Self directed "checkbook" LLC IRA
San Antonio, TX · Member since 2009 · 86 posts · 13 votes
Self directed "checkbook" LLC IRA
Most Popular Reply
Lender · Los Angeles, CA · Member since 2009 · 1k+ posts · 2k+ votes
15yThe IRS doesn't define flipping or rehabbing with respect to UBIT, that I've ever found. Please chime in if you have a reference. Flipping is just another business activity and it considers your IRA just another organization, as should you.
You can read the code, specifically 26 U.S.C. §408 for IRA's (see §408(e)(1)) and 26 U.S.C. §511 for UBIT, but the best place to learn in real English is the IRS website definition itself itself and also IRS Publication 598. This publication actually presents many examples of organizations that are and are not subject to UBIT. It’s not for the faint of heart but not too bad. Tie your shoes tight and drink plenty of coffee before you begin.
Here’s the bottom line, direct from 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.
Jon’s repossession would not be subject to UBIT because it was not a part of his business that he regularly carried on (at least not hopefully).
Jeff
27 Replies
- 15yCurt DavisBusiness MemberFlipper/Rehabber · Memphis, TN · Member since 2008 · 5k+ posts · 2k+ votes
With the checkbook approach you control the money, with companies like Entrust or Equity Trust you have to request funds and sign lots of documents. Checkbook would be the way to go.
Curt Davis - KAIZEN Realty538 Reviews - SFR Investor · Orange County, CA · Member since 2009 · 1k+ posts · 1k+ votes15y
Originally posted by Curt Davis:
With the checkbook approach you control the money, with companies like Entrust or Equity Trust you have to request funds and sign lots of documents. Checkbook would be the way to go.Unless you're in California where every LLC costs $800 annually. I set up a regular SDIRA and will pay $10 per check requested. So as long as I write less than 80 checks a year, I should be ahead of the game (I currently write less than 25 checks/year with my current non-IRA LLC).
- Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes15y
I'm with Equity Trust and getting them to fund the transaction I'm working on now is like pulling molars. My addendum to your question is what is wrong/risky about checkbook control? I know the obvious is that you may run afoul of IRS rules. Anything else?
- Real Estate Investor · Fishers, IN · Member since 2009 · 408 posts · 196 votes15y
I am finding the same dental work that Jon is lately with ETC.
While checkbook control sounds and I am sure a good option, I personally prefer that layer of 3rd party protection in my dealings with SDIRA's. No matter how experienced you are in IRA's, having a 3rd party help look over your shoulder will help accidents from occurring and having the IRA become disqualified.
- Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes15y
Originally posted by Kevin Kaczmarek:
I am finding the same dental work that Jon is lately with ETC.While checkbook control sounds and I am sure a good option, I personally prefer that layer of 3rd party protection in my dealings with SDIRA's. No matter how experienced you are in IRA's, having a 3rd party help look over your shoulder will help accidents from occurring and having the IRA become disqualified.
Yeah, it would be a disaster for a large, seasoned IRA to become disqualified. Anyone know of it happening?
- San Antonio, TX · Member since 2009 · 86 posts · 13 votes15y
Thanks guys. The issue of a cumbersome or untimely process of payments was one of my concerns and why I was considering the checkbook IRA. I sent Entrust a note asking about the checkbook approach (they don't offer checkbook) and received a response from them heavily against the checkbook approach...yet I've also received many responses from those firms advocating their use.
- Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes15y
I think the best question is what type of RE investments will you pursue in your SDIRA?
If none are of the time sensative type, then a standard SDIRA with a TPA would be fine.If you invest in things like tax liens or trustee sale purchases, then time is an issue and checkbook control is necessary.
As to the concerns mentioned about having a TPA involved for added protection to keep you inside the rules of the IRS, even with a TPA, you could invest in a prohibited transaction or with a disqualified party. As such, in either casee, it is important that you understand the IRS rules regarding SDIRA's clearly before making any investment, checkbook control or not. If you are uncertain, you should ask for guidance from a knowledgable person. (there are many of us here too in addition to your financial advisors)
- San Antonio, TX · Member since 2009 · 86 posts · 13 votes15y
Thanks, Will. At this point it would be used for property flipping...when I think of timely bidding, paying contractors and purchasing materials I'm just not sure having the third party intervention is a feasible approach with this type of venue. I'm sensitive to the issue of prohibited transactions and disqualified individuals...as with all types of programs.
- Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes15y
Keep in mind that flipping (fix and flipping, I think you mean, but same is true for wholesaling) is an active business. That means the income is subject to UBIT. Once you hit $11,000 income, that tax rate is 35%. I've yet to convince myself this is a profitable use of an IRA.
I ended up in a similar position, though, when I repossessed a house from a hard money loan gone bad. I'm not sure how I would have done that with a traditional custodian. The GC required a series of payments, which would have been a pain. The landscape guy, though, had me buy the dirt, sod, plants, etc. That would have been impossible. Then there were water bills and insurance bills.
- Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes15y
Chuck,
For rehab flips inside an IRA, I would choose nothing other than the checkbook control without question.
Keep in mind as Jon stated, UBIT will apply and that can be very costly. You would have to weigh the return difference between a passive investment from the IRA such as making loans vs the active flip which will get taxed at high rates. If you do well and make a 60% annual retrun from flipping inside the iRA, know that a large chunk of that will be taken away via UBIT cutting your annual returns down, then upon withdrawal at retirement, you get taxed again. So, the end return after UBIT should still be at least 30% or better or it is not worth the active effort it takes. You would be better served flipping outside an IRA and usingt the IRA funds to fund others flip deals, stay passive, stay inside all IRS rules, and avoid double taxation.
- Lender · Los Angeles, CA · Member since 2009 · 1k+ posts · 2k+ votes15yBut not if they’re so slow you can’t get a deal done. I have both a plain vanilla SDIRA and a gold plated self-directed 401k with checkbook control. My SDIRA is through IRA Services in San Carlos, CA. I use it to fund loans and couldn’t be happier. It typically takes them two days to review a deal and another two to fund. They've funded even faster when asked and I find them remarkably easy to deal with. Sounds like Equity Trust is a non-starter here.
Originally posted by Kevin Kaczmarek:
I am finding the same dental work that Jon is lately with ETC.
While checkbook control sounds and I am sure a good option, I personally prefer that layer of 3rd party protection in my dealings with SDIRA's. No matter how experienced you are in IRA's, having a 3rd party help look over your shoulder will help accidents from occurring and having the IRA become disqualified.In view of the speed in which you have to pay contractors, and the quantity of checks you’ll write, I’m not sure I’d even want IRA Services in this loop. Better to go the checkbook route in this case.Originally posted by Chuck Brickman:
… At this point it would be used for property flipping... - Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes15yJon, I don't have any links to reference for you at this time, perhaps the link mister Steve Babiak can assist, however, I do know this as fact:
Originally posted by Jon Klaus:
Will or Jon, do you mind posting links to resources that say how flipping in an IRA is subject to UBIT? And I'd love to see the IRS definition of flipping. Thanks.
"The government requires that all businesses in the U.S. pay taxes. If any business sells some or all of its products or services without paying taxes, it would have an unfair advantage over its competitors. For this reason, UBIT could be triggered if your IRA owns all or part of a business that earns its income through the sale of a product or service. Flipping real estate and developing land for resale are examples of investments that are considered "businesses" —which makes profits generated by such activities fair game for taxation." - Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes15y
jON - The IRS section 513 is the area that governs UBIT so you may want to reference that.
Here is alink I found on that section. If you can make sense of the lehgal mumbo jumbo run-on sentences in here, good luck,but it does verify what I stated above.
http://us-code.vlex.com/vid/sec-unrelated-trade-business-19209232 - Lender · Los Angeles, CA · Member since 2009 · 1k+ posts · 2k+ votes15y
The IRS doesn't define flipping or rehabbing with respect to UBIT, that I've ever found. Please chime in if you have a reference. Flipping is just another business activity and it considers your IRA just another organization, as should you.
