Flipping Vs. Cash-Flowing: Which Real Estate Investment Is Best For My Self-Directed IRA?

A self-directed IRA (SDIRA) gives you the opportunity to manage your own investments. This freedom allows you to invest your money in alternative assets. One particular alternative asset that has become ever-popular with the individual investor in recent years is real estate.

Using your self-directed IRA to invest in real estate is a great way to see a positive return and diversify your investment portfolio. But there are several things to consider before jumping in. 

When it comes to real estate, there are different property types in which you can invest - commercial, residential, industrial, and mixed-use. There are also different vehicles for investing, such as REITs, crowdfunding platforms, real estate related stocks, and private equity funds. There are even differences in terms of strategy regarding how you want your real estate investment to produce revenue. 

A common question real estate investors ask about revenue strategy is whether they should flip their properties or cash-flow them (i.e. buy and hold / rent). Both are great ways to put your money to work, expand your portfolio and take advantage of income-producing assets. 

Before making a decision, it’s important to understand some specifics of each of these options, however. Let’s take a look at some important things to consider as you explore which type of real estate investment strategy may be right for you.

Flipping Properties With a Self-Directed IRA

Property flipping continues to be a popular way to make a significant return on investment (ROI). Many people love the thought of purchasing a distressed property for a discount and turning it into the jewel of the block. In fact, in recent years, TV shows have played a big role in romanticizing this process. 

Using your self-directed IRA to invest in flipping your properties can be a great way to diversify, but here are some things you need to consider when doing this inside of an SDIRA.

No Sweat Equity Allowed

When flipping properties in your self-directed IRA, your role has to be much different than when you’re doing this outside of an SDIRA. You will need to be completely hands-off when it comes to the renovation work.

While you will still be making negotiations and performing the financial transactions, you cannot be on-site acting as a general contractor or performing any of the labor yourself. 

Any work you physically perform is considered adding value to your IRA, something the IRS prohibits. Make sure you are comfortable acting more as an investment manager rather than a contractor before moving forward with your flipping investment.

Unrelated Business Income Tax 

Unlike investing in stocks or even a cash-flowing property, flipping is considered an active investment. The profits you receive from a property flip are not under the same tax shelter as other investments and can be subject to Unrelated Business Income Tax (UBIT)

The details of UBIT are very nuanced and dependent on how often you use your IRA to flip real estate. A reliable and trustworthy custodian - someone who understands the tax implications and is up to date with IRS compliance requirements - can help you avoid prohibited transactions. The last thing you want is to make a costly tax mistake and negate your large returns. 

Large Up-Front Costs 

If you decide to go into flipping, make sure you keep in mind the upfront costs. You’ll need to invest in the cost of the property itself, then the cost of the repairs and any upgrades required. You will need a large amount of money before seeing any kind of return. 

Market Volatility

Something on everyone’s minds these days is rising interest rates. Market conditions and interest rates can affect how much the house will sell for. When interest rates are high, there may be fewer buyers looking for real estate, resulting in a lower sale price come time to sell.

Cash-Flowing Properties With a Self-Directed IRA

Cash-flowing properties are a common way to maintain a regular income month to month. Investing in rentals in your self-directed IRA is a great way to gain the steady, passive income most investors are searching for. Think about the following considerations when deciding if cash-flowing properties are right for you. 

Up-Front Costs

Similar to flipping, there will be the upfront cost of purchasing the property you plan to use for rental income. This upfront cost may also include updates and renovations, depending on the condition of the property and your income goals. 

You’ll also need to consider the property’s location and what you can reasonably expect as far as rental income. Some locations will not command the same prices as others. This is something to consider when you are initially purchasing the property and when you are planning upgrades or renovations. You want to make sure your return will be worth the investment. 

Regular Maintenance

Unlike a flipped property, you will be responsible for any repairs that need to be done for your cash-flowing property to remain up to code and appealing to renters. Similar to above, you cannot be the middle-man for any maintenance. All expenses must be paid directly out of your IRA. 

Hedge Against Market Volatility

Fortunately, once your rental property is purchased, your monthly income is not dependent on interest rates. There will not be a sudden drop or increase in the rent you collect due to conditions outside your control. While market conditions do have an impact on rental prices, it’s generally more stable. 

How Chicago Trust Administration Services Can Help

The beauty of self-directed IRAs is that you have the freedom and flexibility to decide where you want to invest your money. Investing in real estate is exciting and has the potential to provide you and your family with unparalleled returns. 

At Chicago Trust Administration Services, we want to come alongside you and help you tackle the complicated tax implications of real estate investing, whether you choose flipping or cash-flowing properties. 

We understand the ins and outs of using a self-directed IRA to invest in real estate and can help you understand the legalities of these types of investments. 

To see how we can help, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.

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*The content and opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

**CTAS professionals are not financial advisors and cannot provide advice or recommendations regarding specific investment decisions.