Limited Returns Business Startup - ROBS v Solo 401k

[Mark Terry]

Hello BP community.  I have spent the last couple of weeks researching my start up, meeting with Attorneys and CPAs trying to find the strategy the best suits me.  I have lurked in the forum and done loads of research online. Unfortunately, the folks that I am meeting locally aren't familiar with ROBS or the ins and out of Solo 401ks.  

Here is a quick summary:

I currently operate a Sole Prop for my Architecture and Real Estate sales business and would like to start a REI business that I plan to keep separated from my Sole Prop. The main goal  is to limit my realized annual income and keep investment deals tax deferred to help grow the investment company. I do not want to take salary or distributions from REI company for at least 5 years (unless forced to in case of C Corp.) The REI business will work between 3-4 flip projects and 1 buy and hold per year. The first 5-7 years are not about generating passive income, rather building networth through real estate holdings.

I have a 401k from a job I have left that I would like to use to start the REI business. I have been looking at both ROBS and Solo 401k. The CPAs I speak to are very concerned about the "double taxation" that would occur within a C Corp of the ROBS (even though I look to keep profits reinvested, through 1031 exchanges when it makes sense) It seems that the Solo 401k would provide me more freedom but I am not clear about the non-recourse loan options in Massachusetts and if this is even a viable option. This 401k I am looking to rollover has about $60k and I wanted to invest about $20k from savings. What are folks' experience with going this route?

[Brian Eastman]

@Mark Terry

Retirement funding is not likely to fully align with your goals.

Option A: Solo 401(k)

Your current architecture & real estate sales business could sponsor a Solo 401(k) plan so long as you remain in an owner-only business format across all enterprises you control.  Such a plan would give you the benefit of deferring income you generate from architecture and real estate sales.  The plan could invest into real estate, but must do so fully at arm's length.  You cannot be actively involved such as by doing architectural design or being the agent of record on plan transactions.  All gains would go to the plan.  However, gains from passive income such as rentals and private lending are fully sheltered to a retirement plan.  Gains from a trade or business such as repeated house flipping as you propose would not be fully sheltered.  UBIT taxation which can max out at 37% trust rates federally would apply.  

Option B: ROBS

The ROBS program would be well suited to acting as a real estate developer/flipper.  Such a plan format requires that there be an active product/service business such as an active real estate development company.  You would need to be actively engaged in that business and draw a reasonable salary in order to participate in the C-Corp retirement plan.  So, not drawing income is not an option.  While there are no taxes or penalties for rolling your existing tax-deferred retirement savings into such a structure and capitalizing the C-Corp - the corporation will pay normal corporate taxes (at 21% federal currently) and you would also pay income tax on any salary you take from the company.  You can generously defer some of that salary into the plan, however.

So...

If your goal is to grow your existing tax-sheltered retirement savings by investing in an asset class you understand, the Solo 401(k) would be a good fit, with limitations on your involvement and a shift to passive real estate strategies such as rentals or hard money lending as opposed to flipping.

If your goal is to create and be actively engaged in a real estate development company, and have access to existing retirement funds to capitalize that business, then the ROBS structure will be the better fit.