Making a loan for purchasing income property from Solo 401k ..
Investor · Hermosa Beach, CA · Member since 2012 · 42 posts · 6 votes
I am contemplating to make a loan from my solo 401k to a friend.
The loan will be secured by the property.
I would be interested in a word of wisdom on how it is properly done to avoid trouble with IRS and/or loosing tax exempt status of the funds.
What paperwork is sufficient? do I need to put solo 401k on deed of the property?
Any advice or personal experience would be appreciated
LEONID ORLOV, in addition to what Jon Holdman has said, and assuming you are lending from a self directed 401k, not taking a loan from your conventional 401k:
1. Check with your attorney to make sure that you are not in violation of the SAFE act. If the loan is considered to be residential, you (your 401k) could need to be licensed. To avoid this, you would need to engage a mortgage broker.
2. If, as I suspect, you are lending to an entity, then be SURE that the borrower doesn't intend to occupy. Ever. You also won't need the mortgage broker to do the residential compliance paperwork.
3. Make sure you have checked with your IRA Custodian to get the correct exact wording on how the promissory note should be worded (the exact name the note should be in)
4. Submit your DOI (direction of investment) to your custodian (if you use Equity Trust, expect it to take several tries to get the paperwork right). You will need to submit the promissory note and mortgage/deed of trust with the DOI, so your private loan savvy attorney will have had to draw up the Note and Mortgage/DOT already.
5. If your Custodian provides the service, you can log on and create a payment coupon for your borrower to use for payments. Be sure NOT to take the payments yourself, they must go to your 401k.
6. Have your attorney draft a discharge for when the loan is paid off. You will need to provide that payoff for recording when it is finally paid, and it will need to be signed by the custodian.
There are more details involved, but these are the basic steps. If you let me know who your self directed 401k custodian is, I may be able to give more detail.
These are my two problems with this:
1) I won't do business with friends unless I'm fine with not being friends.
2) There is significant opportunity costs associated with taking loans from your 401K.
Otherwise, I think no matter what advice you are given here, it would be foolish not to contact an RE Attorney to have a contract drawn up.
Brian Hoyt, I think he was intending this was a self direct. I hope LEONID ORLOV can clarify. If it is self directed account then it could be done; however, I do not like to do business with friends. You could find much better investments than a loan on a property unless you are looking at giving a hard money loan.
If you are not using a self directed account; I would be very careful with this situation. Just tell him that you can't access the funds.
Always talk to your attorney and accountant.
-Steven the Tax Guy
I am not worried about loaning to a friend, we both know its a business. LTV and income from the property is so favorable that one would be crazy to default on such l loan .. and the lender (my solo401k)would be happy to repossess the property.
What I am concerned with is to do it properly to make IRS happy :-)
Any word of wisdom or referrals in CA would be appreciated
You don't really need to do anything to make the IRS happy.
Document the loan properly and do the transaction with a title company. Your Solo 401K will be the lender. The borrower will give your Solo 401K a deed of trust (or mortgage) giving the 401k a security interest in the property. The 401k will send the funds to the title company who will disburse them to the seller, borrower, or whoever is appropriate. The details are going to vary depending on if this is a straight loan or a purchase loan. There should also be a promissory note for the transaction.
You personally should not really be a party to the transaction at all. You're just acting on your 401k's behalf.
Be sure you're in first position. Get a title search and a "lender's title policy" paid for by the borrower.
LEONID ORLOV, in addition to what Jon Holdman has said, and assuming you are lending from a self directed 401k, not taking a loan from your conventional 401k:
1. Check with your attorney to make sure that you are not in violation of the SAFE act. If the loan is considered to be residential, you (your 401k) could need to be licensed. To avoid this, you would need to engage a mortgage broker.
2. If, as I suspect, you are lending to an entity, then be SURE that the borrower doesn't intend to occupy. Ever. You also won't need the mortgage broker to do the residential compliance paperwork.
3. Make sure you have checked with your IRA Custodian to get the correct exact wording on how the promissory note should be worded (the exact name the note should be in)
4. Submit your DOI (direction of investment) to your custodian (if you use Equity Trust, expect it to take several tries to get the paperwork right). You will need to submit the promissory note and mortgage/deed of trust with the DOI, so your private loan savvy attorney will have had to draw up the Note and Mortgage/DOT already.
5. If your Custodian provides the service, you can log on and create a payment coupon for your borrower to use for payments. Be sure NOT to take the payments yourself, they must go to your 401k.
6. Have your attorney draft a discharge for when the loan is paid off. You will need to provide that payoff for recording when it is finally paid, and it will need to be signed by the custodian.
