Can I use Self Directed 401K proceeds to invest with a partner?

Question

I am looking to take checkbook control of my past 401K and other retirement funds.  I am looking to invest $125K with two other partners who plans on investing another $350k into a $800k property.  The property is a secluded cabin on large acreage in the mountains that we want to AirBnB as a backcountry resort.  We think the property can sustain its own payments, maintenance, etc, with the amount we plan on putting down but not much else.  This is a bet on large tracts of alpine property being increasingly hard to come by in the future.   It is almost purely an appreciation play.

If my other partners manage and take care of the property (and I don't benefit from the property), can I invest with them if I'm not co-signing for the loan?  From my research, it feels like a tenant-in-common (TIC) option is really the only option here but that may require that the renters pay each of us with separate checks during each stay (which is not going to happen).  Is there any other way to make this deal happen?

My brainstorming has led me to think we can set up an adventure touring company that has the cabin as a rental.  I would buy shares of the company with my SD401k funds.  I'm not sure this is very straightforward (or even do-able).

Are there simpler ways to make this happen if we're going to have a 50% loan to value on the property?  I'm guessing that the bank will require sign off on the loan from anyone who has over a 20% ownership stake (my stake would be 25% at the current investment levels) which is a no go as I'm assuming the loan can not have recourse on my SD401k.  Would it make a difference if the loan was non-recourse (due to having 50% down)?  If I had a 19% stake in the business/property?

I went from thinking I'd be able to put my $125k into the deal and get bought out 5 years down the road with a nice little windfall from the other partners but the more I read, the more I think this is even possible.  The partners believe they can buy me out in 5 years but they don't think they have the money to get the deal done at this time.  What if I just offered a loan to the partners and left it at that?

Thank you for your feedback.

Brian Eastman · Answer

@Josh Collins

It would be difficult for your 401k to be a lender if bank financing is also used.  You'd be in 2nd position and that may complicate the primary loan underwriting and create too much risk for you

The Solo 401k can be a partner, either in a TIC or by forming a LLC where the plan and the partners each have fractional ownership.  Speak with your real estate attorney to see what works best for the project.  Even it it is just a TIC. one of the non-plan parties could form a DBA that opens a bank account and handles the cash and reconciles with the partners periodically.

How to structure the loan is the challenge.  The loan needs to be non-recourse with respect to the 401k, but can include a guarantee from the other partners.  Perhaps they get an extra point or two of equity in exchange for that guarantee/risk that your plan is not taking (or not, but that is possible).  Some lenders will structure such a loan if the risk is manageable for them - i.e. low enough LTV, good property, etc.  Alternately, the whole loan could be non-recourse, which reduces risk for the partners as well.  Expect a bit higher down, interest, etc., but everything hinges on risk/reward in looking at the numbers.  You'll need to deal with a local/regional bank that is willing to sit down and customize a loan, not a national lender.

Dmitriy Fomichenko · Answer

@Josh Collins, to answer your questions:

If my other partners manage and take care of the property (and I don't benefit from the property), can I invest with them if I'm not co-signing for the loan?

NO! You are not allowed to provide personal guarantee when investing with your 401k.

The partners believe they can buy me out in 5 years but they don't think they have the money to get the deal done at this time.  What if I just offered a loan to the partners and left it at that?

That is what I would recommend you to do, simply be a lender to them on this deal. If your 401k is part owner it would be challenging to get the property financed, plus as short term rental it might be considered business income and therefore expose your 401k to Unrelated Business Income Tax.

Matt Groth · Answer

@Josh Collins even if you can work out the 401k details, it seems high risk to me. 5 years isn't very long to count on the appreciation. I ran sled dogs for 18 years, and operated a tour business for the last 3 of those years. I have since "retired" from dogs. Adventure tourism is a tough business. I ran trips every day of the winter, but profited very little for the amount of work. Insurance is crazy, and, for most forms of adventure, there is A LOT of overhead. If you go this route, make sure your partners keep a close eye on the budget.  It can very easily be lots of money coming in, with even more going out. Good luck!

Brian Eastman · Answer

@Josh Collins

I am not sure about the property type limitations, but FirstBank does offer non-recourse loans.  PM me and I can share with you a contact that is knowledgeable on the topic.  They may or may not be able to do a recourse loan with some borrowers only providing a guarantee.  Will at the least save you working through the phone tree to get to the right person.

Josh Collins · Answer

@Brian Eastman

Thank you so much for your opinions.  This has been invaluable.  This is a deal in CO.  Do you by chance know of any banks that like to finance mountain real estate?  Thank you again for your help.  I feel like I understand how this should work but I can't quite connect the dots.

Brian Eastman · Answer

Of course the "gurus" want it to sound easy.  And in some cases, it can be as simple as put together a deal with profit potential and pitch it to your network.  If the deal is good, the money will follow.

What complicates your deal is the involvement of bank financing - and while "complicating", that does not necessarily mean prohibitively.  You know the limitations.  Go see if you can get a bank to work with you.  You very well may.

If not, well then maybe it is too speculative.   Or, bypass the banks and network and see if rather than 3 partners and a bank loan you might be able to cobble it together with 4-5 partners, or 3 partners and a private lender.

Again, it all really hinges on the quality of the deal.

Josh Collins · Answer

@Dmitriy Fomichenko

Correct, I would not provide the personal guarantee.

I didn't think of the unrelated business tax angle if we set this up as an "adventure company" or something similar.

Personally, I like the idea that I'm just a lender and if they don't cash me out then I become equity owner.  Frankly, I'm okay with either option.  I'm thinking that acting as just a lender will complicated things with the bank loan.  Obviously the loan from my 401K would be additional debt to service whereas if I'm an owner, the property wouldn't have the loan payment to my 401k to count against the property's financials.  In our opinion, because we're both self employed -which creates other issues with banks - we were thinking we'd want to put as much money down as possible to reduce the mortgage payment as much as possible to make it look as enticing to a bank as possible.  Adding the mortgage payment to my 401K adds additional expense to the loan app.

@Brian Eastman

Acting as a lender would "complicate the primary loan underwriting and create too much risk for you".

That was my thought too.  I was under the impression that if I keep my equity under 20% there is a good chance I don't have to provide a personal guarantee.  I'm also under the impression that many banks have done loans where just one person provides the personal guarantee no matter the amount of funds and/or equity in the deal.  Having just said that aloud, it just dawned on me that they probably have to have sufficient financial standing other than just a good credit score to back up the deal and sign off on a personal guarantee.

I was hoping that I could invest in the property with my 401k funds and be hands off.  If my partner can't buy me out in 5 years, I then just take on an equity stake of which I can sell to a 3rd party or keep until retirement age.  I've been to seminars where the "guru" just says to hit up your friends with old 401Ks and family members with IRAs that aren't doing anything and have them invest in your deal using those funds.  How does that differ from this deal?  Is it because our deal is mostly land speculation?  What am I missing?  They certainly make it seem a lot more straightforward than it is.

Can I use Self Directed 401K proceeds to invest with a partner?

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