Over the last several years, a growing number of self-directed IRA and solo 401(k) plans have looked to make investments in short-term rental properties listed on popoular websites such as Airbnb and HomeAway.com. The idea about using retirement funds to make the investment is that all income and gains would be tax-deferred or tax-free in the case of a self-directed Roth IRA or Roth 401(k) Plan.
Airbnb is the most popular short-term rental site. Since the company launched in 2009, it’s grown from helping 21,000 guests a year find a place to stay to helping six million a year go on holiday, and currently lists a staggering 800,000 properties in 34,000 cities across 90 different countries.
Since the creation of IRAs back in the early 1970s, the IRS has always permitted a real estate IRA to purchase, hold, or flip real estate. In fact, it states it right on the IRS website. By using a self-directed Roth IRA to buy real estate, one will be able to purchase real estate or flip homes tax-free and without requiring custodian consent! In fact, the Internal Revenue Code does not describe what a self-directed IRA can invest in, only what it cannot invest in. Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain types of transactions. In general, as long as the self-directed IRA does not purchase life insurance, collectibles, or engage in a prohibited transaction outlined in Code Section 4975, then the investment can be made.
A traditional IRA custodian (financial institution) will not allow you to purchase real estate using your IRA or retirement funds. Therefore, in order to have the ability to engage in house flipping transactions using retirement funds, a Self Directed IRA LLC is a great option.
In general, most passive investments that your Self-Directed IRA might invest in are exempt from UBTI. Some examples of exempt type of income include: interest from loans, dividends, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate. However, the following types of income could subject a Self-Directed IRA to the UBTI tax:
- Income from the operations of an active trade or business through a passthrough entity, such as an LLC.
- Using a nonrecourse loan to purchase a property (there is an exception for a 401(k) plan)
- Using margin on a stock purchase
The IRS does not offer much guidance on the use of self-directed IRAs and short-term rentals, such as Airbnb, especially with respect to Unrelated Business Taxable Income Tax (UBTI) rules.
This is the only IRS guidance on the issue with respect to UBTI:
Treas. Reg. § 1.512(b)-1(c)(5)6 is the most important regulation in this area and provides:
[P]ayments for the use or occupancy of rooms and other space where services are also rendered to the occupant, such as for the use or occupancy of rooms or other quarters in hotels, boarding houses, or apartment houses furnishing hotel services, or in tourist camps or tourist homes, motor courts or motels, or for the use or occupancy of space in parking lots, warehouses, or storage garages, does not constitute rent from real property. Generally, services are considered rendered to the occupant if they are primarily for his convenience and are other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only. The supplying of maid service, for example, constitutes such service; whereas the furnishing of heat and light, the cleaning of public entrances, exits, stairways and lobbies, the collection of trash, etc. are not considered as services rendered to the occupant. Payments for the use or occupancy of entire private residences or living quarters in duplex or multiple housing units, of offices in any office building, etc., are generally treated as rent from real property. (emphasis added).
Therefore, it would appear that as long as one would not be providing daily maid services with respect to the short-term renal operation, the investment should not be treated as a hotel or motel type of income stream and would generate rental income that would be exempt from the UBTI tax rules.
Using a self-directed IRA to make short-term rental investments via an Airbnb website, for example, could provide to be a great way to invest in what you know and understand as well as generate tax-deferred or tax-free income, in the case of a Roth.
Adam Bergman is the founder of the IRA Financial Group & IRA Financial Trust Company. For more information on this topic please call 800-472-0646.