I can still used the funds in the LLC to flip Real Eatate.
I’m really going to have to get professional counseling on this issues.
@Esha Addy Here is something I wrote recently:
The days of working for the same company for 40 years, investing in a matching 401(k) retirement account, and retiring at 50 with plenty of money to live out retirement without financial worries are OVER. These days, the average employee works for 12-15 employers throughout their working lifetime. People are forced to work much later in their life to sustain their living and must significantly reduce their spending once in retirement. The median savings for retirement for working-age families is $5,000 dollars. These are scary things to think about especially as entitlement programs will be bankrupt as the millions of baby boomers head into retirement. So we know we can’t rely on the government or on high yield retirement accounts either. Nor does anyone want to retire and have to pinch pennies by slowly draining their stock and bond investment portfolio. Owning real estate is a great way to ensure steady income coming in to support your family after you enter retirement.
A solution to prepare your family and you for retirement would be to convert your retirement account into a self directed IRA and use this to invest in income producing real estate. The easiest way to do this would be to invest in a syndicate which pools passive investors' money together in order to purchase, renovate, operate, and sell investment properties. The way this works is a general partner (GP) of a syndication, which is the active operator such as Menlo Atherton Developments, creates a single purpose LLC to purchase a new investment. Next, shares of ownership in this LLC are sold to the passive investors. At this point, a self directed IRA would be able to purchase partial ownership in a large investment property and reap all of the income and appreciation rewards without taking any of the risks associated with the debt of the real estate. This purchase will however trigger UDFI which means some of the rental income will be taxed but at most likely very favorable rates. I encourage you to can reach out to me as well as run the numbers with your CPA if you are interested in investing in a real estate syndication deal through a retirement account.
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