Can rental income be used to contribute to retirement...explained inside...

Question

As an independent contractor years back I was able to exceed traditional 401k limits w/super/megaroth. This was glorious. Since then the company which provided the solo 401k was acquired, rules changed so that now (in 2023) what companies offer this option? I'm also now a W2, not a 1099.

We have a rental that may eek out profit by the end of the year. Passive income would no qualify...(note passive income IS taxed as normal income...gets added to reportable income for that year) Do people (have you) actually set up a company to for property management , charing a fee to each property for services? My wife and I do spend a fair amount time in the management...we do everything ourselves but landscaping.

How can we take earnings and invest in a tax advantaged (ideally roth401k?) My understanding is that any taxable 'source of income" can have its own retirement options. Note the standard 401k and IRA limits will be maxed..This needs to be AFTER TAX contributions that can then convert to Roth.

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Respectfully ask not to be contacted directly by financial advisors seeking new business.

UPDATE:

The above strategy is a thing... and many open up management companies for this purpose.
Presume standard annual 401k/IRA are maxed. Husband and wife are both W2. 5k earned that year in rental income for discussion.
Thoughts on the below plan?

• Establish company specifically for rental management.
• Over the course of the year new company will be paid $5k for services from rental income.
• Schedule C shows $5k (and payments are shown as expense on rental side.)
• 15.9% of $5k paid for Self Employment (apx. $800.00)
(note this would be less than ordinary income paid otherwise, plus 50% of SE tax is a deduction.)
• $4,200 contributed to solo traditional 401, then converted to Roth.

What other considerations are missing?
How about IRA requirements, for instance to be a real estate professional you need to document x# of hours (which is nearly impossible to do w/a W2 job.) Contribution limits (presuming max is the number around 60k, and this wouldn't be close.) Are checks/receipts/proof of payments needed or would transfers be ok? I would likely open a dedicated bank account to receive payment from rental income, then contribute to solo 401k from this account.

Contribution Rules?
Since this would only ever be from the 'Employer' side for foreseeable future, would the contribution to the employee be limited to 25% (5k - expenses -50% self employment tax,) or ok to use net? How would contribution limits work?

Thank you for any insight...

Jeff Nash · Answer

You are knowledgeable and on the right track as far as needing income from self-employment. @Dmitriy Fomichenko can address your fact pattern without any conflict of interest.

Todd Goedeke · Answer

@Pixel Rogue don t forget about a major advantage of a Solo401k is the ability to transfer old 401ks and IRAs into a separate Solo 401k for you and your spouse. There is no UBTI generated from leveraged RE inside a Solo401k as compared to an IRA which generates UBTI when using leverage.

Doug Smith · Answer

In the mornings, I make it a point to log in and see if I can help a handful of people, but sometimes I worry that I type just to "hear the sound of my own voice". I think we all fall into that trap sometimes. I logged on to answer this, saw that @Jeff Nash, a CPA, answered the question, and thought to myself what in the world could I add to the commentary of an expert who has already answered the question. It just reminded me to stay in my lane and only answer questions where I'm a true expert.

Bill B. · Answer

Real estate is pretty tax advantaged. By eke out a profit do you mean after depreciation? If so, that’s pretty good, or a property you’ve held for quite sometime as that usually erases most taxable income. By eke out do you mean $10,000 or more? Enough to make this worth the effort? (Enough to save a thousand or two.) If you only meant thousands I would assume you could find deductions you might have missed like your cellphone and it’s monthly bill, your internet, your iPad/computer, home office, mileage, umbrella insurance, supplies/equipment, CPA, etc etc.

Glad to hear another success story either way.

Pixel Rogue · Answer

One of the replies sent my thinking down another path - purchasing a property through se401k, which then spun this thread as I starting thinking out loud.
So now this thead is a mix of different strategies for different purposes... didn't intend it to to that way.

We have ways to exist real estate to minimize tax liabilities....momve between rentals as they are sold, 1031 for a long term home etc.

Then we introduced purchasing an investment property through the se401k, meaning income generated wouldn't be taxed or reported to bump up brackets etc.

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For those asking, we have W2 jobs, savings, investments etc.`There wouldn't be 'zero' reportable income but I find it helpful to understand as extremes, so for discussion purposes the idea of rental income that wouldn't be considered reportable income as it would be in the 401k.

