Real Estate IRA vs. Solo 401k

54 Replies

So my wife and I are starting to look for a house to buy with our IRA, and then rent out, probably in Florida. This is something we have been considering for a couple years, and understand the procedure and rules.

But as of last night I started learning about doing the same thing from a Solo 401k, which we would fund from our IRA, which apparently we are eligible for since I have been self-employed with my own business for the last 20 years. So we also understand the ins and outs of running a business, along with the related responsibilities and tax laws. My wife is a diligent bookkeeper, and we have a sharp CPA doing our taxes and giving general advice.

I am learning about all the advantages of using a Solo 401k instead of an IRA, but what are the disadvantages? It appears that I don't need a custodian for this, but what professional services do I need, besides a CPA? Any other pitfalls to watch out for?

Is the money easily moved from the IRA to the Solo 401k?

We would be leveraging this with a non-recourse loan. Would this be done the same way as with an IRA? Do the lenders care one way or the other?

Thanks for any help.

David

@David B.

when you compare self directed IRA with truly self directed Solo 401k, there is no disadvantages. It is much better in many different aspects (been discussed many times), if you like to learn more just go and review some of my past posts.

Using Solo 401k would be much easier, because you don't have to go to the custodian each time you want to make the investment or pay expense. As trustee you can have a checkbook control - so the administration of your investments is quite simple.

Also @David B. in order to establish and maintain your Solo 401k plan in compliance with the IRS, you need experienced and knowledgeable service provider, but in addition to that you don't really need any other professional services besides those you mentioned already. It looks that you already have the experience and knowledge to administer your own Solo 401k plan.

The funds from other retirement accounts can be easily moved into Solo 401k, the process is pretty simple. When it comes to using leverage, the process would be the same when using leverage with an IRA, however, HUGE difference is that there is not UDFI tax on leveraged real estate with Solo 401k!

Yes, and you don't really need an accountant. Just file the 5500 (SF or EZ)form each year, and keep very good records, something you should do no matter how any real estate investment is owned. We have four houses in our Solo401K plan.

Thanks for the replies.

I had read several of your excellent discussions about Solo 401Ks, Dmitriy, and this was a major factor that got me interested in them. After hearing all the advantages, I was curious to hear of the disadvantages. It doesn't sound like there are any, except possibly for people who don't currently own a business.

It sounds like basically once the account is set up, our accountant can basically handle the annual stuff himself.

In another discussion I saw that some consider it to be very difficult to keep the accounting straight if we combine both my and my wife's IRAs into a single Solo 401k. Somehow, though, this sounds easier than managing two separate accounts. We just have to keep accurate accounting of the proportions of all the payments, is that right?

I think some small portion of the funds in one of our IRAs is in a Roth IRA. (I should know this.) Does this matter at all?

Regards,

David

I am also researching the Solo 401k vs SDIRA and hoping to find some clarification and possibly some links to previous threads.

-When pulling money out of Solo 401k at age 59.5+ will withdrawals be tax free similar to a self directed Roth IRA or will they be taxed?

-I am 35 and already have $100k in a traditional IRA that I was considering rolling into a SDIRA so that all profits over the next 25 years will be tax free. Would a Solo 401k offer this as well?

@David B.

I'm glad you found my discussions useful. Assuming that you qualify for Solo 401k, there is really no disadvantages when comparing it to SD IRA (and if you don't qualify for Solo(k) you would not be comparing the two anyway).

@Stephen Masek is right, you have to keep good regards regardless whether you investing in your 401k or personally.

While technically you can keep both spouses funds in one account, I would not recommend doing so. It would be accounting nightmare to keep track of the percentage one you start investing. Each of you would have separate account under the Solo 401k plan.

You will have to leave your Roth IRA alone, it can not be rolled over into Solo 401k.

Originally posted by @Burnham Shepherd:
I am also researching the Solo 401k vs SDIRA and hoping to find some clarification and possibly some links to previous threads.

Burnham, to read some of my past discussions, you can click on my name, then scroll down to "Statistics" and click on number of posts. Read and learn, I hope you will find this helpful.

Originally posted by @Burnham Shepherd:

-When pulling money out of Solo 401k at age 59.5+ will withdrawals be tax free similar to a self directed Roth IRA or will they be taxed?

Solo 401k plan has two buckets: regular, pre-tax (just like traditional IRA) and Roth, after-tax (just like Roth IRA). Taxation works exactly the same as with an IRA or any other retirement account, if you taking distributions from pre-tax account, you will be taxed on the distribution amount. If you are pulling funds form Roth Solo 401k portion - it will be tax free just like with Roth IRA.

Originally posted by @Burnham Shepherd:

-I am 35 and already have $100k in a traditional IRA that I was considering rolling into a SDIRA so that all profits over the next 25 years will be tax free. Would a Solo 401k offer this as well?

If you rollover your $100K from traditional IRA into SDIRA, your profits over the next 25 years will be tax-deferred, but not tax-free (unless you convert into Roth IRA now and pay the taxes on $100K).

The Solo 401k would work the same. Here are the steps:

  1. Create Solo 401k Plan
  2. Rollover your Traditional IRA into Solo 401k
  3. Convert your pre-tax amount into after-tax (Roth) and pay the taxes now so that you can invest tax-free for the rest of your life (make sure to consult with your accountant about the tax consequences).

Please note: If you convert Traditional IRA into Roth IRA now, you will not be able to then roll it over into Solo 401k. You can not move Roth IRA into Roth Solo 401k, so be sure to follow the steps that I outlined above (convert only after the funds already in your Solo 401k).

Hope this helps!

Yep, each spouse needs a separate business checking account.

Thank you Dmitriy!

