Solo 401K/ IRA and Tax concerns under my LLC

Tax, SDIRAs & Cost Segregation
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Solo 401K/ IRA and Tax concerns under my LLC

Account Closed
Phoenix, AZ · Member since 2016 · 15 posts · 1 vote

Hello, very new to this forum and this topic.  I am trying to put together the following information and would be grateful for any thoughts you all may have.

1.  I would like to take one of my current employer 401K's and make that self directed.  Once that is accomplished I would like to use that money to fund either hard money loans or purchase rental property.  Question:  I am assuming that either the interest from the loan or the rental income would be tax deferred?  Is that correct?

2.  I am also thinking about doing this with after tax money but would like to shelter as much of the loan interest and / or rental income from taxes.  I read some on this topic but I am getting confused on the terms Active vs. Passive income.  It appears Passive income is bad since it appears on my 1040 as regular income which means I cannot subtract my expenses first from this amount?  Is that correct?

3. I read in another blog that getting a mortgage for a home owned by a LLC is difficult? Why is that?

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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
10y

Hello @Account Closed and welcome to the best real estate networking site in the world! As you engage with the community you will find this to be a great place for education, resources and potential deals.

Just wanted to add my two cents to the above comments. 

If you are going to be investing in a tax deferred environment (self-directed IRA or 401k), generally it works best with private lending (you mentioned hard money loans) and if you have after-tax funds (personal savings) - those would be best used by buying rental properties. The reason for that is you get tax benefits by personally owning real estate and you basically loose them with an IRA. 

If you are making those non-traditional investments with your retirement account, both: the interest from the loan and rental payments would be tax-deferred. However, if you use leverage to acquire rental property in an IRA then the portion of the income that comes from the financed portion of the property will be subject to UBIT (Unrelated Business Income Tax) which tops at 40% (Solo 401k is exempt from this tax).

The active vs passive income comes into play if you are trying to qualify for a Solo 401k. You need a business or self-employment activity that generates active income in order to be able to establish a Solo 401k plan (which is way more powerful and advantageous comparing to SD IRA), therefore SD Solo 401k plan will not work for everyone, but pretty much anyone can setup SD IRA.

Passive income in itself is not bad, I think it should be goal for every investor to create an income stream to replace any active or earned income and achieve financial independence. Wouldn't it be nice for you to have enough income coming in month after month without you doing anything (passive income)?

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  • Brian EastmanPro Member
    Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
    10y

    @Account Closed

    Firstly, unless you are over age 59 1/2 or have left employment with a company, you typically cannot move a current employer plan to another plan.

    If you have the ability to move funds to a plan of your choosing, a self-directed IRA looks to be what you qualify for. Your passive rental holdings with personal funds are passive investment income, not self-employment income capable of being directed into a self-employed 401k. Passive rental income can be very good and comes with many potential write offs.

    Banks want to be able to come after you personally in the event of a default. That is why they typically will not lend to a LLC. There are commercial and non-recourse lenders that will lend to a LLC, but they are generally evaluating the property, not you as the borrower. These types of loans are available, but not generally from the mainstream large lending banks.

    0Reply
  • Account Closed
    OP
    Phoenix, AZ · Member since 2016 · 15 posts · 1 vote
    10y

    Thank you Brian for your informative and timely response.  In reality, I probably could fund the entire cost of a home with my current 401K, but that obviously would lower my internal rate of return.

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  • Brian EastmanPro Member
    Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
    10y

    @Account Closed

    I'm not sure I follow your point.

    If you purchased a home with your 401k funds, would the income and appreciation on that property be less than your current investments with the 401k?

    Or, are you indicating that if the plan purchased all cash, that would be a lower rate of return than if the plan funds were used as a down payment and leveraged with a mortgage? A self-directed IRA or Solo 401k may leverage with a non-recourse mortgage.

    Also, if you want to "tag" someone, you need to type the @ symbol then the first few letters of their name.  A popup will then appear from which you can select them.

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  • Account Closed
    OP
    Phoenix, AZ · Member since 2016 · 15 posts · 1 vote
    10y

    @Brian Eastman  I was simply indicating that based upon my calculations if you purchase this home with a mortgage and only place 20% down your internal rate of return would be about 34% versus if you bought the home out right your internal rate of return would be about 12% 

    0Reply
  • Brian EastmanPro Member
    Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
    10y

    @Account Closed

    As I noted, an IRA or Solo 401k may use mortgages. Because the loan is non-recourse, lenders typically want more like 30-40% down, but that still gives you the potential to utilize leverage and achieve a higher cash-on-cash return for your plan dollars. Leverage is not available to an IRA in the stock market, so this is a real game changer for retirement saving.

    1Reply
  • Account Closed
    OP
    Phoenix, AZ · Member since 2016 · 15 posts · 1 vote
    10y

    @Brian Eastman thanks much!

    0Reply
  • Rajeev Kotyan
    Professional · Lexington, MA · Member since 2016 · 136 posts · 43 votes
    10y

    @Brian Eastman: Leverage is available to an IRA in the stock market, but just like the non-recourse lenders, there is only a handful of them that provide leverage, but only to their select clients.

    0Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    10y

    Hello @Account Closed and welcome to the best real estate networking site in the world! As you engage with the community you will find this to be a great place for education, resources and potential deals.

    Just wanted to add my two cents to the above comments. 

    If you are going to be investing in a tax deferred environment (self-directed IRA or 401k), generally it works best with private lending (you mentioned hard money loans) and if you have after-tax funds (personal savings) - those would be best used by buying rental properties. The reason for that is you get tax benefits by personally owning real estate and you basically loose them with an IRA. 

    If you are making those non-traditional investments with your retirement account, both: the interest from the loan and rental payments would be tax-deferred. However, if you use leverage to acquire rental property in an IRA then the portion of the income that comes from the financed portion of the property will be subject to UBIT (Unrelated Business Income Tax) which tops at 40% (Solo 401k is exempt from this tax).

    The active vs passive income comes into play if you are trying to qualify for a Solo 401k. You need a business or self-employment activity that generates active income in order to be able to establish a Solo 401k plan (which is way more powerful and advantageous comparing to SD IRA), therefore SD Solo 401k plan will not work for everyone, but pretty much anyone can setup SD IRA.

    Passive income in itself is not bad, I think it should be goal for every investor to create an income stream to replace any active or earned income and achieve financial independence. Wouldn't it be nice for you to have enough income coming in month after month without you doing anything (passive income)?

    3Reply
  • Mark Nolan
    Professional · Carlsbad, CA · Member since 2012 · 12k+ posts · 1k+ votes
    10y

    @Ted LeSueur

    The following links shed more light on the 401k and IRA regulations directly from an IRS perspective.

    https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-investments

    https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-prohibited-transactions

    https://www.irs.gov/retirement-plans/retirement-plan-investments-faqs

    0Reply
  • Account Closed
    OP
    Phoenix, AZ · Member since 2016 · 15 posts · 1 vote
    10y

    @Mark Nolan, thanks Mark I will take a look at these.

    0Reply
  • Fred Weiller
    Investor · Pleasanton, CA · Member since 2016 · 46 posts · 17 votes
    10y

    @Account Closed You may want to check NASB for non-recourse loans for self directed IRAs/LLCs

    https://www.nasb.com/home-loans/ira-lending/

    Hope this helps,

    Fred

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