Quincy Long said in the following article* that you can flip real estate options in a SD-IRA. Can this be done multiple times per year without being classified as a “dealer” ? Because it’s options and not physical real estate would the “dealer” status not apply ?
Also, if the option flipping is done frequently, would I incur UBIT because I’m carrying on an “active business” ?
Are there ways to avoid UBIT and still do multiple option flips in a SD-IRA ?
You ask some very good questions in your email about flipping options. The key to understanding the rules for self-directed IRAs is to always remember that an IRA is intended to be for investment purposes only. People make the mistake all the time of trying to effectively run a business using their personal services for the benefit of their IRA, which is a prohibited transaction. The Tax Court has given the IRS a win in a number of cases where people have done this.
IRS Publication 598 may be of some assistance in answering your questions about Unrelated Business Income Tax as it applies to options. According to Publication 598, “Unrelated business income is the income from a trade or business regularly conducted by an exempt organization and not substantially related to the organization of its exempt purpose or function, except that the organization uses the profits derived from this activity.” So the question as it pertains to options is whether or not the activity would be considered a ‘trade or business’ which is ‘regularly conducted.’ One way of determining how the IRS might view this is to ask your CPA how he would report the income on your personal income tax return if it was done outside of the IRA. If his answer is that it would be reported on Schedule C, then it almost certainly will cause the IRA to owe UBIT, and may cause even more problems, depending on the circumstances.
Specifically on options, IRS Publication 598 states (on page 10), when speaking of exclusions from UBI, “Lapse or termination of options. Any gain from the lapse or termination of options to buy or sell securities is excluded from unrelated business taxable income. The exclusion applies only if the option is written in connection with the exempt organization’s investment activities. Therefore, this exclusion is not available if the organization is engaged in the trade or business of writing options or the options are held by the organization as inventory or for sale to customers in the ordinary course of a trade or business.” [emphasis added] While not precisely speaking about real estate options, it is pretty clear that if you trade options at a level where they would be considered as inventory for sale to customers in the ordinary course of a trade or business it will cause the IRA to owe taxes. This is analogous to a flipper of real estate. Think of the company who ‘buys ugly houses.’ To a franchisee of that organization, a house is just inventory, because they are a real estate dealer. I think if you trade too many real estate options you could land in the same situation as a real estate flipper.
So how many options can you do? How much can you do before you are providing ‘services’ to your IRA in violation of the prohibited transaction rules, as opposed to merely making investment decisions? These are questions that cannot be answered with certainty. The best guideline I can provide you with is to make sure all of your IRA transactions are structured and treated as investments, and not the resale of inventory. Purchasing and selling an option on real estate once is most likely not a business activity, and you are not likely to be considered to be providing a service to your IRA other than investment selection. Do that same transaction 25 times in the same year in the same account and it changes character. Where the line is I cannot tell you. Remember also that you can self-direct a traditional IRA, a Roth IRA, a SEP IRA, a SIMPLE IRA, an individual 401(k), an HSA, and a Coverdell Education Savings Account (CESA). You may have multiple accounts for you and your family. Unless you are very active, in general you should have no problems with having your IRA become a dealer in options.
The best advice is to have a mix of different types of investments in your IRA. If you hit a home run on some of them then that’s great for your retirement. Good luck with your investments!