401k / Self-Directed IRA Question

[Aaron Sauceda]

Hi All,

I'm a new investor located in Orange County, CA. With the usual caveats in mind -- i.e., this doesn't constitute legal advice / consult your CPA, attorney, etc. -- I wanted to get a sense for how experienced investors approach funding and taxes, and better understand how to leverage things such as a Self-Directed IRA to invest in real estate.

I have a W-2 job and was previously contributing to my Roth 401k. There's a relatively small, yet material, balance there now. Is there a cost-effective way to roll that over into an account that allows me to invest into real estate? Similarly, based on when I started, my company match begins on 1/1/2017. At that time, I will contribute the minimum to maximize my match. Is there a way to structure my accounts in order to utilize those funds, including the company match, to invest in real estate?

Lastly, as I'm starting my business, is there a way to reduce my overall tax liability? Are things such as Internet, cell phone, cable, gas and other items I'd use both personally and for business tax deductible to the extent I use them for my business? 

I understand I may be getting ahead of myself, but I'd like to be educated early on regarding funding and tax-related issues. Any tips to ensure I start on the right foot -- or at least start with the right frame of mind -- are greatly appreciated.

All the best,
Aaron 

[Dmitriy Fomichenko]

Aaron, welcome to BP and it's great to see a fellow from OC here! You are a wise man, doing your research and home work ahead of time.

Since you are starting your own business, the best thing for you would most likely be self-directed Solo 401k plan (assuming you will not have full time employees in your business besides yourself and your wife). You will be able to rollover your other retirement accounts in there and have full control and the ability to invest in non-traditional assets such as real estate.

You can learn more about it's features and benefits in this blog:

http://www.biggerpockets.com/blogs/2810/blog_posts...

[Jo-Ann Lapin]

A good person to consult with is Kareen hall over at u direct. There are certain restrictions that you must consider and she could be a good resource for you. 

[Jason Green]

buy "Tax Free Wealth" audio book by Tom Wheelwright. It will pay for itself about 100 times over

[Justin Windham]

@Aaron Sauceda

I agree that the Solo 401k would be your best best as long as you will not have any employees in your business. The Solo 401k can have a built in Roth component that accepts transfers from your employer's Roth 401k funds. It is likely the most cost effective solution depending on how you will invest the funds.

With regard to tax deductions for business expenses, an experience CPA or other qualified tax advisor would certainly be worth their fee to advise you what can and can't be deducted for your particular situation. For a general overview of some of these deductions, you can continue reading here on BP and other online sources to get an idea as you get your business up and running.

Welcome to BP and congrats on the business!

[William Morrison]

Two good reads on IRAs and Solo 401ks with examples and differences are:
Leverage Your IRA
by Matthew M. Allen
Best price is on the NASB site.
and
Live Tax Free Forever (through Your Solo 401k)
by Michael J. McDermott
It is like a lot of real estate and financial books that really have an important message but limited scope. So some fluff to justify a book, but worth it.
I used Sense Financial to setup my Solo 401k and have been very happy with it and the follow on support and help.

[Bryan O.]

@Aaron Sauceda I might have misread. Everyone seems to be pointing to a solo 401k (which is awesome and I love them), but it sounds to me like you are continuing employment with the company that holds your 401k, right?

Typically, while your 401k is still active with your employer you cannot roll those funds over. They are basically locked. You CAN roll out any funds you rolled in from a previous employer. That could be worth looking into, but usually is not allowed. If you really want to get into the nuts and bolts I wrote a long post about how to find out if you can roll out of your current employers fund and into a soloK without shooting yourself in the foot.

Also remember that if you stand up a soloK to do so on an entity that has ACTIVE income (rent income is passive).

Best of luck and happy investing!

[William Morrison]

Originally posted by @Bryan O.:

@Aaron Sauceda I might have misread. Everyone seems to be pointing to a solo 401k (which is awesome and I love them), but it sounds to me like you are continuing employment with the company that holds your 401k, right?

Typically, while your 401k is still active with your employer you cannot roll those funds over. They are basically locked. You CAN roll out any funds you rolled in from a previous employer. That could be worth looking into, but usually is not allowed. If you really want to get into the nuts and bolts I wrote a long post about how to find out if you can roll out of your current employers fund and into a soloK without shooting yourself in the foot.

Also remember that if you stand up a soloK to do so on an entity that has ACTIVE income (rent income is passive).

Best of luck and happy investing!

Nice read on the 401k Bryan.
When looking to setup my Solo 401k I found several entities that were passive that surprised me.  The rental one is real important considering the audience we have here on BP.  You can set up an entity that manages properties or provides rental property services.  I wouldn't use a DIY source though.  It's not the entity itself I would worry about but penalties and taxes on an invalidated Solo 401k that you have rolled over several years later.  They are pretty harsh.
It seems CPAs and others are split on whether an Single Member LLC will work or not as well. Seems some file as employees but the language appears pretty clear it's a distribution not W-2 income. I went with an S-Corp to be sure. Some advantages and some disadvantages.

[Bryan O.]

