Unfortunately not, rental income is considered "passive". To qualify for the Solo 401k you must have legitimate self-employment activity with "earned" (non-passive) income.
One possible solution would be to convert one of your rentals to AirBnB (or short term rentals). If the average stay is below 7 days then such income would be considered "earned" income and would qualify you for the Solo 401k.
Unfortunately not, rental income is considered "passive". To qualify for the Solo 401k you must have legitimate self-employment activity with "earned" (non-passive) income.
One possible solution would be to convert one of your rentals to AirBnB (or short term rentals). If the average stay is below 7 days then such income would be considered "earned" income and would qualify you for the Solo 401k.
In general, rental income is reported on Schedule E and is not subject to self-employment tax/FICA, and thus, not eligible for plan contributions. However, if you can treat some of that income as self-employment income (management fee), then you may become eligible to establish a solo 401(k) plans. Hope this helps. Thanks Adam
@Dmitriy Fomichenko - Thank you for clarifying. Say that your LLC has revenue coming from a qualified source - freelancing, side hustle, small business, etc. You decide to buy an investment property and want to title it under that LLC for an additional income stream. Can you roll that investment property income into your Solo 401K prior to paying tax on it?
Or, can my LLC with the Solo K be the property manager for my own investment properties that are held under separate LLC's?
You could buy an investment property under you "business" LLC. Would it be wise decision from the tax and liability standpoint? This is a totally different question which you should discuss with your CPA and attorney.
No, rental income is “passive” in it’s nature, only “earned” income can be contributed into 401K.
To answer your last question: this is possible but would it make sense from tax perspective? Again something to discuss with your tax professional.
I'm not an expert, but my understanding is that you can us a self directed IRA for rental properties, and if you later run a business that qualifies for a Solo 401k, you can roll over the IRA into a solo 401k as long as it isn't a Roth.
Hello all, hope everyone is safe and healthy. Now to answer the question, rental income will be passive income and you can also discuss this CPA. An individual 401(k) is designed for a business owner with no employees. The IRS rules say you can’t contribute to a solo 401(k) if you have full-time employees, though you can use the plan to cover both you and your spouse.
@Mindy Jensen , I like Attorney Adam Bergman s answer. If you form a property management company to manage your real estate the advantages of a Solo 401k may far outweigh an IRA . Ifyou have large $ IRAs or old 401k monies to roll into a Solo 401k the ability to avoid UBIT taxes far outweigh the small amount of self employment tax to pay.
Depending on how much (or how little) income you generate... In order to setup a Solo 401k plan you must have legitimate business activity that generates profit, and it must be ongoing.
Generally speaking, converting what could be treated as passive income to earned income capable if sponsoring a solo 401(k) is a losing proposition. The administrative overhead may outweigh any perceived benefits of a Solo 401(k).
A Checkbook IRA can be an alternative vehicle with much of the same investment flexibility.
Generally speaking, converting what could be treated as passive income to earned income capable if sponsoring a solo 401(k) is a losing proposition. The administrative overhead may outweigh any perceived benefits of a Solo 401(k).
A Checkbook IRA can be an alternative vehicle with much of the same investment flexibility.
I don't think there would be any conversion of the income in this case, short term rental income normally would not be considered as "passive" but rather "earned" and subject to self-employment tax.
My statement was more general to the thread than specific to the one post about short term rental income.
Our experience is that the marketing - very much including here on BP - has a very strong bias towards the Solo 401(k). It is a great plan and we put such plans in place for many investors. However, this creates a real shiny object syndrome were a whole lot of people who have no business with a Solo 401(k) become fixated on this one plan option and focus on "how do I make it happen". Often, the better answer is a different plan format that entirely suits their needs for diversification of their tax-sheltered retirement savings.
If someone for their own legitimate reasons has qualifying self-employment, great.
When folks start talking about creating self-employment just so they can have a Solo 401(k), I would say 85% or more are creating more work than the corresponding benefit they may receive from a Solo 401(k) as compared to say a Checkbook IRA.
Being self-employed requires time away from other endeavors and family. One must keep records related to the business and potentially file an additional tax return, each of which cost time and money. In order to continue to sponsor a Solo 401(k) the business must be legitimate and ongoing not just to setup the plan, but for the long term. Once the sponsoring employer goes away, the plan must be terminated and rolled over to an IRA.
Taking passive rental income and creating a separate corporation to provide management services to oneself as mentioned earlier in the thread not only has the time and expense of setting up, maintaining records for and reporting taxes for that separate corporation, but also adds 15.3% in self-employment taxes to any of the income now deemed to be self-employment.
