Solo 401k for RE Investing

[Roseann Koefoed]

I have a cash flowing MF portfolio (about 80 units) and I will be leaving my corporate job soon to 1) be a better Mom to my kids and 2) focus on growing my RE portfolio.  My husband and I each have about $500k in retirement savings (401ks, IRÁ, ROTH).  

Since I will be leaving my corporate job and effectively self-employed as I manage most of my MF portfolio, can I roll my retirement savings into a Solo 401k and invest in RE with the money?

I understand that any RE earnings would have to stay in the account until I retire.  But I wanted to buy 1-2 short term rentals with the money.  STRs that I could use for personal use (family vacations) once or twice a year.  Can I do that without violating any rules?

If my husband (who has a brokers license on the side of his day job) were to broker the RE transaction my Solo 401k purchases, can he take that commission without violating any rules?

So many questions.  Help me!

[Dmitriy Fomichenko]

@Roseann Koefoed,

As long as you have legitimate self-employment or an active business, you will be able to establish a self-directed Solo 401k plan. The 401k can accept rollovers from any other qualified retirement plan except the Roth IRA (for now, there is proposed legislation so that this restriction may be removed in the future).

Both you and your husband (and also your immediate family members) are considered disqualified persons to your 401k, so you are not allowed to provide any services to the plan nor receive any personal benefits from the investments of the 401k plan. That means that you can not stay in the properties owned by the 401k (there are no loopholes around this rule). If your husband were to serve as a RE broker on this transaction - you would be breaking IRS rules twice: disqualified persons providing service to the plan and receiving personal benefits (commissions). So, NO, he can't be the broker related to the transaction of your 401k. 

More on prohibited transactions here:

https://www.irs.gov/retirement-plans/plan-participant-employ...

Don't be disappointed, however. There are many other ways to invest your 401k without breaking the rules. You are certainly on the right path! 

[Zachary Jensen]

Hey @Roseann Koefoed, 

First of all, congrats on the success so far! You're living a lot of people's dreams. As far as some rules to look out for, one crucial stipulation is that the property must be rented for 7 days or less on average. While this may exempt it from being classified as a rental activity, active participation remains a requirement, necessitating compliance with three tests: spending 500 hours on the property, dedicating at least 100 hours (and more than any other participant), and performing all the necessary work needed.

Additionally, long-term viability and consideration of depreciation recapture are important concerns. Excess business losses are capped for single individuals at $250,000 and for married individuals at $500,000, with any surplus being suspended and carried forward. Notably, short-term rentals are categorized as non-residential properties. If over 50% of guests stay on a transient basis, the property is subject to depreciation over 39 years. Bonus depreciation and Section 179 allowances for improvements can be utilized, with the latter, however, capped at zero to prevent negative losses. Determining whether the venture falls under a service or rental business hinges on the provision of substantial services; for instance, if a bed and breakfast service is offered, it must be reported on Schedule C, triggering a 15.3% self-employment tax.

Moreover, personal use plays a crucial role in the classification of the property. If used for 15 days or more or 10% of the rental days at fair market value, it becomes a residence, subject to specific regulations. The REPS-9 election prohibits grouping short-term and long-term rentals, emphasizing the need for careful strategic planning. Notably, personal visits for maintenance purposes do not contribute to personal use calculations. The involvement of onsite management, often seen as a potential red flag, can lead to the property failing crucial qualification tests. Understanding these rules is essential for investors seeking to capitalize on the short-term rental loophole while maintaining compliance with tax regulations.

[John Underwood]

In addition to what has been said, a Solo401k is super powerful. I would make it a ROTH if at all possible.

I have bought distressed properties cheap and fixed them up with Solo401k money. They cash flow really well!

Also a huge benefit is you can get a non recourse loan and not have to pay UBIT tax on the profits made with the leverage.

[Kory Reynolds]

I would be VERY careful about doing any direct real estate investing with a retirement account.  Yes it is possible, but there are so many land minds to step up, and the penalties so severe, it almost isn't worth it.  Real estate is already relatively tax advantaged anyways.

The prohibited transaction rules can be quite onerous - even some sweat equity on the property can trigger problems for you. Then if you end up doing a self directed IRA instead of a Solo 401k from not having any self employment income, you are subject to UBIT rules, which can cost you thousands in fee annually just for the filing depending on the complexity - in addition to the tax owed. If it is a normal 70/30 leveraged property, you may end up subject to tax on 70% of your returns anyways - so cost benefit, is that 30% tax free portion worth the high tax rates paid and additional filing fees to get tax free treatment on the 30%?

Investing in syndications, passively with an unrelated party (beware of UBIT if an IRA on both of those), or just hard money loans to third parties are all great ways to invest in real estate with a retirement account to minimize as many headaches as possible.

[John Underwood]

Quote from @Kory Reynolds:

I would be VERY careful about doing any direct real estate investing with a retirement account.  Yes it is possible, but there are so many land minds to step up, and the penalties so severe, it almost isn't worth it.  Real estate is already relatively tax advantaged anyways.

