Partnering on a Flip using SDIRA

9 Replies

I am partnering on a fix and flip using my SDIRA. We are still in the process of closing on the property. My partner and my SDIRA will be partial owners of the property.

My partner will then use their money to pay for the renovations and when we sell we will have a 75/25 split in profit. Them getting the 75 because they will be doing the work and funding the rehab.

Is there anything wrong with doing this? I just want to make sure that everything is legal.

What if they run out of money? What if they don't complete the renovation? What if they die in a parachuting accident? There is nothing wrong with your deal unless something goes wrong. 

@Eulogio Villasenor

You should probably stop and get some qualified counsel on board.

There is risk in what you propose, though there is risk in any investment.  Controlling that risk with knowledge and good contracts is prudent.

From an IRA perspective, there is also a concern. Flipping is a trade or business. When a tax exempt entity like an IRA engages in a trade or business on a regular or repeated basis the gains become subject to taxation as Unrelated Business Taxable Income (UBTI). This is a topic to review with your SDIRA custodian. One flip is probably not a concern, but using this strategy with regularity could be problematic.

An IRA is designed to receive passive income like dividends, interest, rent from real property, etc. Perhaps being a lender to this flipper would be lower risk and more in line with IRS rules for IRA plans.

@Brian Eastman if I did lending? How would that work? Lend the amount for them to complete their purchase of the property and the amount for rehab in on loan? Like a hard money loan?

Also, how would I structure profit? I’m planning on getting 25% of profit after all costs.

@Eulogio Villasenor

If you are getting an equity split, then you have equity participation in the trade or business transaction.  A note is for a set rate of interest not contingent on the profitability of the enterprise.

I suggest you get qualified counsel on your team. What you are aiming for and thinking is simple, is less simple than you might be thinking. The time to educate yourself about IRS rules for an IRA is before you start making investments.

Originally posted by @Eulogio Villasenor :

I am partnering on a fix and flip using my SDIRA. We are still in the process of closing on the property. My partner and my SDIRA will be partial owners of the property.

My partner will then use their money to pay for the renovations and when we sell we will have a 75/25 split in profit. Them getting the 75 because they will be doing the work and funding the rehab.

Is there anything wrong with doing this? I just want to make sure that everything is legal.

I have seen many taxpayers jeopardize the IRA because they don't know even the basic rules.

Prohibited Transactions:

While the IRS does not dictate investment assets, it does have rules regarding whom an IRA may have transactions with. Breaking these rules will threaten the tax-advantaged status of the IRA investments and could cost the investor a lot of money, so the key guidelines should be reviewed.

An IRA may not have a "transaction" with or for the benefit of the following "disqualified persons":

  • The IRA owner.
  • The owner's spouse.
  • The owner's ascendants (parents and grandparents).
  • The owner's direct descendants (children and grandchildren).
  • The owner's direct descendants' spouses.
  • Certain fiduciaries (CPAs, attorneys, financial planners, etc.).
  • Retirement plans held by disqualified persons.
  • Any entity that these persons own or control.

“Prohibited transactions” include:

  • Selling something the IRA owner already owns to the IRA.
  • Buying something from the IRA.
  • Being compensated by the IRA.
  • Extending credit to the IRA.
  • Having personal use of the assets in the IRA.
  • Pledging the IRA to secure a personal loan.

The reasoning behind these rules is straightforward: They prevent any "funny business" with people attempting to create a non-retirement benefit from their investments or to pay non-market values for assets to rig deals to benefit their families. The bottom line is that disqualified persons are not allowed to derive any immediate benefit from the account, meaning, for example, they cannot live in or use real estate owned by the IRA.

Here are a few other IRA facts that frequently come into play and that should be considered when choosing assets while protecting the tax-advantaged status of an SDIRA:

  • Physical precious metals in an IRA may not be held directly by the IRA holder.
  • An IRA can loan money out with or without collateral attached to the note.
  • An IRA can purchase an interest in a private company expressed as shares of stock or equity ownership.
  • An IRA holder may not perform sweat equity on a real estate asset.
  • An IRA holder may not receive compensation from an IRA-owned asset.
  • An IRA can secure a loan to purchase a real estate asset but it must be "non-recourse" to the IRA holder or other disqualified person.
  • Unrelated business income tax (UBIT) may apply to IRAs that own leveraged real estate or an ongoing, revenue-producing business.
  • An IRA can pay vendors (from lawn care to legal work to insurance coverage) to service assets in the account.
  • An IRA can purchase assets with partners (people, even family members; companies; other IRAs; etc.).

@Eulogio Villasenor

I would look to engage the transaction as a lender instead of an equity partner.

You may want to consider a large interest rate to make up up for the 25% equity that you were expecting.

UBIT are concerns if you act as an equity partner in a flip.

Best of luck