While the Solo 401(k) has many nice features, two of the primary advantages such plans have over IRA alternatives are higher contribution limits and the immunity from taxation on UDFI in leveraged real estate transactions. If one is utilizing a minimal or made up business, there is not likely any significant income involved, so no opportunity for new contributions. Sure, you can rollover funds from a prior plan, but you can do that in an IRA as well. For an average investor with less than $200K to rollover and invest, the cost of UBIT on Unrelated Debt-Financed Income rental is likely going to be less than $400-$500 per year.
So my question when speaking with investors is. "Is saving $400 per year worth the effort and expense of creating and maintaining a business that you are not currently operating today?"
I used the word "generally" it does not make sense... in my prior post. There are of course exceptions. If you do not have a business today but have a legitimate reason to start operating a business... If you happen to have a significant amount of capital in an old plan to rollover like $400K or more, and plan to focus on debt-financed real estate syndications that will generate UDFI... These types of scenarios can tilt the cost/benefit ratio in favor of "reaching a bit" to have access to a Solo 401(k).
My point is that so much of the marketing hype around the Solo 401(k) overlooks the very important premise that just because the Solo 401(k) is cool, that does not make it the best option for all investors. The fact that many plan providers only offer the Solo 401(k) and therefore only promote that product does not help.
We speak with a whole lot of potential investors who have spent too much time self-educating on the internet and as a result have created some convoluted fantasy plan to obtain a Solo 401(k) they either have no business establishing or for which they will not see any meaningful difference in usage as compared to a self-directed IRA.
I agree with you, Solo 401k is a fine vehicle but only for those who are eligible. I also talk to folks on regular basis who mistakenly think that because they own a rental or just set up an LLC without underlying business in place, they can now set up Solo 401k. There are also those who had the qualified plan established without being eligible for one.
@Brian Eastman@Dmitriy Fomichenko, RATHER than speak in generalities let s speak in specifics and compare UDFI in an IRA vs $0 in Solo 401k.
Case Study:$100,000 in IRA purchasing 200k RE. A duplex is purchased and Triple net leased to a business operator of a Short Term Vacation Rental at 10% or $20,000 net income. Only expense is mortgage interest of $4,000/yr. In this case isn t the UDFI calculated as such: $10,000(50% of income attributed to debt financing) - $4000 ( mort into expense)-$1,000. ( 1k exempt)= $5,000 UDFI to which tax rate is 15% or $750.
Every extra $100,000 of capital in the IRA more than doubles the UDFI tax on initial 100k of capital as tax rates increase.
Also assume a person forms an LLC for the purpose of having a property management company manage a property for 7%, $700-$200(expenses)=$500
FICA taxes= $500 x 15.3%=$77
So by filling out a schedule C for business and paying $77 in taxes, self employment, you are saying it's not worth it? Saving $750 and multiples thereof is not worth it if you just pay $77?
In real life there are many people retiring and rolling over monies in 401ks and IRAs in excess of 500k. They have no desire to start a business but currently own RE. To tell those people not to start a property management company because it might cost them $100 in self employment tax yet saving them potentially thousands in UDFI, does not make good business sense.
Your math is not quite right. Gross income & expenses are used in the ratio of debt financing to calculate UDFI, not just the net income. You have also not included certain allowable write offs, of which depreciation will be a big deduction. Just spitballing, but I'd expect more like $200-$300 in UBIT owed on that transaction. The NNN structure could cost you a few write-offs, but depreciation would still be a factor.
Maintaining a LLC and keeping records and doing a tax return and renewing a LLC with the state ($25 in Wisconsin, but perhaps more elsewhere) all take time and money as well. Most people will not find that beneficial for $700 worth of "income". My time is worth money, so calling the property management record keeping and tax preparation free as you have is a bit off the mark.
With transactions aligning with your example, I would suspect on $100K it is just about break even. At $200K or more, then you start seeing some return on the effort to sustain a 401(k) and eliminate UBIT, but it is still only a few hundred dollars a year. A lot of people will choose to go with the simpler approach that requires less time and mental effort.
If you want to get to specific numbers on a deal, you will want to have your CPA run an analysis.
@Brian Eastman I have consulted with a CPA. Your math is off. The UBIT tax due to leveraging is higher than your estimate. Understand that triple net leases have no expenses. Gross= net. Even adding in depreciation( 25 yr, straight line) it totals $4000 per year.
Software is a wonderful tool to keep track of expenses and income in a business. You may have heard of Quickbooks?
Yes, RE investors should talk to a qualified tax attorney or CPA when deciding if a Solo 401k and accompanying business makes sense vs an IRA.
