Absolutely Confused...Let's Get Real about SOLO-401K's

Tax, SDIRAs & Cost Segregation
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Absolutely Confused...Let's Get Real about SOLO-401K's

Gary Kane
Flipper/Rehabber · Jacksonville, FL · Member since 2016 · 47 posts · 8 votes

I have been reading (scouring) the forum on SDIRA/SDIRA-LLC/SOLO-401K information, and am absolutely confused! And the more I read, the more cautious I am getting!

So what is the real deal on these setups?  Do I need to worry about the IRS breathing down my back every year with my SDIRA? Or SOLO-K?

And let's clear the air on SOLO-K's...what is the true requirement on being eligible to set up one of these for REI'ing?

1. I am a full-time W-2 employee, with a 401K already.
2. I am not self-employed (earned income), but some say I could be easily (EBay, MLM, etc.).
3. Does selling on EBay REALLY qualify as self employed, able to set-up a SOLO-K? A backdoor?
4. How long do you have to be self-employed before REI'ing.
5. Wouldn't the very nature of doing REI'ing (Rehab and sell) qualify as earned income? Wait, you have no proof of earned income yet, how can you have a SOLO-K...chicken vs the egg syndrome?
4. So the IRS thinks I'm an EBay seller, and now I have all this REI income (Buy and hold, Rehad/Flip, etc.). What will the IRS say?

All my scouring has led me to believe that a SOLO-K would be more efficient for REI. I want a few rentals, and do some Buy/Rehab/Sell for profit, and also do some JV's (lending)...But I want to be legit and not worry about violating any IRS rules.

Need some help...hope I'm not rustling some feathers, just need some clarification.

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

@Gary Kane

In order to establish a Solo 401k, you need to have an active business with the potential to make contributions to the 401k plan.  This can be something fairly minimal, so long is it produces legitimate income that you report on your taxes, such as with a schedule C.  The benefits of the 401k, however, are mostly focused on higher contributions, which must come from the income of the business that is sponsoring the plan, so if you are selling $1500 on eBay, is it really worth going through the process of establishing and administering a Solo 401k?  Likely not.

A self directed IRA is an equally viable means to diversify existing retirement savings into real estate, and you do not need to change plan formats if 2-3 years down the road you get tired of dealing with eBay and are no longer self-employed.

The IRS is not specifically targeting self-directed retirement plans.  

You do seem to be confused about the business that sponsors the plan and the investment activities of the plan. If you setup a self-directed IRA or Solo 401k and invest that plan in real estate, that is the plan investing in those assets. That is not income to you that goes on your tax return, and the investments of the plan are not the business that sponsors the plan. That would be akin to a snake eating its own tail.

Too much time on the internet can definitely lead to confusion on these topics.  There are some professionals here on BP with a ton of expertise that can help you boil down the matter to the specifics of your situation.  Get on the phone and have some conversations.  Once you speak to someone who knows what they are doing, you will know, and they will get you on the right path.

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

    @Gary Kane

    In order to establish a Solo 401k, you need to have an active business with the potential to make contributions to the 401k plan.  This can be something fairly minimal, so long is it produces legitimate income that you report on your taxes, such as with a schedule C.  The benefits of the 401k, however, are mostly focused on higher contributions, which must come from the income of the business that is sponsoring the plan, so if you are selling $1500 on eBay, is it really worth going through the process of establishing and administering a Solo 401k?  Likely not.

    A self directed IRA is an equally viable means to diversify existing retirement savings into real estate, and you do not need to change plan formats if 2-3 years down the road you get tired of dealing with eBay and are no longer self-employed.

    The IRS is not specifically targeting self-directed retirement plans.  

    You do seem to be confused about the business that sponsors the plan and the investment activities of the plan. If you setup a self-directed IRA or Solo 401k and invest that plan in real estate, that is the plan investing in those assets. That is not income to you that goes on your tax return, and the investments of the plan are not the business that sponsors the plan. That would be akin to a snake eating its own tail.

    Too much time on the internet can definitely lead to confusion on these topics.  There are some professionals here on BP with a ton of expertise that can help you boil down the matter to the specifics of your situation.  Get on the phone and have some conversations.  Once you speak to someone who knows what they are doing, you will know, and they will get you on the right path.

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

    @Gary Kane

    No need to be confused, and good questions. Solo 401k plans are no different then full-time employer plans in that they are both sponsored by a business; however, the IRS created solo 401k plans to even the playing between big company employer plans  by relaxing the rules for self-employed businesses to be able to qualify for solo 401k plans (see IRS Pub. 560 which list the requirements to qualify for a self-employed 401k).

    • The following IRS website page clearly confirms the above.

    https://www.irs.gov/retirement-plans/one-participant-401k-plans

    "The one-participant 401(k) plan isn't a new type of 401(k) plan. It's a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse. These plans have the same rules and requirements as any other 401(k) plan."

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

    Gary, while Solo 401k plan is more powerful than an IRA - it is not for everyone. You must have a legitimate self-employment activity (a hobby would not work) and you must maintain this business in order to maintain your 401k plan, in other words there needs to be continuity for your self-employment activity.

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  • Don KonipolBusiness Member
    Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
    10y

    Just one more note.  Income from investment activities, such as rental income from real estate, is not business income, it is classified as investment income (rents and royalties), and therefore sheltering that income via a 401k is not possible.  If one were to take the income thrown off from these assets as say property management income, then that would be a business and that income can be sheltered by use of a retirement account.  However, by changing investment income to ordinary income, on would now owe social security and Medicare tax, at the combined rate of 15.3% (both sides), less deduction from income of one half of the tax, so effective rate of 12 - 13 %.  Further, sheltering income via a retirement account does not eliminate the tax, it defers the tax until the income is recognized as a distribution from the retirement account (mandatory distributions begin at age 701/2.).  Note: if you have already reached maximum FIFA contribution from other ordinary income, then this additional ordinary income created by turning investment income into business income would be taxed additionally at only the Medicare rate.

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  • Gary Kane
    OP
    Flipper/Rehabber · Jacksonville, FL · Member since 2016 · 47 posts · 8 votes
    10y

    Thank you gentlemen for your replies!  I still have some questions but will save those when I can get on the phone with a good custodian (plus attorney and CPA)  :)

    I'm fully aware of the benefits of deferred income with an IRA, particularly 401K's. My plan is to 'build' on my existing SDIRA (not setup for Real Estate yet), and defer any earnings and profit, and continue to leverage those assets.

    Thanks again...this has been eating away at me so I had to get off my chest. Was up watching the Notre Dame/Texas game (too bad the Irish lost, great game!) so thought I would post.  BP is an awesome venue!

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