Clay Malcolm covers some important notes about UBIT, unrelated business income tax, and your fix and flipping business.
As mentioned before, you’re able to invest in real estate with your SDIRA but depending on how many properties you flip, the IRS might see it as a flipping business and UBIT will be applied. Talk with your legal team for advice.
Mike: Welcome back to the flipnerd.com REI Classroom, where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Clay: Hi and welcome to the REI Classroom. My name is Clay Malcolm from New Direction IRA. And today, we’re going to be talking about UBIT considerations for fix and flippers.
Mike: This REI Classroom real estate lesson is sponsored by uglyopportunities.com.
Clay: UBIT, as you may now, is unrelated business income tax. And in some cases, the way that your IRA invests can incur UBIT because of the nature of the asset. Fixing and flipping is one of the ways that that come into play sometimes. As you probably know, your IRA can go out and buy a piece of real estate and it keeps its tax advantages whether it’s a traditional or Roth or even an HSA. When it purchases that property, if the property needs a fix-up, the IRA can pay for that as well and realize the profits from that rehab, so obviously a fix and flip.
Now the profits on a single fix and flip usually wouldn’t incur any UBIT because that’s really just your IRA finding a deal, making the most of it and receiving the proceeds, which is pretty much normal procedure. Now, if you start to do that procedure over and over again, what might happen is that the IRS starts to see your IRA as operating a fix and flip business rather than simply acquiring an asset and selling it to make a profit. And the reason that that comes into play for the IRS, of course, is because if they consider your IRA to be an on-going business, they want to make sure that that business is paying business tax before the investor gets their dividends or profits, just the same way as you would if you invested in Apple stock or GM or something like that. They pay business tax before their investors see any of the return.
When it comes to fixing and flipping, of course, it’s an interesting line because there’s not a black and white number of fix and flips that you can do in a particular or given a time period that will say, “Okay, this is the line where you went from simply finding assets, fixing them and buying them to an on-going fix and flip business.” So at some point after you start making these types of moves in your IRA, you certainly want to talk to your financial and legal team about how you want to handle that. And under any circumstances, incurring UBIT is not a penalty. There’s nothing wrong with it. It’s not illegal. It’s just one of those things that are a cost of doing business in your IRA.
And so what you would do is get your IRA a Tax ID Number, go to your CPA or whoever your tax person is and start to file 990-Ts. That’s the form that the IRA files to calculate UBIT. In this particular case, what you will be calculating is unrelated business taxable income, in other words, the net profit that was achieved by the business and that would be taxed at the trust and estate rate. So one of the considerations that IRA fix and flippers need to think about is, “How could I mitigate that if I wanted to?” And the answer is, of course, your IRA could own a C corp because in that arrangement or even in LLC that has C corp type taxes associated with it. In that case, your IRA would own a business, but the business would have already taken care of the business tax and so the business tax would not come back to your IRA in the form of UBIT.
So there are a few ways to get around it even if your IRA is going to be a fix and flip operating business. And again, in a lot of cases, this cost of doing business is well outweighed by the profit that you’ll make on the deals that you’re getting into. One of the things that I will say about fix and flippers in an IRA is that, of course, you can’t do the work yourself. The IRA holder and all disqualified persons are prohibited from doing the work themselves. So make sure to have your IRA fix and flip business hiring non-disqualified vendors to do the work on the property. But other than that, make sure you consider UBIT when you start doing multiple fix and flips, and happy investing. We’ll see you next time.
Mike: HomeVestors, the “We Buy Ugly Houses” folks, is a franchised system of hundreds of real estate investors that have purchased over 65,000 houses. If you’d like to learn more about the most powerful real estate investing system in existence, whether you’re a pro looking to take your business to the next level or whether you have no experience at all, but a burning passion to be successful in real estate investing, please visit FlipNerd.com/ugly to learn more.
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