using solo 401k to invest in real estate business

[Christa S Rickard]

I currently have a self-directed IRA through Etrade. However, I want to use some of that to start investing in real estate. I know I can't do that directly with Etrade, but will need some special documents to set it up. My question is about real estate investment options using a solo 401k.

I'm starting an investment company with my best friend - either an S corp or LLC. We are both contributing money and will share costs/profits.

I understand the main restrictions on using a solo 401k and keeping the money trail very clear/clean. What I'm not clear about is if I can invest the cash from my solo  401k into the new company while she also invests cash, possibly from her solo 401k, into that same company. When the company starts drawing a profit, each solo 401k gets an equal share (proportional to the percent of cash invested) paid back into the account through the business the same way an investor would receive profits. 

Is this allowed if I'm the trustee of the solo 401k as well as owner/partner of the business in which it's investing?

[Brian Eastman]

@Christa S Rickard

A Solo 401(k) or self-directed IRA is a tool for diversification of your tax sheltered retirement savings. While such plans may invest in real estate, everything has to be done entirely at arm's length and exclusively for the benefit of the plan. You cannot operate a business using such a plan or be personally involved beyond really acting as a fund manager - making decisions and deploying the plan capital.

All capital in a Solo 401(k) could be placed into an arm's length investment such as a rental property, private mortgage note, etc.  While the Solo 401(k) does offer a participant loan provision, that is limited to the lesser of $50K or 50% of your plan value.  That is not a plan investment, but rather you borrowing from your plan to put capital in your pocket for some purpose.

The Rollover as Business Startup is an entirely different solution, designed to allow for the capitalization of a business in which you have direct involvement using existing retirement funds.  You have to be an owner/operator of the business, and the enterprise needs to be engaging in a true business providing a product or service - not passive investment holdings such as rental properties.  While there are no taxes or penalties for using the plan funds to become a shareholder of your corporation, the corporation will operate in the taxable realm.  So, it is a tradeoff between access and tax sheltering, to some degree.