Many people who are interested in investing in a self-directed IRA or Solo 401(k) retirement plan are drawn to property flipping because it is a popular investment interest. The opportunity to turn a profit by flipping houses has been strong in many markets over the past few years.
Since self-directed retirement plans allow people to have more control over their investment activities, it’s not surprising that flipping is so popular.
We wanted to take a step-by-step look at how a flip transaction would work in a self-directed IRA LLC. We’ll use the IRA LLC structure as an example because it is simpler, but the concepts are similar in a Solo 401(k) trust.
Understand the Strategy
A thorough evaluation of the flipping strategy is the most critical step in the whole process. Make sure you understand the restrictions on arm’s length transactions that apply to IRAs so you know what you can and can’t do.
You’ll need to figure out how much flipping you’re planning to do with your IRA, and whether that will make you subject to UBIT. If you find that your real estate investments are not performing as well as you would like, you may want to consider investing less frequently or looking into alternative approaches, such as private lending to people who flipping houses.
Understand your Market
Is flipping the right strategy where you live? There is no definite answer as to whether it is a good time to buy a house or not. This is because it varies depending on numerous factors, such as the age and condition of homes, pricing trends, and who is buying currently.
You should only consider flipping a property if you think it will be successful.
Setup your Checkbook IRA or Solo 401(k) Plan
You will need to have a retirement plan set up before you can start working on deals.
In order to write an offer, you need to be named under the plan and any expenses like earnest money or inspections need to be paid for with funds from the plan.
You will need to be able to act immediately if you are planning to purchase from an auction or a wholesaler. If you want to set up and fund a plan, it will take 3-4 weeks, so you need to be ready in advance. If you don’t have a plan, you will miss out on great opportunities.
If you’re interested in flipping, you should look into a self-directed plan that will give you control over your money, like a Checkbook IRA LLC or a Solo 401(k).
Purchasing the Property
There are various ways to acquire properties to flip; you can buy them from a regular real estate agent, from a bulk property seller, or at an auction. The LLC will always be the purchaser of property and will be on the title.
As the manager of the LLC, you have the authority to negotiate the terms of purchase and execute contracts for purchase.
You can also use your LLC-held bank account to wire, ACH, or cashier’s check funds to purchase the property. You are authorized to make all decisions for the LLC without needing approval from anyone else.
Insure the Project
It is important to insure your IRA investment against potential losses or liability.
When you “flip” a property, you are essentially buying and selling it very quickly, which can create a lot of exposure to risk in both the purchasing and selling process. To protect yourself, you need to have specialized insurance coverage.
Because vacant flip properties are typically obvious when they’re being worked on, they can be prime targets for thieves and vandals. If anything is stolen from the job-site, your IRA LLC will need to be covered.
Create your Project Plan
The step of acquiring the property may happen before or after the purchase, depending on how the property is acquired. After evaluating the necessary repairs and upgrades, obtain quotes from your contractors, and develop a solid project plan for the rehab.
It’s crucial to have a clear scope of work and the right team in place with a workable schedule when you’re flipping a house. If you have the expertise, you can perform this part of the project as the LLC manager.
You can hire someone to manage the rehab process for you.
Step Back and be the Fund Manager
As a person who is not legally allowed to be a part of your IRA, you are not allowed to have a lot of responsibility in executing the project plan.
You shouldn’t provide goods or services to the IRA in order to add value. You should not get any permits or use your personal licenses for the project. You don’t want to have to make trips to the hardware store every day to get supplies for your contractor.
No Credit Accounts
A common question we often hear is, “Can an IRA LLC get a credit card or commercial account for a flip project?”
The appeal of borrowing money, accessing commercial discounts, and collecting rewards points are all appealing. Unfortunately, this isn’t possible in a self-directed IRA.
A personal guarantee cannot be given for any debt instrument used by an IRA. A party that has been disqualified would violate IRS rules if they were to do something. So far, we haven’t found a bank that will give a credit card to an LLC that is owned by an IRA without the person guaranteeing it themselves.
Market the Property
To profit from your flip property, it is important to market it properly to potential buyers.
Some investors like to put up a sign on the property on the day construction starts in order to generate excitement. It may be better to wait until the project is done and the house is clean to attract better quality buyers.
When you are trying to determine the best time to start marketing your house, you will need to consider the type of neighborhood it is in, how long it is likely to stay on the market, and how much it is likely to sell for.
The quality of your marketing efforts should not be compromised regardless of how you choose to time them.
The Sale
As the LLC’s manager, you have the authority to negotiate and complete sales on its behalf.
Make sure the LLC is listed as the seller of the property, and use the LLC tax ID. The title company or attorney will need to issue form 1099-S to report the income to the LLC. This is not a problem.
The IRS will not expect the income from the LLC to be reported on a tax return because they will be aware that it is wholly owned by a tax-exempt IRA.
