Solo 401k sense

[Shawn Root]

Hello everyone.  Thanks for all of the great info on these forums.

A little history....

I have a decent job that I don't want to leave anytime soon, but I realize that I am not going to have the kind of retirement I want unless I start taking better control of my retirement money.  I have almost 300k sitting in some old retirement accounts.  They haven't been growing very much and I'd like to use that money to invest in real estate.  I was once an accidental landlord because I kept a home I had when I moved and rented it out.  I made many typical mistakes, including renting to family.  

I've been puzzling over the solo 401k and solo IRA options that some people are recommending and I'm having trouble working through the numbers, so I have a few questions.

1. Is the amount lost to immediate taxes and penalties really that detrimental over the life of the investment when you take into account the ability to do your own work on properties (cheaper) and things like depreciation. What about the UBIT? Does that change the analysis? If you are holding in an LLC, doesn't it have to pay some taxes?

2. Is it really possible to get non-recourse financing for properties held by the retirement account? How hard is it to find those banks? How onerous is it? How much extra in interest rate and how much less LTV will they loan?

3. The Roth versions seem like interesting options.  How well do they protect all of the income and profit from appreciation?

Thanks for your help.

Shawn

[Kevin E.]

I'm interested in this exercise as well.  I don't have the credentials to give you any advice, just trying to clarify the question.  So for the sake of your side-by-side comparison, you want to figure out the after-tax value of $300,000 at retirement, with the constants you've established:

Purchase real estate (as opposed to notes, tax liens, etc) by leveraging $300,000 currently held in a retirement account

Assuming a 33% tax & penalties loss for all distributions.

Assume that the investment would perform equally in both scenarios, with the following exceptions:

• Property held in retirement funds require using an unrelated party for maintenance and other "blue collar" tasks. Have you put a price tag on your labor vs contracted labor? Give us your best estimate of the percentage to include in the maintenance/repair/replacement costs
• Property held in an SDIRA would require setup and administration fees, including the establishment of an LLC for greater check control, as you mentioned. Has someone out there determined a reasonable cost for this as a percentage of Gross Income?
• If could establish a simple business and qualify for a Solo 401k instead, theoretically you could dispense with the LLC and save on some of those setup and administration costs. Anyone want to throw out a theoretical cost difference between SDIRA/LLC vs Solo 401k setup and administration? You would want to include the cost of UBIT in the IRA option.
• What else?

For capital gains, with the retirement account your pre-tax appreciation dollars are taxed at retirement. On the other hand, your post-tax Roth, and a little less than $500,000 of your post-tax non-retirement dollars (if you choose to 1031-exchange your way into your eventual retirement home and use the Section 121 exclusion), would be tax-free.  You would have to assign a value to the cost of taxing your retirement dollars now or later.

For depreciation, you're deferring post-tax/penalty dollars that will be repaid at retirement (assuming you want to actually spend your retirement funds and not just 1031 them till death and take advantage of stepped-up basis). I'm curious to see a calculation that accounts for this over time. As best as I can see, that $800,000 investment should spit back at least $20,000 in depreciation deductions each year, which pays for your $100k tax/penalty for the early distribution in about five years and could be leveraged into an additional $80,000 of property each year. At retirement, your recapture rate would be 25% verses whatever your retirement distribution tax rate would be.

In either case you get to borrow from the IRS, so you would have to decide if that $20k/year loan outside the retirement account is better or worse than the tax-deferred loan you'd be paying back with 10% interest by taking the early distribution

Finally, there's the marriage consideration. If my wife found out I was making an early distribution from my 401k/IRA to invest in real estate, given the questionable purchases I've made thus far, I would be made to sleep outside of our owner-occupied primary residence and be highly depreciated.