David M. · Answer

@Pixel Rogue

Little lost here...

For tax advantaged investment purposes in real estate, my understanding (never done this) is one would open a IRA or Roth IRA self-directed account. Fund it. Then, the self-directed account opens a LLC that would hold Title to a property. The key is getting a self-directed account, unless say a brokerage account where you can only buy stocks and bonds.

So, the se401k or Roth se401k could be moot.

Yes, using a tax advantage account to invest in real estate to commonly done to my knowledge.

P.S. I sent you a separate message

Pixel Rogue · Answer

Did a super roth a few years back, loved it. Situations changed and I forgot the 25% limit. The personal side would already be maxed out through W2 employer. It would only be my company paying into the plan and, with the 25% cap, + se tax, there might not be enough to matter.

NOW - while we never actually planned for this so restructuring would be needed, yes we could probably purchase an investment property from the retirement funds. Having one of those moments saying 'what, really? and I'm just learning this now?' Presuming Roth works equally as well? This potentially changes everything....

Please correct this inflated aspiration presumption:
• Set up an SE401k, shift things around to fund enough to purchase a property.
• Purchase property, get it rented.
• All profit is tax free for life of investment - can live off this in theory?
• This income is not taxable and would not add to income brackets
• Presuming no benefits to expenses, nothing to write off against in t his scenario.

Questions:
• Income could, in theory, feed the SE401k balance...contributions monthly?
In theory, no annual contribution limit?
• Could this work for similar investments (that a 1031 would accept) to something
such as a DSTs, CrowdStreet/FundRaise - more passive options?
• Could one of my LLCs sell to me SE401k, essentially converting a current investment?
(at the cost of transfer tax and fees)
Presume there are rules preventing the LLC from selling to SE401k for $1.00.
Curious on rules around sales price for such a situation. For example, the LLC could
sell to SE401k for leveraged amount?
• Could I still purchase a property through SE401k as an LLC?
Seems like this could work.

Todd Goedeke · Answer

@Pixel Rogue I would refer all tax questions to a qualified accountant or tax atty.

Here is information gleaned from You Tube site of IRA Financial Group. The owner has written a couple books on Solo401ks.

The reason for having real estate in your Solo401k is so that all future income and capital gains is tax deferred or tax free( Roth subaccount). There are no taxes or mortgage interest to deduct if there are no taxes in first place.

If you are current owner of RE you can t 1031 that property into a Solo401k. Nor would you want to since a 1031 is to continue to defer gain.

One option is to not do a 1031 but just sell and take proceeds to build a STVR. Using cost segregation the depreciation deduction can wipeout all capital gains and additional w-2 income.

David M. · Answer

@Pixel Rogue

First, I apologize as I've skimmed over this thread --- there is such a mix of information...

Of course, consult a qualified professional...

Yes, you can "convert" your passive rental income into active income so that you can use it to contribute to retirement accounts. For example, a self-employed 401k, aka solo 401k, you can contribute ~22.5k yourself (basically the first profits of the LLC) and then your LLC contributes 25% of its profit up ~$65k (both amounts change yearly and I don't bother to remmeber them exactly). This is even faster than using the SEP IRA and now the primary account because of these recent rule changes. The tax advantage is a bit hazy because you can still deduct your half of the se tax. Its actually a circular equation and the IRS has a chart so that you calculate a final number if I recall correctly.

You can make se401k accounts with Fidelity for no charge.

People/investors do use self-directed IRAs which allow them to invest in real property. Some people's IRAs are large enough that they can own (I think with leverage) an entire property and rent it out. Yes, all the 'profit' is tax free since its being done in a retirement account.

I hope this helps. Take care.

Pixel Rogue · Answer

Reading more on this topic. Would a mortgage in the name of a Solo 401k be considered similar to an LLC from a bank perspective, discouraged by most and requires different levels of financing? Curious, however not 100% applicable as I expect the purchase to be a cash buy or 1031 as-is exchange.

Now, that brings another question into view... let's say you purchase an investment property through a Solo401k, would that mean all expenses/income do not hit personal income tax and remain sidelined?

Is mortgage interest the only gotcha of UBTI?

Can rental income be used to contribute to retirement...explained inside...

Can rental income be used to contribute to retirement...explained inside...

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