When the trade is completed, the LLC will get its money from the bank, and the IRA will get its share as well. Your next job is to find an investment opportunity for the IRA money.
BONUS: How to use a Self Directed IRA to Invest in Real Estate
What is a Self-Directed IRA and 401(K)?
The majority of individuals consider stocks, bonds, and mutual funds when determining their IRA or 401(k). Most retirement accounts are made up of investment vehicles like stocks and bonds, so it makes sense that people would be confused.
A self-directed IRA means that you can choose from a wider range of investment options for your retirement funds. The options available to you depend on the financial institution you are working with.
You can choose to invest in traditional index funds and individual stocks with popular providers like Vanguard, Schwab, and TD Ameritrade. If you’re only interested in investments of that type, those providers can be great resources.
There is a different level of self-direction where you can choose your own investments from a larger selection. These self-directed providers, like us, enable you to not only select your own investments, but also invest in assets such as real estate, debt instruments (private mortgages), privately held companies, and digital assets such as bitcoin.
Contribution Limits and Distributions From Self-Directed IRAs
There are no special rules or regulations for self-directed retirement accounts. There are limits to how much you can contribute to the account each year.
Here’s a chart of the current contribution limits for all IRA accounts:
TRADITIONAL or ROTH IRA CONTRIBUTION LIMITS | 2020 |
Age 49 or younger | $6,000 |
Catch Up Contributions Age 50+ | $7,000 |
You may withdraw money from your self-directed account at any time. If you withdraw money from your account before you are 59.5 years old, you will have to pay a 10% penalty (as well as any income taxes that may apply). There are some people who are interested in early retirement and who share strategies for accessing retirement money early without penalty.
In addition, remember that if you already have a Traditional IRA, Roth IRA, or 401k from a previous employer, you can transfer (i.e. roll over) funds to a self-directed account. You don’t have to move all the money from your current account. A portion of the funds can be transferred to American IRA or another self-directed custodian to invest in real estate.
Now, let’s look at how that process works.
Real Estate in your Self-Directed IRA
. . A self-directed IRA that invests in real estate is an IRA or 401(k) that buys an investment property . . . This means that you cannot use your real estate IRA to purchase your primary residence or vacation home.
The IRS is concerned that you are investing your self-directed retirement accounts in a way that will not generate income. This means you can invest using real estate strategies like:
- Private mortgages (i.e. loans)
- Rental / income properties
- Land
- Tax liens
- Fix and flip properties (i.e. can be quickly resold for a profit)
- Wholesale properties (i.e. flipping to other investors)
- New construction “spec” homes (i.e. it’s built before a buyer is found, a lot like a fix and flip).
Investing in real estate through a self-directed IRA account can be profitable and legal. As someone who works at American IRA, I get to see some of the most creative investors and dealmakers in the business. By using their skills in real estate and entrepreneurship in a self-directed IRA account, they have been able to grow their wealth significantly.
We want to be clear that you could lose money by investing poorly. It is a good idea to learn from other people’s mistakes and from websites like coachcarson.com, so that you can avoid making the same mistakes yourself.
Some of the benefits of investing in rental property through a self-directed IRA include: -The ability to use your retirement savings to invest in a stable asset -The potential to earn high rates of return on your investment -The potential to hedge against inflation -The ability to diversify your retirement portfolio
The Rules for Investing in Real Estate With a Self-Directed IRA
There are two key concepts to understand when making self-directed investments. You want to analyze:
- Who is involved in the transaction
- What individuals and companies are providing services
The IRS prohibits purchasing assets from or selling them to “disqualified persons/companies” in order to prevent self-dealing within these retirement accounts. A person who is not qualified cannot receive a benefit or provide services to your retirement account’s investment assets (such as a rental property).
To stay within the rules, you must first understand who the disqualified persons and companies are.
Disqualified Persons/Companies
The chart below explains which individuals and entities are disqualified from entering into transactions (such as loaning, borrowing, or selling) with your self-directed IRA or 401(K) account.
Disqualified Services
Make sure that you are aware of the services done on behalf of your retirement account’s investments. Real estate agents and closing attorneys/escrow offices cannot be disqualified persons or companies for a transaction.
For many of you in the DIY crowd, you will not be able to do any work on the property yourselves. The IRS views this as an excessive contribution (you are contributing too much money to your account).
If you, for example, put a new roof on the property or install a new kitchen yourself, this will add value to the property. In other words, you can’t complete the necessary work for that roof or kitchen. You cannot have your IRA (or property management company) complete the work. You must hire out third party individuals or companies.
We suggest that you continue to study as there are other nuances to these rules. If you learn the main rules, you can avoid any big problems.
The people you would need for a Real Estate IRA transaction are as follows: a real estate agent, a real estate attorney, a financial planner, and a tax advisor.
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