What is the best way to utilize a self directed IRA to purchase and flip homes?
I have a client that asked me this question tonight and I was stumped. Please help!
First you need to set up self-directed IRA and fund it.
Second, you identify the investment and coordinate with your IRA custodian to purchase it.
More convenient way of handling this is to use what's known as Checkbook IRA (IRA owned LLC) or truly self-directed Solo 401k where you as the trustee of the plan are in control.
Keep in mind that flipping homes out of your IRA most likely will be considered as active business and profits will be subject to UBIT (Unrelated Business Income Tax). Be sure to consult with knowledgeable tax expert on this subject.
An alternative to that is to use retirement account as the source of funds and provide financing. This way you don't have to mess with the UBIT.
The subject to SD IRA and Solo 401k has been discussed here on the forum many times so be sure go back and review related posts.
There is not a simple answer to this question, as the "best" way will depend on the investors situation. There are several self directed retirement plan formats they can choose from. So, the caveat to the following is that the investor should speak with an industry and/or tax professional.
An IRA or 401k can invest in real property, either to hold or to flip. The IRA account holder can direct the investments for a flip transaction, but cannot be personally involved as the contractor or personally receive any benefit from the transaction. The are essentially making the decisions, executing the contracts and handling the expense/income transactions exclusively for the benefit of their retirement plan.
When a tax exempt entity such as a retirement plan engages in a trade or business, and is therefore competing with taxpaying businesses, there is a trust tax known as UBTI that applies. The maximum rate can be as high as 39.6% on the gains from a transaction. A clear understanding of the impacts of this taxation is critical. The bottom line, however, is that even though there is the cost of this taxation when an IRA engages in flipping, the net, after-tax returns can still be superior to other investments an IRA might make.
An alternative is for the IRA investor to be the bank instead of the flipper. By providing capital to another party (who must be unrelated to the IRA account holder), and simply receiving interest on the loaned money, this becomes a passive investment transaction not subject to UBTI.
For some investors, it can make sense for the IRA or 401k to form a "blocker corporation". In this case, the retirement plan holds the ownership of a C Corporation that then engages in the flipping activities. The Corporation will pay tax on the gains from flipping, usually at a lower rate in the 25% range. The corporation can then issue dividends to the retirement plan and that income is tax-sheltered to the plan. This is a more sophisticated approach that will only benefit serious investors with the willingness to adhere to several layers of compliance, and comes with the additional administrative costs of the corporation, but it can result in significant tax savings.
The IRS does not have specific caps on a loan from an IRA. The loan must comply with sate usury laws.
There is no upper limit on the interest rate that you can earn. Think of it just like any other investment, there is no limit on how much return you can receive. When your IRA lends money to a borrower, the interest is usually decided between you and your borrower. The only restriction is that your IRA can only provide financing to a non-disqualified person. For example, your IRA cannot issue a loan to yourself, your spouse, or your children, etc.
You may want to consider exploring the 401k business financing plan (ROBS) as it will allow you to fund a real estate operating company without subjecting the 401k to UBIT.
This is a subject that has come up before. One thing you have to look at is who is giving you the advice. If you notice all three of the above expert's have directed you to also seek advice from an accountant. He is the one who will also have answers that these guys will not have answers to.
The real issue here is the UBIT tax. The premise here is are you a dealer in real estate. The reason I say this is that you must hire someone that is a professional to do all work for the 401K as an example.
In my case our company does all the work for you. Your 401k is the member of the LLC that owns the property but it does no work. You are the manager with us but you do no work. This is left to us. It does gives you decision making ability. The key here is that you maintain control.
With deed of trust lending you give away the control to someone else.
This is the problem with deed of trust lending. You don't have control of the asset. So the key here is loss of control. If something goes wrong with the barrower, you are forced to foreclose on the lien as well. Once you do this it puts you back in the position of owning and controlling what's is left of the asset when you get it back.
In my case my clients dont do the work, they should not be a dealer in real estate (average two flips per year). Ask your accountant on this specific issue. My clients have control, and the 401k has ownership interest. No need to foreclose if it owns it.
If you want a solid company that knows this area very well, check with Jim Hitt at American IRA, google him.
Also I have asked this question to Brian above. I will ask to all three above. Please provide me with any code section in the law that show this will not work properly. Also Mark mentioned ROBS as well. So Mark your response on this would be great as well.
My two cents
You are correct that a 401k or an IRA funds can be passively invested in real-estate.
Doing it now. first stop was my CPA. second was my Attorney. just to cover my bases.
Ira was set up with the help of a Texas company. Provident trust, (Nevada), Arkansas bases LLC. and funds held in local bank, I hold the checkbook. I cannot use the funds personally. only for the benefit of the IRA. Buying my second house in the LLC now.
Hoping to flip this one. Moneys will be returned to IRA. for future Purchases.
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I just bought my first through my self directed IRA a couple weeks ago. It's a cool resource
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