Favor SD401k over SDIRA?

Question

This is my very first post! I have been reading about Self Directed IRAs as it was a recommendation from a conference I attended (and paid quite a bit for) regarding real estate investing. The way it was described made it seem like I could roll money from my previous employer 401k's and use that money to fund buy-and-flip property transactions. From my reading, a lot of reading, I think I have determined that a SDIRA is not the vehicle I should use. From my understanding, and please correct me if I am wrong, any proceeds from the flip would have to go back into the SDIRA, meaning that I could not use the proceeds to pay off other business expenses. I also could not use entities that I, my partner (wife), or family member set up.

I turned my research to self directed 401k's. They seem to be a better fit for what I am would like to do. I can roll over money from 401k accounts I have from former companies into a self directed 401k account. From there, I could loan myself the lesser of 50% of the SD401K or $50k to use for whatever purposes I choose. I would then have to replay the loan over the course of a specified time frame at a particular interest rate. Is that correct? Here is what I want to do (using arbitrary numbers):

- Put $80k into a self directed 401k account

- Pull $15k out to use for a down payment for property to rehab

- Use hard money for balance of rehab property purchase (I know the rates can be high for hard money but I have not built the private money relationships yet as we are not proven yet).

- Use Business Line for property rehab costs

Now, after the rehab is complete and the property has sold, I would then pay off the hard money lender, repay the business line, and then put the $15k, interest, and a little extra back into the SD401K. The rest of the money (let's say $17k) would then be used for business expenses, small salary, and used to build company reserve funds.

I know that pulling all the money directly out of my old 401K's to completely fund the purchase would generate a rather substantial hit to the funds available to which there would be limited recourse as a $100k loan may actually only generate $65k of actual available funds. This would also wipe out any profit if I were to try to put $100k back into the property.

Is there anything that I am missing? Is there a better/different way? I have done so much reading that my mind is turning into mush. I really think I am hit by the analysis paralysis bug.

Please advise.

Justin Windham · Answer

@Damien Cobbs

Welcome to BP! Brian gave you some great info.

You can put more money into your Solo 401k if you have earned income from your self-employment activity. You can actually contribute 100% of your first $18,000 in earned income to the plan if you are under at 50 ($24,000 age 50 and above). The key here is making sure you have earned income.

Yes, you can use funds from a SD 401k for down payments (or entire purchases for that matter) on fix and flips as well as buy and hold investments. Are you familiar with the prohibited transactions rules that will limit some aspects of how this can be done?

With regard to eligibility for the SD 401k, there is no restriction on being employed full time elsewhere or having a 401k with that employer. If making contributions to both plans, you'll need to aggregate those contributions when calculating employee deferral limits, meaning you don't get to double your contribution limits for having 2 employer plans.

Brian Eastman · Answer

@Damien Cobbs

The answers from Brian and Justin (who are further East and start their day earlier) are pointing you in the right direction.

It sounds like you are putting together a real estate development (re-development) company for flipping.  That company can establish a Solo 401k.  You can borrow from the plan and put that money into company deals.  Otherwise there can be no intersection between the plan and the company - since the company is a disqualified party to the plan.

If you build up the plan, the plan can separately invest in real estate, but any such investments need to be executed at arms length, avoid your company and your lineal family, and your role must be purely administrative.  You cannot put sweat equity into the plan projects.

The 401k may invest in long term properties, flips or notes, all of which might fit into they types of opportunities you will find in your market.  Passive income from rents or interest on notes will be 100% sheltered to the plan.  Active trade or business income such as from flipping with a plan is subject to taxation known as UBIT - not necessarily a no-go, but something you want to understand thoroughly.  If you can do a deal, pay UBIT, and still make more return and a passive deal, you have come out ahead.

Sounds like the next step in your research is to speak with a few professionals, then consult with your tax advisor.

Brandon Agee · Answer

Would any account allow for a buy and hold rental?  Do you need to pay all cash?  Are you able to pocket the profits if the property is owned within the retirement account?

Dmitriy Fomichenko · Answer

@Damien Cobbs

self-directed Solo 401k plan will give you more flexibility and might be more cost-effective, but the same prohibited transaction rules that apply to an IRA would apply to 401k as well.

You also may want to consider using your 401k as a bank to fund someone else's flip, instead of flipping inside of the 401k, this way you don't have to deal with Unrelated Business Income Taxes and all of the interest income and points earned by your 401k would be completely sheltered from taxes.

Bryan O. · Answer

Hi @Damien Cobbs. If the business entity you have attached your sd401k to does not make ACTIVE income, you will never be able to contribute to it. It sounds like you want to flip, so if you flip through an LLC, and that LLC has the solo 401k tied to it, then that is active income and is good. If you rent the units, that is passive income and cannot be used for allowing contributions.

If all you really want to do is use the money to self-fund, most employer sponsored 401k plans allow you to take the loan. You just check with your plan administrator and fill out the paperwork. Easy-peasy.

My recommendation is to fund as much of your flip as you can with your up to 50%/$50k loan from the 401k, but do NOT try to use more than that. That becomes early distribution and the penalties aren't worth it. Anything beyond the allowed loan amount will likely be cheaper using hard money.

Best of luck.

Damien Cobbs · Answer

@Brian Eastman

Thank you for the information. Yes, I fell "victim" to the real estate gurus and their ridiculously expensive courses and I almost fell victim to the hype of the SDIRA. Fortunately, I researched that first, else I would have been greatly upset.

What other ways would I be able to contribute money to the SD401k? I am actually trying to do a couple of things: build retirement savings hence wanting to put a "little extra" into the SD401k (which may not be possible), build/operate a real estate business, pay down personal debts, and have an alternate way of funding college for my children. They all hinge on real estate investments I want to make now and in the future. I would be able to use funds from the SD401k to use for down payments for fix-and-flips but not for buy-n-holds, is that correct? Is there a restriction to also work full-time with another company were I am an employee with another active 401k?

Brian Eastman · Answer

@Damien Cobbs

Let me start by saying that most of what I have ever heard from expensive real estate guru classes about self directed retirement plans is garbage.  There is a real tendency to make it seem like "extra money YOU can use to fund deals", which is very much not the case.  They hide behind "check with your tax attorney" disclaimers and then spout stuff with little basis in fact that is purely meant to get folks excited so they'll spend more money.  Hate to say it, but I see it all the time.

What you propose would work.  It sounds as if building your retirement savings is not the goal, but accessing some of that capital now to build your own real estate business is.  A Solo 401k can do that, and you do not even need a self-directed SoloK if all you really want is the loan feature.  Of course, with a Self-Directed Solo 401k you could use the plan funds to invest in real estate, notes, etc.

When you borrow from a 401k, you may only pay the plan back the borrowed principal plus interest which is generally in the range of Prime + 1 or 2 points depending on the plan.  You may not put "a little extra" back into the plan.

In order to establish a Solo 401k you need to be self employed and have no full time employees.  Passive real estate holdings are not self employment.  Flipping or wholesaling activities are.

Favor SD401k over SDIRA?

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