You can read the code, specifically 26 U.S.C. §408 for IRA's (see §408(e)(1)) and 26 U.S.C. §511 for UBIT, but the best place to learn in real English is the IRS website definition itself itself and also IRS Publication 598. This publication actually presents many examples of organizations that are and are not subject to UBIT. It’s not for the faint of heart but not too bad. Tie your shoes tight and drink plenty of coffee before you begin.
Here’s the bottom line, direct from 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.Jon’s repossession would not be subject to UBIT because it was not a part of his business that he regularly carried on (at least not hopefully).
Jeff
- Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes15y
Pub 598 is what I read some years back on this topic. It goes through a number of examples of what is and what isn't subject to UBIT. There are a number of specific sources of income that are exemptions to UBIT. Two are passive investments; like loans, stocks or bonds; and rental income. But then for rental income there is a exemption to the exemption if the rental has debt financing.
In the same why fix and flipping is viewed as a "dealer" activity, its an active business rather than a passive investment. The example they use repeatedly is a non-profit university running a bookstore. Your IRA is just like the non-profit university. Running the bookstore is an unrelated business. So the bookstore income is subject to UBIT. Fix and flipping is an active business and so subject to UBIT. That's why, IMHO, making hard money loans to flippers is a better activity for an IRA. That's a passive business and not subject to UBIT.
My CPA agreed with Jeff regarding the repo situation. She discussed it with the IRS and they agreed, too. It didn't really matter to me, though, since the sale was at a loss.
- Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes15y
I agree, Jon's foreclosure and taking back the property is not subject to UBIT.
As I pointed out and Jeff has elaborated on, flipping is an active business and meets all 3 requirements for an unrelated business and therefore IS subject to UBIT.
- Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes15y
I understand. The university is tax exempt because it is an educational organization. The bookstore is an unrelated business.
The business of running a bookstore is unrelated to education because you can have a perfectly good school without a bookstore. That is clear.
What is not clear to me is, why is a for profit business unrelated to growing your retirement savings? The purpose of your IRA, it's mission, is to grow your retirement funds. How is a for profit business unrelated to that?
Everything I have read from the IRS about UBIT specifically talks about tax exempt organizations, typically section 501. That is an entirely different animal than a retirement account. So I don't see why it applies.
I am sure the answer is in letter rulings and court precedents. I would love to read the actual source documents that link UBIT to IRAs
- Louisville, CO · Member since 2011 · 13 posts · 11 votes14y
UBIT - Publication 598 directly links IRAs to UBIT. They are treated exactly like non-profits in many respects you can also refer to the information on the 990-T which is the tax return an IRA files to report the taxes. The instructions refer to IRAs and other plans as well. Including Health Savings Accounts (HSA), which can be self directed as well.
- Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes14y
Bill,
Thanks for the reply. Pub 598 does directly link IRAs to UBIT. However I saw nothing in there as to why (or what) would be unrelated to an IRA. If the IRAs purpose is to grow assets and income for your retirement, why would any method to do so be unrelated.
Thanks again - Ned
- Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes14yNed, you are reading into the term "unrelated" to literally. The reason a for profit business held in an IRA would be taxable is to level the playing field as stated before. Yes, the purpose of your IRA is to grow in value, however, if you use a regular business to do so rather than the passive approaches, you will be subject to UBIT, not because the business is "unrelated" to your IRA, but because the mans of the growth of your IRA competes with other like-kind business' which would give your IRA an advantage over others. This is soley why UBIT is applicable in flipping RE.
- Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes14y
Should you perform the active flipping business inside your IRA or not? This is the real question and can be answered only by each individual and the choices and abilities they have.
As a simplified example:
Lets say your IRA has $100k cash.
Option 1: Use the IRA funds to make a loan to another flipper at 10% annual interest (highest rate in CA without violating CA state usury law). If the loan is out all 365 days of the year, your IRA grows by $10k. (It is likely that there would be down time in between one loan to another so you would likely not get all 365 days of interest.Option 2: Your IRA purchases a $70k home, puts $20k in rehab and the balance $10k in holding costs for a total investment of $100k. Then sells the property for $140k, after re-sell costs, the IRA is left with $120k ($100k original investment and $20k profit. This entire process takes 4 months, then it is repeated 2 months later on a second investment using $120k in funds to net a total of $145k in the IRA at end of year. Now UBIT takes the share of the $45k profit (approx. 18k) and the IRA has now grown from $100k to $127k which is an anual return of 27%.
