Donated Down Payment

[Lindsey Smith]

Hi! I'm new to Bigger Pockets and happy to be here. I am gearing up to buy my first rental property within the next six months. My husband owns his own small business, and I am forming a LLC in my name to keep the rental completely separate from, and add an extra layer of protection for his business. We would like to be able to use money from his business to help fund the down payment, and are not sure about the best way to do that. Do we need to pass it through payroll (where it will be taxed accordingly), to our joint account, and then route it to my business account? Or, is there a way for his business to gift/donate the money to my business (no repayment planned, as it would not be a loan)? That option seems similar to partnering with an investor, with no expectation of repayment. Also, I'm wondering if partnering with a private investor (private citizen) is any different from a private investor (company).

[George Blower]

Originally posted by @Dion Longo:

Hi Lindsay and BP community! I'm very excited this is my first post and I've been following BP for over a year intensely. I am also interested in this subject as well. I have a self directed 401k account and would like to use it for investing in my real estate LLC. I really need it broken down into laymens terms to understand it. Could someone help me with that or you Lindsay as well.

1) You are prohibited from investing your retirement funds in an LLC that you own in your own name.

2) One option would be to purchase the real estate in the name of the 401k (e.g. XZY Solo 401k Trust). Another option would be to first set up a new single member LLC of which the solo 401k is the member, then transfer the funds to a bank account in the name of the LLC and then purchase the property in the name of the LLC. Please note that in all cases you can't own the property in your name or in the name of an LLC which is owned by you.

3) In addition, please note the following general considerations:

General Considerations Re Investing Retirement Funds in Real Estate:

1. If you purchase via an IRA (as opposed to a 401k), you will need to open an IRA account at a specialty trust company that allows for investments in real estate. Unless you invest via an LLC owned by the IRA, you will not have checkbook control over the funds which means you need to run transactions (e.g. income, expenses, etc.) through the trust company who will need time to process the transactions and generally charge fees for each transaction. On the other hand, keep in mind that there are costs associated with maintaining an LLC (such as the $800 annual franchise tax in California).

2. If you are self-employed with no employees, you can set up a Solo 401k through a 401k provider which allows for investing in real estate. In that case, you can simply have the account at a bank or brokerage where you will have direct checkbook control.

3. In either case, all of the income and expenses will need to flow in and out of the retirement account.

4. In either case and if you will use debt to acquire the real estate, it must be non-recourse financing. See more at the following link: https://www.biggerpockets.com/blogs/9552/70408-ira... If debt-financed real estate is acquired via an IRA, any income attributable to such investment will generally be subject to unrelated debt finance income tax.

5. In either case, you can't live on the property or otherwise use it for personal use.

6. In either case, you can't work on the property as it must be a passive investment (e.g. you must hire someone to fix the toilet and can't pay the expense with non-retirement funds).

7. In either case, you must purchase/sell real estate from/to an unrelated person and the real estate can't be titled in your name personally (e.g. in the case of the 401k, it would be titled in the name of the 401k and you would sign as trustee of the 401k).

8. In either case, you should verify that you are eligible to transfer the funds from your existing retirement account (e.g. if the funds are in your current employer 401k, you will likely not be able to transfer until you quit your job).

Considerations in Setting up a Solo 401k to invest in real estate:

1. First, you must be eligible to set up a Solo 401k. In order to be eligible, you must be self-employed (e.g. providing goods and/or services through your personal effort), reporting self-employment activity on your taxes (e.g. Schedule C if you a sole proprietor) & you do not have any w-2 employees working for your self-employed business or otherwise.

2. If you are self-employed with no employees, you can set up a Solo 401k through a 401k provider which allows for investing in real estate. In that case, you can simply have the account at a bank or brokerage where you will have direct checkbook control.

3. All of the income and expenses will need to flow in and out of the retirement account.

4. If you will you debt to acquire the real estate, it must be non-recourse financing. See more at the following link: https://www.biggerpockets.com/blogs/9552/70408-ira...

5. You can't live on the property or otherwise use it for personal use.

6. You can't work on the property as it must be a passive investment (e.g. you must hire someone to fix the toilet and can't pay the expense with non-retirement funds).

7. You must purchase/sell real estate from/to an unrelated person and the real estate can't be titled in your name personally (e.g. in the case of the 401k, it would be titled in the name of the 401k and you would sign as trustee of the 401k).

8. You should verify that you are eligible to transfer the funds from your existing retirement account (e.g. if the funds are in your current employer 401k, you will likely not be able to transfer until you quit your job).

Considerations in Choosing a Solo 401k Provider:

1. Confirm that the provider has a pristine reputation (e.g. Better Business Bureau reviews, etc.).

2. You may wish to confirm that the new 401k provider has experience with the particular investments in which you intend to invest your retirement funds as you very likely will have questions in terms of the mechanics (e.g. how do you invest in real estate, etc.).

3. You may wish to confirm that the new 401k provider will handle the ongoing compliance support such as any required 5500 filing (e.g. 5500-EZ for a one-participant plan with assets in excess of $250,000), any required tax reporting (e.g. 1099-r in the event of a distribution or in-plan Roth conversion), mandatory plan updates and amendments, etc.

4. If you might take a 401k loan, you may wish to confirm that the new 401k provider will prepare the required 401k participant loan documents.