With the Roth 401k, I was told that the employee annual contribution up to $17,500 would go toward a Roth component within the 401k and the employer match up to $33,500 would go toward a traditional 401k component (which would be taxed in retirement upon withdrawal). Is this correct? If so I am trying to avoid any tax on retirement savings when withdrawing upon maturity.

Also, when rolling over the traditional IRA of $100k that I have into a Solo Roth 401k, will I be able to elect to roll the entire $100k into the Roth portion of the 401k so that the profits can grow tax free? And if so, when paying the upfront taxes on the $100k would I be able to use separate funds so as to not diminish this $100k seed money or would the tax be taken out of the $100k?

@Burnham Shepherd

The annual salary deferral contribution of $17,500 ($23,000 if you are over 50) can go to either pre-tax or after tax (Roth) bucket of your Solo 401k.

The profit sharing component going into pre-tax and will be taxed when taking distribution, unless you convert those funds into Roth at some point of time down the read.

You can not roll over traditional IRA into Roth Solo 401k bucket. The steps are as follow:

  1. Rollover your Traditional IRA into Solo 401k
  2. Convert your pre-tax amount into Roth Solo 401k and pay taxes on the conversion amount (you can do it in stages to minimize the tax liability and may choose to convert the entire amount all at once, but be sure to consult with your accountant and be aware of the tax hit)
  3. Yes, you should be able to pay taxes with personal funds so that the 401k would not diminish.

Interesting. So at any point I could take the 25% employer contribution and convert to the Roth bucket (paying taxes on the conversion amount)?

Also, regarding safety against a Ponzi or Bernie Madoff scenario:

-Are funds safe from such abuses with a custodian of SDIRA or Solo 401k or could a custodian shut their doors and you lose everything?

-Does being custodian of your own Solo 401K allow you to keep funds at your bank of choice and under your own control?

Many thanks again Dmitriy!!

@Burnham Shepherd

with self-directed IRA or Solo 401k you are the one who picks the investments not the custodian, so you are responsible for conducting proper due diligence about the potential investments.

With SDIRA you don't have direct access to your retirement funds, they are held with the custodian and you instruct them how to invest it (unless you utilize IRA LLC structure). However, with truly self-directed Solo 401k plan, you are the trustee (there is no custodian involved), and as a trustee you are the only one who controls the funds and can keep them at any bank of your choice.

As far as each spouse needing a separate business checking account. How would this affect purchases and making payments? Can payments be made from both accounts on the same property, or either?

For instance, to pay a $60k down payment on the purchase, can we split it, say, $40k from my account and $20k from my wife's ?

To buy a new water heater for the house, can we pay for it all from either my or her account as we choose? And then the next expense we could make out of the other spouse's account?

Thanks!

David

Originally posted by @Dmitriy Fomichenko :
When it comes to using leverage, the process would be the same when using leverage with an IRA, however, HUGE difference is that there is not UDFI tax on leveraged real estate with Solo 401k!

Is UDFI the same as UBIT I have heard about on IRAs?

Originally posted by @David B. :

Is UDFI the same as UBIT I have heard about on IRAs?

UDFI (Unrelated Debt Financed Income) is the income produced from the financed portion of the property inside of a retirement account and it triggers UBIT (Unrelated Business Income Tax) when transaction happens inside of an IRA. Solo 401k is exempt from this rule.

Hope this helps.

All expenses and income need to be split proportionally based on percentage of ownership of each IRA. The IRA's cannot "take turns" paying for expenses.

To keep the financing straight along with expense allocation, I would suggest forming an LLC that names your wife's account within the 401K and your own account within the 401K as members and organizers. You and your wife would be named as managers NOT MEMBERS! An account can then be opened for this "daughter" LLC, your wife's 401K money and your 401K money can be deposited into the account, then the house can be bought. You, or your accountant can establish a ledger for this, showing the proportional contributions to the new LLC. That way expenses will be paid from this account, profits will be reported to it, and each account will receive its proportional share of profit or loss.

Since each account is buying membership in an LLC, this removes any doubt that the house was purchased by one account, then sold to the other, which is a prohibited transaction. Each account owns the LLC, then the LLC buys the house. This keeps the transaction very clean.

so do I understand correctly that if I've set up an LLC for RE purchasing and then set up a solo 401k for myself, roll over my existing IRA funds, I can then purchase with leverage a duplex in my name to hold and rent but use all funds from my solo 401k?

@Russelin Kisiel

You can purchase investment property (duplex) in your IRA or 401k. The property title will not be in your name, but in the name of the 401k instead.

You can use leverage, however, it must be non-recourse loan as you are prohibited form providing personal guarantee when buying investment property in your retirement account.

Hope this helps!

@Dmitriy Fomichenko yes thanks! I'm also wondering if it's difficult to get conventional financing through the LLC. how do you purchase the first property using my solo 401k $$$?

@Russelin Kisiel

I'm not sure why you keep referring to the LLC when you are planning on buying inside of a 401k, it can buy the property on it's own, without use of LLC. And you can't use conventional financing as I mentioned above, it has to be non-recourse. Getting non-recourse loan is easy, you don't have to personally qualify for it. Property you are buying qualifies, lender will want to make sure it's work the risk for them, that it produces sufficient rental income and you have enough reserves in your retirement account.

Feel free to contact me directly to discuss the specifics of your situation.

One consideration that all Individual 401k holders should think about is the idea of plan restatements. If for whatever reason, legislation changes and plan documents need to be revised to stay current or be re-approved, that may come at an added cost if you've purchased a package for a set price.

@Dmitriy Fomichenko

How would you handle that if rules change? Would the plan need to be reapproved by the DOL?

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