Decision time - Was your IRA growth of 27% worth the active efforts and time or is the passive approach gaining only 10% better? Only each investor could decide, but I would be happy with 27% returns in my IRA.
- Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes14y
Originally posted by Will Barnard:
Thanks Will,
That's the best explanation I have heard. I see now where you wrote it above.
The IRS sure has some twisted and conflicting interpretations of their own rules. But I knew that much already.
- Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes14y
Thanks Ned, sorry for the typos, my typing skills are not even in the same ballpark as my RE flipping skills! Typo correction is "means of the growth . . . "
I hear that! It is almost like they intentionally write it so confusing so that attorneys can have paychecks for explaining the non-sense.
What is so hard with simply stating -" if your IRA invests in competing active business, then it will be subject to UBIT" - end of story! - Real Estate Investor · paw paw, MI · Member since 2010 · 17 posts · 5 votes13y
[u]Just found this... more confused now.
Are the gains or income taxable from IRA real estate investments?
This is a frequently asked question. The answer is NO - in most cases.
If an IRA buys investment real estate and then sells it at a profit, all income generated while it was held in the IRA and all the gains resulting from sale WILL be either tax-deferred (regular IRA) or possibly tax-free (Roth IRA), IF the purchases were all cash with IRA funds.
If the IRA borrows to finance the purchases, any income and capital gain that is attributable to debt-financing will be subject to taxation. So, for example, if an IRA puts 50% down on a rental property and that property generates $10,000 net income after expenses per year, the IRA will be taxed on 50% of the net income (the amount financed) less the first $1,000 which is tax exempt, or $4,000 (e.g., 50% x $10,000 = $5,000, less the $1,000 exemption = $4,000). The tax is charged at the Trust tax rate schedule because an IRA is considered a Trust for the purpose of tax. The tax applied is called Unrelated Debt Financed Income tax or UDFI tax.
Similarly, when the property is sold, the IRA will have to pay capital gains tax on any gain that was debt-financed. For example, if the same property was sold two years after purchase for a $100,000 profit, 50% (assuming there had not been any reduction in the debt) of the gain, or $50,000, would be subject to tax at a rate of 15% (the current long term capital gain rate). This results in a tax of $7,500. The remaining $92,500 would go back to the IRA tax-deferred. The IRA would also have to pay UDFI tax on any income on the property in the year of sale. Finally, if the debt had been reduced through principal payments on the loan, then the amount of UDFI and capital gains tax would be calculated based on the average indebtedness over the twelve months prior to the sale. If all the debt had been paid off one year prior to the sale, there would be no capital gains or UDFI at the time of sale.
Are you saying that if I buy income-producing or other real estate using all cash and sell it for profit, that I never pay any tax?
No. If you buy real estate, stocks, mutual funds, etc. with a traditional IRA, without incurring debt to the IRA, all the profit and income flows through to the IRA tax-DEFERRED. You can buy and sell property for twenty years or more in an IRA without paying either capital gains or income tax, provided that the investments are not debt-financed. If some or all of the investments are debt-financed you will pay UDFI tax on the amount of income and capital gains that were generated using debt. But assuming, for simplicity's sake, that you buy 100 acres in Wyoming with cash and sell it 10 years later for a $400,000 gain after the [b]debt has been retired for at least twelve months, all of the proceeds would go back into the IRA tax deferred for the next investment.
You can continue to do this until you either voluntarily decide to take withdrawals from your IRA (penalty-free after age 59 ½), or until you are required to at age 70 ½. Once you begin to withdraw funds or assets from your IRA, you are taxed at current ordinary income tax rates on the fair market value of what you withdraw. If you withdraw $25,000 in cash, you have to add $25,000 to your taxable income as reported on your 1040 in the year of the withdrawal. If you withdraw 100 acres in Wyoming in one distribution (as opposed to fractionalizing the distribution over a number of years to reduce the one-time tax hit), you will have to have the property appraised and the value will be reported by the custodian as a taxable distribution on your 1099.
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