The prohibited transaction rules can be quite onerous - even some sweat equity on the property can trigger problems for you. Then if you end up doing a self directed IRA instead of a Solo 401k from not having any self employment income, you are subject to UBIT rules, which can cost you thousands in fee annually just for the filing depending on the complexity - in addition to the tax owed. If it is a normal 70/30 leveraged property, you may end up subject to tax on 70% of your returns anyways - so cost benefit, is that 30% tax free portion worth the high tax rates paid and additional filing fees to get tax free treatment on the 30%?

Investing in syndications, passively with an unrelated party (beware of UBIT if an IRA on both of those), or just hard money loans to third parties are all great ways to invest in real estate with a retirement account to minimize as many headaches as possible.

My self directed IRA's (one being a Solo401k, both being ROTH's) both own houses. I have studied the rules and even taken a class.

There are rules that must be followed and if you do you'll be fine.

The people I have read about that got in trouble were blatantly breaking the rules.

[Kory Reynolds]

Quote from @John Underwood:

Quote from @Kory Reynolds:

I would be VERY careful about doing any direct real estate investing with a retirement account.  Yes it is possible, but there are so many land minds to step up, and the penalties so severe, it almost isn't worth it.  Real estate is already relatively tax advantaged anyways.

The prohibited transaction rules can be quite onerous - even some sweat equity on the property can trigger problems for you. Then if you end up doing a self directed IRA instead of a Solo 401k from not having any self employment income, you are subject to UBIT rules, which can cost you thousands in fee annually just for the filing depending on the complexity - in addition to the tax owed. If it is a normal 70/30 leveraged property, you may end up subject to tax on 70% of your returns anyways - so cost benefit, is that 30% tax free portion worth the high tax rates paid and additional filing fees to get tax free treatment on the 30%?

Investing in syndications, passively with an unrelated party (beware of UBIT if an IRA on both of those), or just hard money loans to third parties are all great ways to invest in real estate with a retirement account to minimize as many headaches as possible.

My self directed IRA's (one being a Solo401k, both being ROTH's) both own houses. I have studied the rules and even taken a class.

There are rules that must be followed and if you do you'll be fine.

The people I have read about that got in trouble were blatantly breaking the rules.

 I do agree - if you follow the rules, you'll be fine.  And good on you - it sounds like you have done more to educate yourself and go about things the right way than most (by far).  The problem is, the great majority people don't bother to educate themselves on it and just go for it.  Each year I have a handful of new or prospective clients come to us that have done some real estate investing with their qualified accounts, and in literally every single case they were doing things wrong without being aware (or just pretending to us they didn't know) that they were not following the rules - prohibited transactions and/or not addressing UBIT reporting.  Certainly those out there doing it right (I still have a couple of clients that are), but it does seem to be in the minority.

[Costin I.]

@Roseann Koefoed - Solo401K is a very powerful SDIRA (and the best of all SDIRA variants IMO). It has only 2 caveats for all I know: 1. You can't roll over Roth funds from other IRAs into the Solo 401K Roth portion (so beware of that, if you have now a big chunk of your retirement funds in a Roth). 2. You can't have employees.

Also as a general rule, placing a tax-advantaged investment into a tax advantage account nullifies the whole idea of tax-advantage - thus, IMO, purchasing and holding real estate in your SDIRA is not the best use of the IRA money. You can't take advantage of depreciation (both on your RE holdings and from syndications, and that is one the most trumpeted "advantages" of investing into syndication), you can't actively participate in flips, etc. You can however do other investments, private lending (HML), personal loans.

[Roseann Koefoed]

Thank you all for your responses.  The more I think about it, the more I realize that a Solo 401k is probably not an option for me because I will not have self-employment income.  I don't pay myself an investment management or property management fee from my properties because I wholly own them.  All my money comes from the properties' cash flow.  And my intention is to make one larger investment each year, do a cost-seg, and thereby reduce my income and tax for the year to zero.

Based on this, I would qualify for a SEP IRA or SDIRA (are they the same thing?), but not a Solo 401k, correct? I already act as a lender for a friend who flips properties (I've bought a couple deals from him). So I'm thinking that I can create a SEP IRA and use it to loan to my friend instead of using my personal equity. I would like to roll both regular and ROTH 401k money into this account. But to keep it cleaner, I'd prefer that it's 100% ROTH. So if I convert the regular 401k money to ROTH at the conversion and "pay taxes now" on that converted amount - is it possible that the taxed owed is zero if I'm converting in a future year when I have no corporate income (and my RE income is zero net of depreciation)? Or is there some level of penalty or minimum tax paid when you convert from regular 401k/IRA to ROTH?

I always use leverage when I invest, so it sounds like investing directly in RE with the SEP IRA would not work for me because of the UBIT.

I realize I'm really getting in the weeds here but appreciate the help!  If you sent me a PM, I will try to call you!

[Dmitriy Fomichenko]

@Roseann Koefoed,

I see that you booked an appointment with me. Let's discuss the qualification questions and the best vehicle for you during our call. 

Both SD IRA and Solo 401k can be used for private lending, which is my personal favorite for retirement accounts. I funded several dozen loans with my retirement money and it is great!

You can't combine Roth and Traditional money in one account unless you do a Roth conversion, which would be a taxable event.

There is no one-size-fits-all when it comes to investing using your retirement funds, but you certainly can own rentals with leverage in an IRA and this can be very profitable.

We can discuss all of these subjects during our call.