UDFI and UBIT Taxation Dodge With i401(k)?

Question

So I am doing more digging on self-directed 401(k)s.  Specifically I am interested in the i401(k) and LodestarSD Solo 401k, although I am not sure that they are functionally much different other than the fee structure.  I'm digging into this.

My question is about both UDFI and UBIT for loans taken up to $50k or whatever the limit is for these vehicles.  If these constructs allow one to take a personal loan from their closely-held company do you still have to pay UDFI and/or UBIT taxes on flip-type investments if this is where the money is invested?

What say you tax wizards?  Hopefully what is written above makes sense.

Bill Humphrey · Answer

Hi Bryan,

The rules about business activity within a plan, regardless of if it is an IRA, 401k or any other plan such as an HSA are the same.  UBIT will apply if you are running a business in the plan.  Note that fixing and flipping can easily be deemed a business.  We have had clients audited and the result was that the plan owed income taxes.  Not the worst thing, but certainly something you would like to know in advance.

For the most part, Debt-financed real property income within a 401k is exempt from tax UBIT where it would be taxed in an IRA.

Bryan Hancock · Answer

More digging...

Apparently UBIT for "entrepreneurship activities" is pretty much the same as it would be with a SDIRA LLC.  Which is to say that the line is very blurry about when investing turns into running a business that would trigger the trust taxation.

Apparently all UDFI is exempt for some reason.  I'll try to dig into the details of that in the coming days.  Note that this does not necessitate that the dollars are the dollars you borrow from the plan.  My understanding is that it is for all dollars housed in the solo K.  Another thing I read today is that the leading lender of non-recourse funds to solo Ks takes the position that you can't be your own trustee for plans they loan money to.

Oh...and the cap is $49k from what I read.  It goes up a bit if you are older because you have a catch-up provision.

Jon Klaus · Answer

Bryan, these loan proceeds are no longer part of the 401k and are treated like ordinary dollars.  The 401k has a note which is, of course, subject to the rules and benefits of the 401k.

Bryan Hancock · Answer

So I have dug into this a lot more in the last several days and I learned the following:

1.  For people with a holding entity and a operations entity (dealer property) you should set your plan up for your s-corp that siphons off FICA so you can offset OI

2.  The s-corp's solo K cannot invest in debt reduction from the holding entity because of the way title reads

3.  You need a new property titled to your 401(k) to invest the deferred proceeds or you need to find other productive uses for the funds like making loans.  I intend to make loans

This begs the question about whether or not one can change the title of the existing holding properties if they are taken subject-to with what amounts to non-recourse debt and invest in debt paydown at that point.  I still think it would be disallowed or risky though.  A completely new entity could be formed which would be cleaner.  The benefits of investing in long-term properties with self-directed plans are small IMO.

So I could be a lender starting later this year.  Anyone need to borrow some money that has good collateral?

Ebere Okoye · Answer

From what I know, there are not UDFI and UBIT on loans associated with a solo401k. Only loans associated with SDIRA's.

Bryan Hancock · Answer

Yeah...Hopefully that won't be an issue in '12 Bill ;-)

Bill Humphrey · Answer

One more thing, note that the contribution amounts you refer to above require that the company providing the plan have significant income.  The deferral requires at least that much income, but the company contribution is based on 25% of the compensation paid out to the participant.  To get to the maximum you would need income of around $200K.

Bryan Hancock · Answer

So I talked to a number of folks today and learned a lot about this stuff.  You can roll any accounts to this vehicle except for roth IRAs.  That is one of the main tradeoffs I see between this and a SDIRA LLC.  Note that Roth 401(k) money can still be rolled to these constructs.

Virtually everything else seems superior to me unless I am missing something.  The tax structuring is better, the flexibility is higher, and the ongoing fees are much lower.  The only gotcha is the up-front cost.  If you are willing to invest the money it seems like it is well worth the added cost.

The UDFI and UBIT taxation issue is still a bit unclear to me.  I will keep digging on that stuff.

For the taxation piece you can apparently defer the first $16.5k of income and 25% of gross income up to either $49k or $51k...couldn't get a straight answer on that.  Note that the $49k is inclusive of the first $16.5k.  Note that your spouse can bury the same amount too...which puts the total north of $100k if you make enough income.

The i401(k) seems to be cheaper up front and carry more costs later on if the plan needs to change.  The LodestarSD Solo 401k seems to carry a higher cost up front and less ongoing fees.  The LodestarSD Solo 401k also seems to have better ongoing service, but I am still digging in to that.

Any commentary, advice, or opinions is appreciated.

Bryan Hancock · Answer

Is the max contribution still $49k?  Or is it now $51k?  I am trying to figure out how the LodestarSD Solo 401k literature gets to $102k.

Jon Klaus · Answer

UDFI from the loan proceeds (outside of the 401k) is taxible.  My understanding, anyway.

UDFI and UBIT Taxation Dodge With i401(k)?

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