Warbucks - Red Inc for lending and fix-and-flip/rent?

Question

Am looking for the right entity structure. It would be great if you can poke and plug holes. I do intend get a CPA’s input and an attorney’s input after revisions.

As I started writing this, I realized that many on this board are thinking something along these lines as well, though not explicitly captured.

Current Context: 1. I have some money in different buckets that I would like to use for real estate investing: regular IRA, Roth IRA, current employee 401k, Home Equity Line of Credit. 2. I currently work full-time (unrelated to real-estate) and drawing salary. 3. The idea is to set up a multi-member LLC with Solo-401k. Then roll over my regular IRA to the Solo-401k. 4. Also, set up a single-member LLC that is used for fix-and-flip or fix-and-rent.

Immediate business opportunity (over the next couple of weeks to a month): Some fix-and-flippers and fix-and-rent’ers in Baltimore are looking for hard money lending. Even though fix-and-flippers are working on residential properties, they will borrow on a commercial basis (unlike homeowner mortgages which have significant mortgage borrower protections).

Medium-term opportunity: In addition to hard-money lending, I am also looking at opportunities to fix-and-flip and fix-and-rent properties myself.

Proposed Entity structure: Use the WarBucks - Red Ink strategy (see http://www.homesteadschools.com/legal/Lawsuit%20&%20Asset%20Protection%20K.%201.pdf ).

1. Set up a Wyoming based Multi-member LLC (say, Wyoming WarBucks LLC) 1.a. My wife and I will own 98% of Warbucks LLC. My sister-in-law will own 2%, Reason for setting it up a MMLLC: Greater asset protection from outside liability (for e.x., when I am at-fault in an accident and others sue me for damages). 1.b. Use Warbucks Inc purely to lend money. Warbucks primarily (say 99% of the time) lends is to Red Ink. It lends secondarily (say 1% of the time) lends to others (3rd party Fix-n-Flipper LLC). 2. I establish a solo-401k for Wyoming WarBucks and rollover all my IRA money to the solo 401-k. 2.a. Use my solo-401k at Warbucks purely for lending hard-money to others and other passive investments. 3. Set up Maryland Red Ink LLC that is 100% owned by my wife and me. 3.a. For my Fix-and-flip or Fix-and-rent activities, Warbucks lends money to Red Inc. Red Ink uses the borrowed money to purchase and rehab. Warbucks lends money at a high interest rate (say 15% to 20%) such that Red Ink almost always breaks even or makes a slight profit or loss. Warbucks collects interest from Maryland Red Ink and does not have to pay FICA, FUTA, and state tax (since they are interest payments). 3.b. Red Ink’s net worth is minimal – say 3% to 5% of assets. Its remaining assets are borrowed from WarBucks.

Impact on Taxes: Minimize taxes (esp. FICA, FUTA, state tax rates on fix-flip jobs) and audit probability (John Hyre writes that single-member LLCs have a high likelihood of an audit, whereas MMLLC’s audit-rate is low).

Impact on Asset protection: As Red Ink has minimal net worth and is heavily indebted to Warbucks, Red Ink is not an attractive target for lawsuits. Warbucks being a MMLLC has greater asset protection against outside liability.

Questions that immediately come to mind: Does it make a difference if Warbucks is a Wyoming or Maryland entity? Warbucks will lend almost exclusively to Maryland businesses. Will that mean, the Warbucks has to be registered in Maryland as a Foreign entity? If the entity is registered in Maryland, will Maryland levy state taxes on Warbucks LLC profits for LLC members who are Maryland residents (since Warbucks LLC is a pass-through entity)? What if the entity does not have to be registered in Maryland?

Nkrumah Morgan · Answer

I have also been looking for ways to fund my business, and have been looking at the solo 401k. From what I understand, you can roll over certain retirement funds. Set-up a custodial account with check writing privileges. Write your company a check for what ever amount of funds you wish to invest. You have successfully funded your business with a solo 401k, (to put it in the most simple of terms.) With that said, there are steps that must be taken to do it legally. For that, I would strongly suggest talking to an expert in such matters. I have found this website to be an excellent place to start. It is well organized, and easy to understand. With that said, I would still consult your CPA to make sure that it is an avenue that would be beneficial for your particular circumstance. The link provided goes straight to the "contributions" page from which the following information comes:

Now to be eligible to roll over a 401K, I think, you have to have ended your employment with that company. So the 401k that you are currently investing in at your job would be ineligible, but 401Ks from previous employers would work.

To me it sounds like a great way to fund a business venture, if you don't mind risking your current retirement assets to do so. I am 36 years old, so if my business fails, I still have some time to recoup those losses.

If you are rolling over a considerable amount of money into your solo, then asset protection is a definite must have to protect them. That is where your business structure comes into play. Make sure to get competent legal council regarding these matters.

Jeff Barnes · Answer

Ann Bellamy is correct that you need to have income into the LLC in order to contribute to a Solo K. However, just like any other 401k plan, once you have it set up, there is no legal requirement to continue contributing to it. In fact, one of the ways we help folks is to set up their Solo K simply as a way to roll their old 401k into it, then they use the new Solo K for investing in a way that suits them best.