Hi @William Morrison. You can tie a soloK to all of the entities, even a sole proprietorship. A SMLLC is also fine. As long as you don't have other employees (other than a spouse) there doesn't appear to be a restriction on entity type. Just make sure you are using active income for your numbers, not any passive income.

[Justin Windham]

@Bryan O.

You are correct that a Solo 401k can be adopted by any entity type. Though I think William may have been referring to entities to attribute some earned income to the activities of property management when he discussed S-Corp vs LLC. Is that right, @William Morrison?

[William Morrison]

Thanks @Bryan O. and @Justin Windham.  Bryan I had to go back to my notes on the Single Member LLCs.  I had too many years gap.  It's been changing state by state, for me 5 to 8 years or so is not a long time Grin.
I just checked a couple articles talking about how all states now accept them, some kicking and screaming, which was not true when I made my decision.  There are still some sites that track how each state treats asset protection, a whole different subject.
The second part was the earned income. As I understand it I can have earned income and a annual loss in an S-Corp and an LLC (not treated as a corporation) may require a profit to provide a distribution and thus the ability to add to your 401k. The first year I certainly didn't have a profit but do now.
Bottom I went with S-Corp because I got the same answer every time, not so much with the Single Member LLC for what was was attempting to do.  Left my previous job and rolled a portion of my 401k to a Solo 401k.  And as you said active income is the key.  I am a W2 employee if you will with active income.

[John W Sheffer Jr]

Hi @Bryan O., I wonder then if a work around to having employees would be to sub-out your second company with employees. In other words, have the soloK for the parent company which takes in the income and then subs out the work to it's second company thereby eliminating the employee problem. 

[Bryan O.]

Hi @John W Sheffer Jr. It sounds like a good idea. I'm not versed enough to know about that. Some of the providers out there probably do. What do you say @Dmitriy Fomichenko? If you get to a point where you want employees, what is a good way to structure so that you can continue to have the soloK?

[Rajeev Kotyan]

@John W Sheffer Jr: What you propose is actually illegal under the eyes of the Department of Labor for the purposes of a 401K/Solo 401K (this is the agency that has primary oversight on the 401K). If you are owner of multiple entities directly or indirectly (including the method that you suggest), employees of all entities have to be considered for the purposes of having a 401K plan.

Bypassing employees through the creation of conduits is subject to penalties and fines. Please work with a knowledgeable professional on this matter.

[John W Sheffer Jr]

Hi @Rajeev Kotyan, I don't personally have any intentions of doing this. It basically got me to outside the box creative thinking. I know of a large contractor in my area (drywall, framer, finisher) who used to sub-out his own employees (board hangers) to his own company. He paid them per room on large residential buildings in stead of paying them an hourly rate. It was I imagine very lucrative for all parties involved. I recall talking to a couple of the hangers and they claimed to bring home as much 3k in 4 days. I know that they don't do this anymore because of the liability insurance issues though. The above example is sort of what got me thinking in this direction and I guess I wondered if this might have been one more of the benefits for the owner of the company. Anyway, I just wondered if there wasn't a creative work around for this which you have answered. I should mention, I wasn't suggesting that the employees would not be eligible for a 401k through the sub contracted company. It was just if this would be a way for an owner to put away more money into an asset. 

[Rajeev Kotyan]

@Bryan O.: The 401K plan itself can have options and one of the options is Safe Harbor option, but all employees must get a contribution from the employer (generally 3% of their gross income -- yes again I am being very simplistic here). But going from a Solo 401K to a Regular 401K add more complexity when it comes to investing in Real Estate as you have make all the investments to all the participants, and some of this may be subject to SEC regulations on securities (yes even if it is real estate). There are some things that can be done within the 401K plan to limit the complexities, but the rules of by-passing employees are very clear (i.e. you cannot bypass them). 

[Dmitriy Fomichenko]

@Bryan O. and @John W Sheffer Jr,

If you own 80% or more of a company with full time employees and desire to setup a Solo 401k plan for a separate business that you own which has no employees - this idea would not work. In the eyes or IRS and DOL both businesses are looked at as single business. This falls under the "Controlled Group" rules and those rules are in place to ensure that you have to offer the same retirement benefits to everyone employed by either business.

Those rules were established specifically in order to protect the employees from a business owner establishing separate 401K plan for another business in order to avoid offering those employees the same benefits. 

Hope this helps. 

[John W Sheffer Jr]

Hi @Dmitriy Fomichenko ,

Thank you for that information. After re-reading my initial post I believe I may have come across sounding like a scammer who was trying to put one over on employees. That is not the case. I was merely trying to think of out of the box solutions for someone who may have an issue like this. 

[Dmitriy Fomichenko]

@John W Sheffer Jr

I did not get that idea and simply provided you with accurate info regarding the subject. I get this question on regular basis.

[Mark Nolan]

@John W Sheffer Jr

The following is a good resource regarding the controlled group rules as well as the much forgotten affiliated group rules. 

https://webcache.googleusercontent.com/search?q=cache:XpNbE7rz08QJ:https://www.irs.gov/pub/irs-tege/epchd704.pdf+&cd=1&hl=en&ct=clnk&gl=us