Using gross profits for mutifamily down payments, tax deferred?

Question

Hi guys and gals,

In the next month or so I'll be selling 2 flip properties- a single family and a 4 unit. I plan on opening a solo 401K to defer some taxes, but as I understand, annual contributions are capped at $50K (+/-).

The plan is to buy a small multi with the remaining profit. My question is, is there a way for me to move this money into a multifamily while deferring taxes, similar to a 1031?

Dave Foster · Answer

@Taylor Shapiro, couple of problems.

1. If your intent when you purchased the two you are selling with the primary intent of selling then you can't use the 1031.  If your intent was to hold for productive use and you're now selling then 1031 would be appropriate.  So you need to check your intent.

2. In order to defer all taxes in a 1031 you must purchase at least as much as you sell and you must use all of the proceeds from the sale in the next purchase or purchases.

In the scenario you lay out with 100K of gain that you want to use 50K of in the 1031 and contribute 50K to a S401K, you've got to do some benefit calcs

1. It means you'll be doing a partial 1031 exchange and the 50K you do not include in the exchange will be taxable.  You'll want to verify and compare the savings of putting 50K into the 401 K with the tax liability of a partial 1031 exchange.

2. The requirements for complete tax deferral in a 1031 exchange are that you purchase at least as much as your net sale.  You can buy less than what you sell but you pay tax on the difference.  So again you need to put that into your calculations that you will not be able to generate savings if all you do is reinvest the profit.

It might be possible to pull 50K out of the exchange and have the tax on that offset by the contribution into the 401K but then complete the exchange by purchasing a property with the remaining funds which will be all tax deferred.  But I'm doubtful that the savings will equal the liability of the 50K.

Dmitriy Fomichenko · Answer

If you invest in an active business with your IRA or 401k - the gains will be subject to Unrelated Business Income Tax, which tops at 39%. And example of an active business will be flipping activity, vs long term buy and hold which is considered passive.

Dmitriy Fomichenko · Answer

Taylor, you can't just contribute $50K on $100K gains, there is a formula you need to use the calculate the amount you are eligible to contribute. Using your example of $100K net, assuming that you are sole proprietor you can contribute about $36K.

You can't defer gains via 1031 exchange on a flip so the rest of the funds will be taxed, unless you find another way to minimize your tax liability such as donating to a charity... You should discuss your strategy with experienced tax professional ahead of time and come up with a solid plan.

Rajeev Kotyan · Answer

@Brian Eastman: I apologize that I have not completed my profile, and will do so shortly... I do not work for a firm providing legal or tax advice, and anything I am stating is purely from experience and for education of others. Do not have any commercial interests... I will update my profile shortly. Thanks pointing me in the right direction (am new here)

Dmitriy Fomichenko · Answer

@Taylor Shapiro

if you set up self-directed Solo 401k plan you can use your retirement funds to invest in alternative assets, including multi-family. Your investment options with self-directed plan are virtually limitless. All investment gains from assets owned by the 401k will be sheltered from taxes (unless you engage in an active business).

Yes, the contributions are capped at $53,000 per year.

Taylor Shapiro · Answer

Thanks for getting back to me. I need to check in more often!

@Rajeev Kotyan thank you for your insight. In this case, I'm talking about the gains from the sale to be done as a 1031 exchange.

@Dmitriy Fomichenko, @Dave Foster, Let's say I make $100K after the sale of these two flips, $50K each. I contribute $50K to a K Plan and am left with $50K. I don't need the remaining $50K to live on so I'm left with a chunk of change that will ultimately be taxed if left unchecked.

Is it possible to roll the remaining sum into a multifamily, tax deferred?

How can I minimize taxes on the remaining $50K?

Brian Eastman · Answer

@Rajeev Kotyan

Thank you for your contributions on several topics today.

It seems from your profile that you work for a firm providing tax and legal services, potentially associated with retirement plans and estate planning.

It is a general principal of Bigger Pockets that one disclose such a commercial interest when participating here.

Thank you.

Rajeev Kotyan · Answer

@Beverly P.: A 401k plan or an IRA that invests in a business (excluding real estate and venture capital business), assuming that the investment is in a pass-through entity like an LLC (taxed as partnership) or LP, could be subject to Unrelated Business Taxable Income/Loss. For example a 401k or IRA investing in a local pizza store (assuming the pizza store entity is structured as an LLC or LP), the 401k or IRA is subject to tax on the business net income/loss (of course tax paid on income).

@Taylor Shapiro: Are you speaking about funds within the 401k (post contributions) for investing or the gains from the sale to be done as a 1031 exchange? Done correctly both are feasible and possible.

Shelly P. · Answer

@dimitriy Fomichenko

Your investment options with self-directed plan are virtually limitless. All investment gains from assets owned by the 401k will be sheltered from taxes (unless you engage in an active business).

Can you explain what you are referring to as an active business?

Dave Foster · Answer

@Taylor Shapiro, "similar to 1031" sounds like..."but not 1031".  Just curious what your limiters are.  There may be some ways to structure that would still accomplish what you want.

Using gross profits for mutifamily down payments, tax deferred?

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