Eligibility/ Clarification 199A and Self Directed 401k

[Account Closed]

Me and my partner set up an LLC in CA (taxed as a partnership) in 2019. We are the only individuals in the company and performed over 1000hrs each this year and will continually maintain those hours developing our large property which currently has not structures. We leased the land last year (2019) to a successful farm management company and seeking guidance on the next steps.

I am seeking clarification from experienced CPAs familiar with CA laws on how to maximize our deductions/deferrals so we can minimize taxes. From my understanding of IRS guidelines; we definitely qualify for the 199A election which would provide some additional deductions under QBI. I am curious if the company can additionally qualify for a self directed 401k plan (which would allow up to 20% of net income plus personal). I know traditionally "rental income" would not qualify under self employment tax due to passive income rules. However as mentioned earlier we are actively participating in the entire business operations over 1k hours annually. Can we pay ourselves wages under a LLC partnership and would that qualify legally? Can we do a mixture of both wages and QBI? I would prefer not to elect an S-Corp which I know is an option but really havent been sold on the benefits compared to a llc partnership. We set up the self directed 401k prior to year ending not knowing if it was allowed or not. We have heard many different responses over the last few months.

Please advise if any further information is needed.

[Michael Plaks]

Originally posted by @Account Closed:

My question is can both a 199a and a self directed retirement account be done? I should qualify with ease for re pro. Does that now qualify for self employment income which now can then be deferred to a self directed 401k and can be matched by the company llc. Along with also the co. Can qualify for the 199A? The language may not be correct which I’m using but I’m sure the professionals can understand what I’m asking. 

No, the professionals cannot understand. You're unfortunately throwing every tax term into the same food processor, without explaining what dish you're cooking. I already mentioned some of the critical questions above, of which you only clarified #2: the type of activities you'r personally involved in.

I will give you some pointers to start, but they are likely to do more harm than good, I'm afraid, since you're not clear as to what business you're involved in, tax-wise.

1. There're two principally distinct types of businesses in real estate that might apply to you: rentals and development. Maybe more than two. They are completely different for tax purposes.

2. If you're renting - it is passive income. You cannot attach retirement accounts such as 401k to a passive business.

3. If you're developing - it is non-passive income. You can fund a retirement account such as 401k from profits of such business, but you need to have those profits, after expenses. So far, I have not heard of any income you generated as a developer, and farm rental does not count (see #2 above).

4. RE Professional status only applies to deducting losses, and only from rentals. It has nothing to do with anything else like 401k or QBI deduction.

5. QBI deduction applies to any business that has net profit, after expenses. Both rentals and development can qualify, but you only get this deduction if you have a positive net profit from all businesses combined.

6. The safe harbor you quoted is designed to qualify a business as a business. In your case, you seem to qualify without a need for safe harbor. In fact, the safe harbor is mostly useless anyway.

Warning 1: my explanations are over-simplified and not technically accurate, as some of my colleagues might rush to point out.

Warning 2: my explanations are unsafe to use as guidance, given the huge uncertainty of your business. It needs a thorough review by a professional. Not sure who those 20 you talked to were. Why not talk to some of us who contribute to this forum. We are real estate specialists.