Wholesaling and Options in an IRA: How it Works


          When real estate investors discover they can use their IRA, solo 401(k) or other tax-exempt account to invest in real estate, they sometimes mistakenly think it will take a while to build up the balance needed
to get started with any type of significant real estate investing.

          It’s true that CONTRIBUTIONs are limited; in tax year 2021 (you can still make contributions for ’21 through April 15th, 2022) you can contribute up to $6,000 to a traditional or Roth IRA when you’re under age 50; up to $7,000 when you’re 50 and older.

          Despite these relatively low dollar amounts,
there are strategies for real estate investors looking for ways to grow their IRA in a short period of time. Provided you follow the rules, wholesaling or flipping options provide two such opportunities grow a small retirement account significantly.

Wholesaling in an IRA

          Wholesaling is essentially an A to B to C transaction. The seller is in some sort of position to sell the property at a discount. You as the wholesaler have the opportunity because you found this deal to negotiate a discounted price and sell it at a higher price to an end buyer: an investor who buys and rehabs properties.

          You can wholesale properties in your Roth IRA or traditional IRA, or a Coverdell education savings account (CESA) or a health savings account (HSA) and get the wholesale profit tax-free or tax-deferred.

          Here’s how it works: the property goes under contract in the name of the IRA or other account. For example, instead of the contract buyer listed as John Bowens, it will be listed as “Equity Trust Company custodian FBO (for benefit of) John Bowen’s
IRA.” Because I have my account with Equity Trust Company, I log into my Equity Trust account online. I key in all the information, and I request that Equity Trust Company writes the check or sends the wire transfer out to open escrow for my earnest money deposit.

          From there, the earnest money and any other expenses of the transaction MUST be paid for from your self-directed IRA. You can’t write a personal earnest money deposit for a property and then have your IRA benefit.

Wholesaling example: $500 into $10,000

          Let’s say I put a property under contract for $50,000. I then sell that contract to a rehabber for $60,000. I write an earnest money deposit to the seller, person “A” for $500. My total investment from my self-directed IRA is $500.

          Some active wholesaling investors might wonder, “why $500 down? Sometimes I only put a dollar down or $10.” A self-directed IRA is a tax-privileged account and there’s no clearly defined guideline in terms of $10 is not enough, but $500 is OK. It’s a rule of thumb that’s used in the industry. Check with your tax attorney or CPA to determine what they feel is in your best interest. But I know that a lot of investors prefer to put maybe a few hundred dollars down on a deal so that they have some “skin in the game.”

          In this example, I have $500 down, and a contract for $50,000 assigned to an investor buyer. The contract is assigned from B (my IRA, HSA, or CESA) to C
(the end buyer). My self-directed IRA may not have 50,000, but the account had enough for the earnest money deposit, secured the contract, and then assigned the contract to the end buyer.

          The $10,000 assignment fee (plus the $500 earnest money, which the end buyer needs to replace because it will be deducted from HIS purchase price at closing), will be paid directly to my IRA or other plan. And because it’s in my self-directed Roth IRA, there’s no short-term capital gains tax.

Real estate option example

          A real estate option is very similar to a wholesale transaction. The difference is that a real estate option gives the optionee the right to buy a property at a future date at a predetermined price, similar to a stock option.

          Here’s an example: This past year, an Equity Trust client named Chris bought an option to purchase a self-storage facility using her Roth IRA. The seller was in a distressed situation and agreed to give Chris’s IRA the RIGHT to buy the property in return for an option fee of $2,000, paid from her IRA.          

          Chris didn’t want her IRA to own a self-storage facility, but she knows investors in her network who are looking for commercial real estate deals. She found one of those investors--player C—and sold that investor her IRA’s option to buy the property for $20,000.

          Once player C owned the option, he was able to buy the self-storage facility directly from the seller at the agreed-upon option price.

          Her IRA invested $2,000 and made a $20,000 profit, tax-free because it was in her Roth IRA.

          The real estate option vehicle parallels the wholesale transaction vehicle; however, from a legal documentation perspective, they are two different transactions. In terms of preparing your real estate option contract versus a traditional purchase agreement, speak with your real estate attorney.

Things to consider about this strategy

          When using your self-directed IRA or other account for wholesaling or buying and selling options, be cognizant of your account being viewed as running itself like a business, and potentially being subject to unrelated business income tax (UBIT). If you perform too many of these types of transactions in one year, there is the possibility of triggering UBIT.

          In addition, when conducting these types of transactions, it’s important that there’s some “skin in the game,” or a significant capital investment, proportionate to the gains on the particular property acquisition.

Case studies provided are for illustrative and educational purposes only. Past performance is
not indicative of future results. Investing involves risk, including the possible loss of principal. Quotes and information included in the case studies and testimonials were provided by the investors and included with permission. Equity Trust Company does not independently verify all information provided by third parties.

Equity Trust Company is a directed custodian and does not provide tax, legal or investment advice. Any information communicated by Equity Trust Company is for educational purposes only, and should not be construed as tax, legal or investment advice. Whenever making an investment decision, please consult with your tax attorney or financial professional.

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