Purchasing properties as a real estate investment with the intent of quickly reselling the property is commonly referred to as flipping. This is achieved through either a hot real estate market, where property prices are appreciating rapidly, or by completing home renovations or capital improvements to increase the property’s value.
Wholesaling properties is when an investor purchases a property and then resells the property to another investor, often before the first contract closes. The investor does not need to hold a real estate license to wholesale. Income is made by finding the best home deals and then selling the opportunities to other investors that are willing to purchase and renovate the property for a future rental or flip.
Flipping, Wholesaling, and UBIT
The IRS addresses the issue of wholesaling and flipping but is not specific about the official definition and where the line is drawn. This is a significant gray area because if the investor is determined to be in the business of flipping or wholesaling properties, even in the context of an IRA, the full amount of the investment can be considered an unrelated business activity, rather than the more common debt financed scenario outlined throughout this site. This could place the tax-exempt status of the IRA in jeopardy.
If the IRS determines that the investor is flipping or wholesaling properties with enough frequency and volume, the investor could be considered to be operating a trade or running a business, rather than as an average retirement investor. All income would then be considered unrelated to the sole purpose of the IRA, which is to build a retirement fund. In essence, they may determine that you are in the business of flipping or wholesaling real estate instead of using real estate as an avenue to build for retirement.
An occasional real estate investor who buys a home or two in a given year is likely to be deemed as an investor building a retirement fund. An investor who purchases a home with their IRA and then rents it out and holds the asset is generally considered a retirement investor, not a business. If the investor is considered to be building their retirement fund then UBIT is only considered on any debt financed portion of a property purchase.
Essentially, the primary litmus test for wholesalers and rehabbers comes down to the frequency and volume of the real estate transactions. Investing your IRA in a few properties per year in order to build your retirement fund generally will not incur UBIT, but an investor who uses their IRA to wholesale or flip 10 properties per year, for example, is more likely for the IRS to deem as operating a business unrelated to the IRA.