There are more details involved, but these are the basic steps. If you let me know who your self directed 401k custodian is, I may be able to give more detail.
Located in what state? Interest rate? Owner occupied, vacant, or tenanted? Do you use a 401k administrator or is that you? Seniority of the DOT? Flip or hold for income?
There’s not nearly enough information to give you a complete answer so I’ll make some assumptions.
I assume that the loan will be secured by California real estate since that’s where you reside. Yes? The safest way to do this would be to use a broker to originate the loan and assign the note and deed of trust to your 401k at closing. Depending upon where you get your documents, you might want a lawyer to review them. If you use a 401k administrator, they will give you the exact wording for the note and deed-of-trust. If not, the person who sold you your plan should know.
You’ll need lender’s title insurance and an insurance binder naming you the loss payee. The broker can help you with all of this, work with a title company, and complete the mountain of paperwork behind these deals. Don’t try to do this on your own or even with a title company.
Any California loan greater than 10% interest is usurious unless there is an applicable exemption. In your case, the likely applicable exemption is 1) to secure the loan by real estate and 2) to use a broker to originate the loan. There’s nothing wrong with contacting a lawyer to review your documents, but not all lawyers are brokers. You must use a CA licensed real estate broker to get the exemption.
Assuming a flip, when this property is sold or otherwise paid off, escrow will send you a request for payoff demand and usually (not always) a Substitution of Trustee and Full Reconveyance for your administrator to sign, notarize, and mail back. Escrow will also need the wire instructions to your 401k account. Never take possession of this money. Good luck.
Jeff
Thanks to all for your input.
From your questions I discovered that I did not provide necessary details. Here it is:
1. I am in CA.
2. I am an administrator and trustee of my Solo 401k. The plan was created by the pro Bruce Fox from Sacramento( at very reasonable cost I might say). I have opened non-prototype account with Fidelity in the name of the plan and rolled over 401ks funds from various previous employers and contributed to the plan while I was self-employed for 3 years.
3. I have checkbook rights for the account and don't have to deal with custodians, etc.
Its good and bad. Its good, because I can act quickly. Its bad because I have no idea what I am doing and am afraid to make a step that will disqualify funds from tax protected status.
I am mostly in cash and Fidelity pays me 0.01% on the funds.
Financing the loan on income property at the max legal interest rate (which I was told should be within reason Prime+1% will pay provide steady return with low risk. Borrower will post 25-30% down and property generates 3 times more income, than the mortgage pmt will be.
I would buy the property myself, but this would be self-dealing.
I presume that lending to unrelated party will let me stay within the rules.
I hope I provided more details on transaction and would appreciate any additional info refferal or a pointer to the sample documents that I will need.
Thanks again for all your help.
Leonid
Given that you are the administrator and have checkbook control, it is even more likely that you can violate some IRA restriction without knowing it. So I would definitely not use "sample documents". Use a CA attorney, and since this sounds like it could easily be considered a residential loan, use a mortgage broker. You need an attorney familiar with private lending and with self directed 401k's. Sounds like a tall order. My custodian, however, did give me the name of a CA attorney who sets up LLC's within SD IRA's, so they presumably have the experience you need. I didn't use them, I used my MA attorney. If you PM me, I'll send you the contact information
I'm surprised that Will Barnard hasn't chimed in yet - he usually has good input on use of retirement plans in real estate investment.
Some good advice here and some overly confusing stuff too. This is a simple deal.
You as the custodian of your self administered 401k can invest in notes (which is what you are doing here). Since you are in CA, the usury limit is 10% so if you want to make a higher return than that, get a loan broker involved. They will charge points (perhaps you can negotiate 1-2, but that is paid for by the borrower, not you.
Like Jon stated, you will have a deed of trust that will be executed and given to escrow, escrow will record your deed of trust (which will contain the vesting of your 401k plan) concurently with the purchase recording. (I am assuming this is a purchase transaction and not a cash out refi)
You need to get title insurance, have your 401k be named additionally insured on the hazard insurance policy, you should request impounds for taxes and insurance, use a third party processor for the monthly payments and to keep track of all documents, and sit back and have your 401k earn the income (passively I might add!)
If you have any more specific questions, do ask, I generate notes all teh time, am in CA, and have a lot of experience in this arena.
Will
Something to consider is that if you end up having to foreclose, it will be the Solo 401k that has to foreclose and deal with the property after foreclosure. The Solo 401k will have to fund the foreclosure and anything after that. Not you. So, you'll want to be sure you have cash available in the 401k to deal with this fallout, if it happens. It did to me, though with an IRA rather than a 401k. But same issue.