Can I create a Solo 401K with only rental income?

Question

I rent out the in-law unit in my backyard. I also have a full time W2 job. I want to roll over my former employer's 401K into a solo 401K so I can more flexibility wrt investments. I don't want to put my rental income into a solo 401k if I don't need to.

How can I setup a Solo 401k if I have only rental income? I read that you can setup solo 401K if you have only Schedule C income and not Schedule E income.

Dmitriy Fomichenko · Answer

John, rental income is considered to be passive. You need legitimate self-employment activity or business with "earned" income to be eligible for a Solo 401k plan.

You can't contribute passive income from schedule E, but earned self-employment income from schedule C is eligible, so your understanding is correct.

Brian Eastman · Answer

@John D.

Rental income does not qualify to sponsor a Solo 401(k) plan.  It is passive investment earnings, not self-employment income.

If you wish to take existing retirement savings and diversify into things like real estate and private lending, a self-directed checkbook IRA would provide flexibility similar to the Solo 401(k).

Brian Eastman · Answer

@Angel M.

Please discuss this matter with your CPA, who will likely tell you this is self-defeating.

Passive income from rentals is favorably taxed.  To convert some of this income to self-employment income simply for the purpose of then making contributions to a retirement plan is generally non-beneficial.  By the time you add up the self-employment tax and administrative cost of running a property management business and filing a separate tax return for that business, you will not likely come out ahead.

If you were providing property management services for other investors, that would be a different situation.

Ryan Nunya · Answer

@Brian Eastman

Please correct me if I am wrong but I believe airbnb or STR does not count as passive and therefore eligible as long as you put > 500 hrs/yr into the job.

As long as you are changing the sheets and don’t use a management company the leases are more than 14 combined days/yr it is not considered passive.

https://www.hrblock.com/tax-center/wp-content/uploads/2018/05/airbnb-taxes.pdf

As soon as you hire a cleaner, and they work more than 100 hours a year (20hrs/week) you cannot use the soloK.

Brian Eastman · Answer

@Ryan Nunya

You are correct that short-term rentals are a different animal for tax purposes than purely "rental" income as noted in the original post.  STR above certain thresholds is generally considered a services business more akin to a hotel, not passive rental income.

Confirm with your CPA on the best approach to form and perform tax reporting for your short-term rental business.  That business could then very likely sponsor a Solo 401(k) plan.

Angel M. · Answer

I have a similar situation and questions for the experts. I currently have a Roth IRA, a 401K at a previous employer, and 2 duplexes I self manage. My thought is to:

1. Create a property management company (PMC) to manage my rentals

2. Open a solo 401K for PMC

3. Rollover my previous 401K to my new PMC solo 401K

Questions:

1. Do you see any issues with this?

2. Would I need to create an LLC for the PMC?

- My rentals are in my name...so it may look less "fishy," and be easier bookkeeping, for Angel Property Owner to pay PMC LLC for services, rather than Angel Property Owner making checks to Angel Property Manager

3. My thought is to pay the going rate of 10% of monthly rents to PMC. That would translate to roughly $5,000/yr, and I would then save that full amount into the solo 401K.

Thanks in advance!

George Blower · Answer

@John D.

To learn more about what qualifies as self-employment income in order to open a solo 401k plan, see the following:

https://www.irs.gov/businesses/small-businesses-se...

Also, IRS Publication 560 (the publication for self-employed plans such as SEP and SIMPLE IRAs, ans solo 401k plans) has a section that gives examples of self-employment activity.

Justin Windham · Answer

@John D.

Without self-employment activity, a self-directed IRA will be a better match for you. The Solo 401k requires earned income from self-employment. Passive income does not qualify.

Michael Vruvas · Answer

Ahh…there’s a way. And yes it’s legal. if you self manage create a a Property management LLC. You are the only employee. The property management company receives income from your real estate holding company. For your services. Scheduling contractors. Showing the rentals. Maybe even doing the repairs yourself. If you throw salt down on the sidewalk in the winter time. Yep. Anyways. Since your the only employee of the Prop mgmt co, boom solo 401k. In 2024 the max in dollars is $69K. Plus a addition $7500 if over 50 years. Think of yourself as 2 things. Employee and employer. as an employee you can contribute 100% of your salary max of 23K. As the employer, you can make an additional profit-sharing contribution of up to 25% of your compensation or net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself. The limit on compensation that can be used to factor your contribution is $345,000 in 2024.

So yep. There you have it.

Dmitriy Fomichenko · Answer

@Angel M.

I understand that the benefits of the self-directed Solo 401k plan are attractive to you, but again: you must have legitimate business or self-employment activity to justify creation of the plan. Be sure to discuss this with your CPA.

Can I create a Solo 401K with only rental income?

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