Real estate deductions inside solo 401k or self directed IRA

[Doug Kolb]

Hello. I'm looking for some direction regarding specific real-estate deductions while working inside a solo 401k or self directed IRA LLC and working with a rehab on a buy and hold piece of property. I plan on speaking directly to a tax professional, but am looking for some general information so I'm smart before talking to a professional.

I have an LLC which I use for property I have outside of my 401k, and I utilize appropriate deductions (mileage, associated expenses, etc). How does this work when using a solo 401k or self-directed IRA? Do the expenses essentially become contributions to the IRA? Suggestions and thoughts appreciated.

[Brian Eastman]

@Doug Kolb

While George's answer is basically correct, it is not 100% in line with your situation.

Generally speaking, income to an IRA or Solo 401k is tax-sheltered. No taxes are paid on the income, so there is no need to apply deductions to reduce that taxation.

With a self-directed IRA or Solo 401k, this is true in the case of passively sourced income. Passive income includes interest, dividends, royalties and rent from real property, or the sale of an asset that has been held to provide passive income.

Flipping houses within a tax-sheltered entity is not entirely tax-sheltered, however, if such activity is engaged in on a regular or repeated basis.  In such a case where a tax-exempt entity is engaging in a trade or business in a fashion that competes with tax-paying commercial interests, there is a tax known as UBIT that applies to the gains.  This tax levels the playing field so that tax-exempt entities do not drive regular businesses out of business.

In the case where a self-directed plan is creating UBIT exposure, then the deductions associated with producing the income are going to be applicable in reducing the taxable income.  I note, however, that you mention mileage.  Take care to ensure that you are not actively involved in the project and providing services to the plan.  You can administer plan investments, but should not be acting as an "employee" of the plan or errand boy, ... and certainly not swinging hammers.  

In some cases, investors will choose not to flip houses in an IRA or 401k to eliminate the potential tax burden. Having the plan be a hard money lender to another investor who is flipping houses would produce non-taxable passive interest income, for example. Or, the plan can buy & fix a home, but then hold the property as a rental for at least a year. When that property is sold in the future, it is not deemed a flip subject to UBIT since there was legitimate passive use.