Jack Nichols · Answer

@Steven Hamilton II
Thank you,
The business is expecting to produce income, so that part is covered.
I do not understand your statement about "this might be a prime situation to consider ROBS". I thought there were two problems with that:
1. A prohibited transaction for my 401k to invest in a business if I also provide services to that business.
2. Double taxation of 401k.

I am only planning to transfer funds from my Rollover-IRA into the Solo-401k/i401k (from Sunwest Trust). Not from my current employer 401k to the i401k.

I am also not intending to get into a partnership with my i401k.

Steven Hamilton II · Answer

Jack Nichols,

The business at hand does need to be producing or expecting to produce and income before you open the solo 401k; however, this might be a prime situation to consider ROBS. Investing part of your 401k into a C-corp that is held by you and your 401k.

One issue you will have is rolling over your current 401k to a new plan as you are still currently employed.

You always have to add equally when it comes to partnerships with your IRA/401k. If it is 5/50, it needs to remain 50/50. If your 401k is only lending then UBIT is not an issue.

Jeff Barnes · Answer

Ann Bellamy- take a look at the IRS' website at http://www.irs.gov/pub/irs-tege/rollover_chart.pdf to see exactly what type of rollovers are allowed. A 401k is considered a "Qualified Plan" in this chart.

The one big area that the IRS didn't allow, and don't ask me why, is the ability to roll a Roth IRA into a Roth 401k. They are both after-tax contributions, but for some reason they are disallowed.

Ann Bellamy · Answer

Ah, good to know, I'll check with my custodian. What do you know about rolling an IRA into a 401k Jeff Barnes?

Ann Bellamy · Answer

Yes, but you need income from Warbucks to contribute to the solo-k. Double check with a solo k expert to make sure you can roll over IRA funds to a solo k. I don't think you can. Happy to be corrected by an expert. Kaaren Hall, can you help?

Jack Nichols · Answer

Thank you, Ann Bellamy and Jeff Barnes.
I hear your point that this much of setup may be too heavy to start out.
Since my funds are in my IRA, I will just set up a Solo-k and start out lending.
Establishing a solo-k requires setting up a LLC (to show self-employment activity) - the WarBucks LLC.

Setting up the Red Ink can wait.

Ann Bellamy · Answer

I think you need more than an accountant and an attorney: Because you need an expert on Self Directed IRA's and Solo 401k's. I don't think you can roll your IRA and Roth IRA to your 401k. And I also think that if your IRA is more than 50% owner in your LLC, you can never add more money to the capital in the LLC. Again, you need an expert, I'm not one. Also consider UBIT - it may hit hard enough to negate the tax bene's.

I am not the SDIRA expert, but I have a Solo k, Roth Solo k, regular IRA, Roth IRA, and an inherited SDIRA that owns an LLC, so I pay attention. I use these for lending and for buying property and tax liens, they can be very restrictive. Lending is the easiest.

Also, you've referenced Warbucks LLC, Warbucks Inc, Red Ink LLC Red Inc Red Ink

Although I think these are only two entities, it gets confusing because maybe there are more than 2 and it's simply not clear.

It's likely that Warbucks will need to be registered as a foreign company in MD (don't know MD laws so don't really know that), thereby negating the advantage (if there is one) of having a Wyoming LLC. In fact, you'll have to pay two annual fees. For this you need a MD attorney.

This is a lot of asset protection before you've done your first deal. Speaking of John Hyre, (I'm a fan) one of his repeated comments is:
"Don't worry about asset protection until you have assets to protect."

While I understand that it's good to start off on the right foot, you might spend significant available cash on asset protection and not have as much to lend or do flips. And what if you find out that real estate or lending is not for you?

Jeff Barnes · Answer

Jack, it sounds like you've done your homework here, and it looks like a pretty complex setup straight out of the gate. I'm assuming you have setup and/or run businesses before, otherwise it's unlikely you'd want to jump through all the these hoops just to get started.

My first suggestion is to keep it simple in the beginning, then use your profits to get CPA's and attorneys to get everything set up for you in a manner conducive to your goals.

That being said, since I'm neither a CPA or attorney, I can't say for sure what you plan to do is legal, helpful, or worth the headache. What I can tell you is that you will need to check with each and every state you try to do business in and make sure you register your business accordingly. I use a Delaware setup for asset protection and anonymity, but still have to register in each state where we do business, but a lot of that has to do with getting proper licenses and permits, and we raise money in several states, so that is an additional requirement.

Best advice I've ever been given is to come up with a plan, draw up any documents you want, then go to an attorney for review. That way the costs are lower (theoretically) since you have already done a lot of the work, and you can determine if the attorney is right for you. If the attorney says "That won't work" instead of "Here's a better idea/suggestion" then it is a good indication they aren't going to be your best ally.

Warbucks - Red Inc for lending and fix-and-flip/rent?

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