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[ Follow Ups ] [ Post Followup ] [ The Forum Board ] [ FAQ ] Re: Self Directed IRA and Flipping... Capital Gain??? Posted by Richard on November 06, 2009 at 1:14 PM In Reply to: Re: Self Directed IRA and Flipping... Capital Gain??? posted by Richard on November 06, 2009 at 12:50 AM It is important to understand what you can do with a self-directed IRA but it is just as important to know what you cannot. Most self-directed IRA investors know that it is prohibited to invest retirement funds in life insurance, collectibles or any investment that involves a “disqualified person” (certain close relationships). One important factor that impacts the investment choices of self-directed IRA investors and is often overlooked or misunderstood is Unrelated Business Taxable Income or UBIT. UBIT is a special tax that Congress created to apply to tax-exempt entities that produce income from business activity rather than passive investments. In addition to churches, charities and non-profits, IRAs are also affected by UBIT. The focus of this article is how this can impact a self-directed IRA. The types of income that could subject an IRA to UBIT those earned from the sale of a product or service, whether retail or wholesale and regardless of ownership percentage. If your IRA buys a gas station and earns its income from the sale of gasoline, potato chips and cigarettes, this income is clearly business income – you were selling (or exchanging) products. (Such an investment would be impractical as well because if your IRA owned the asset you would be barred from working for or managing that store personally or even shopping there!) Where self-directed IRA investors are most likely to encounter UBIT is in certain types of real estate projects. However this is where the most confusion is found. The types of real estate projects where a self-directed IRA investor would most commonly face UBIT are on the profits generated as a result of rehab/flips or development /construction projects that result in resale. In contrast, incomes from properties purchased for appreciation and/or rental incomes are exempt from taxation in an IRA, unless the property is purchased on leverage—which is an entirely different topic that will be covered in a separate article to follow. The area where investors (and OFTEN their tax advisors!) get confused is in determining which projects produce business income (where UBIT would apply) or simply passive, tax exempt income.The IRS and the tax courts use a series of tests (There are up to 10 factors that can be considered) to determine if an activity is a passive investment or a business activity. No single one of these factors is more important that the others, and no one factor is determinative. Here are some of the most common tests used in no particular order: 1. Intent – Did the individual buy the property with the intent to hold the property for appreciation? Or did the individual buy the property to resell it quickly? If the intent was to hold for appreciation this is a strong indication that it is an investment and not taxable to the IRA. If the intent was for resale that is a strong factor that the activity will be deemed a business and taxable to the IRA. 2. Marketing – Marketing activities include any activities that are designed to attract a potential buyer. The longer you advertise and the more aggressive the marketing, the more likely your investment may be considered a business and be subject to UBTI. 3. Inventory Replacement – If your IRA sells an asset and then replaces that asset with another similar asset to be sold this is holding the property only as inventory. The more rapid or frequent the replacement and resale cycle the more likely that UBTI taxes will apply. Follow Ups: Re: Self Directed IRA and Flipping... Capital Gain??? jmac 1:32 PM, 11/07/09 (0) Re: Self Directed IRA and Flipping... Capital Gain??? Peter 7:07 PM, 11/06/09 (4) Re: Self Directed IRA and Flipping... Capital Gain??? Ed 2:58 PM, 11/08/09 (0) guess I need to learn more Peter 9:56 PM, 11/06/09 (2) Re: guess I need to learn more Dawn 1:53 PM, 11/07/09 (0) Self Directed IRA and UBIT, Roth Conversion, etc Dawn 9:59 AM, 11/07/09 (0) Post a Followup: Name : E-Mail : Subject : Comments: : It is important to understand what you can do with a self-directed IRA but it is just as important to know what you cannot. Most self-directed IRA investors know that it is prohibited to invest retirement funds in life insurance, collectibles or any investment that involves a “disqualified person” (certain close relationships). One important factor that impacts the investment choices of self-directed IRA investors and is often overlooked or misunderstood is Unrelated Business Taxable Income or UBIT. UBIT is a special tax that Congress created to apply to tax-exempt entities that produce income from business activity rather than passive investments. In addition to churches, charities and non-profits, IRAs are also affected by UBIT. The focus of this article is how this can impact a self-directed IRA. The types of income that could subject an IRA to UBIT those earned from the sale of a product or service, whether retail or wholesale and regardless of ownership percentage. If your IRA buys a gas station and earns its income from the sale of gasoline, potato chips and cigarettes, this income is clearly business income – you were selling (or exchanging) products. (Such an investment would be impractical as well because if your IRA owned the asset you would be barred from working for or managing that store personally or even shopping there!) Where self-directed IRA investors are most likely to encounter UBIT is in certain types of real estate projects. However this is where the most confusion is found. The types of real estate projects where a self-directed IRA investor would most commonly face UBIT are on the profits generated as a result of rehab/flips or development /construction projects that result in resale. In contrast, incomes from properties purchased for appreciation and/or rental incomes are exempt from taxation in an IRA, unless the property is purchased on leverage—which is an entirely different topic that will be covered in a separate article to follow. The area where investors (and OFTEN their tax advisors!) get confused is in determining which projects produce business income (where UBIT would apply) or simply passive, tax exempt income.The IRS and the tax courts use a series of tests (There are up to 10 factors that can be considered) to determine if an activity is a passive investment or a business activity. No single one of these factors is more important that the others, and no one factor is determinative. Here are some of the most common tests used in no particular order: : 1. Intent – Did the individual buy the property with the intent to hold the property for appreciation? Or did the individual buy the property to resell it quickly? If the intent was to hold for appreciation this is a strong indication that it is an investment and not taxable to the IRA. If the intent was for resale that is a strong factor that the activity will be deemed a business and taxable to the IRA. : 2. Marketing – Marketing activities include any activities that are designed to attract a potential buyer. The longer you advertise and the more aggressive the marketing, the more likely your investment may be considered a business and be subject to UBTI. : 3. Inventory Replacement – If your IRA sells an asset and then replaces that asset with another similar asset to be sold this is holding the property only as inventory. The more rapid or frequent the replacement and resale cycle the more likely that UBTI taxes will apply. [ Follow Ups ] [ Post Followup ] [ The Forum Board ] [ FAQ ] WWWAdmin 2.0a © 1997 Matt Wright and DBasics Software Company, All Rights Reserved

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