Real Estate IRA vs. Solo 401k

Tax, SDIRAs & Cost Segregation
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Real Estate IRA vs. Solo 401k

David B.
Rochester, NY · Member since 2014 · 24 posts · 0 votes

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

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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
12y

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.

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  • Loren Whitney
    Investor · North Idaho · Member since 2011 · 332 posts · 107 votes
    12y
    Fantastic answer thank you!
    0Reply
  • Lawrence Groves
    Canton, NC · Member since 2009 · 11 posts · 3 votes
    12y

    On June 12th, The U.S. Supreme Court ruled that inherited IRAs are not protected from creditors in bankruptcy. In a unanimous opinion, the Supreme court court held that an IRA inherited by someone other than a spouse cannot be considered a retirement fund, because the IRA's beneficiary cannot invest further money and must take distributions within a set number of years.

    "Nothing about the inherited IRA’s legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete," the ruling said.

    This is just another reason to use a Solo-k as your retirement vehicle instead of an IRA. If you have an IRA, now,may be the time to convert.

    0Reply
  • Sam Leon
    Investor · Fort Lauderdale, FL · Member since 2012 · 1k+ posts · 465 votes
    12y

    When evaluating between the  choice of investing directly from a sdira versus solo 401k seems there are many advantages to go the solo-401k route.

    Are there any advantage to go the sdira route instead?  Are there situations where the sdira may be more appropriate?

    Obviously if you are not self employed and are not inclined to set up a business LLC is one. Are there others?

    I asked around and one answer I got was:

    "Yes, with a sdira you have no check book control, every penny is accounted for by the provider and are ensured there is no prohibited transactions with disqualified people, where as with a solo-401k plan it can be abused and because of that you are almost guaranteed to invite an IRS audit with a solo-401k plan."

    True or false?

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  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    12y

    If you think that you fall into a category of abusing money in your retirement account then checkbook control is not for you, go with custodian option.

    P.S. Even with custodian holding on to your retirement money it still can be abused. You still can commit a "Prohibited Transaction". I'm sure that every single custodian out there, when you sign up for new account, will have you sign a waiver to remove the liability from them - ultimately YOU are responsible for how the funds are used.

    0Reply
  • Jeff Astor
    Spring Valley, NY · Member since 2014 · 34 posts · 6 votes
    12y
    Originally posted by @Sam Leon:

    When evaluating between the  choice of investing directly from a sdira versus solo 401k seems there are many advantages to go the solo-401k route.

    Are there any advantage to go the sdira route instead?  Are there situations where the sdira may be more appropriate?

    Obviously if you are not self employed and are not inclined to set up a business LLC is one. Are there others?

    I asked around and one answer I got was:

    "Yes, with a sdira you have no check book control, every penny is accounted for by the provider and are ensured there is no prohibited transactions with disqualified people, where as with a solo-401k plan it can be abused and because of that you are almost guaranteed to invite an IRS audit with a solo-401k plan."

    True or false?

    False. There are two types of SD IRAs: custodial and checkbook control. In the latter you have checkbook control. 

    The above answer sounds like propaganda from a custodial SD IRA (some of which are experiencing class action lawsuits for misappropriation of funds, which is only possible in the custodial model. See here: http://online.wsj.com/news/articles/SB100014240527...)

    Either way, there are plenty of people successfully using checkbook control SD IRAs and not running into PTs. If you go that route look for a company with a top BBB rating, which indicates that they can help you make sure you don't run into any PTs. 

    1Reply
  • Jeff Astor
    Spring Valley, NY · Member since 2014 · 34 posts · 6 votes
    12y
    Originally posted by @David B.:

    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.

    There are two disadvantages: One, if you have a Roth IRA you can't roll it into a Solo 401k. Two, you have to make yearly contributions to the 401k, not an SD IRA.

    Also, be aware that to be eligible for the Solo 401k you must be self-employed and not have full time employees. If you start out with none and then grow to the point that you hire FT employees you will have to freeze your Solo and probably roll everything into an SD IRA.

    0Reply
  • Sam Leon
    Investor · Fort Lauderdale, FL · Member since 2012 · 1k+ posts · 465 votes
    12y
    Originally posted by @Jeff Astor:
    Originally posted by @Sam Leon:

    When evaluating between the  choice of investing directly from a sdira versus solo 401k seems there are many advantages to go the solo-401k route.

    Are there any advantage to go the sdira route instead?  Are there situations where the sdira may be more appropriate?

    Obviously if you are not self employed and are not inclined to set up a business LLC is one. Are there others?

    I asked around and one answer I got was:

    "Yes, with a sdira you have no check book control, every penny is accounted for by the provider and are ensured there is no prohibited transactions with disqualified people, where as with a solo-401k plan it can be abused and because of that you are almost guaranteed to invite an IRS audit with a solo-401k plan."

    True or false?

    False. There are two types of SD IRAs: custodial and checkbook control. In the latter you have checkbook control. 

    The above answer sounds like propaganda from a custodial SD IRA (some of which are experiencing class action lawsuits for misappropriation of funds, which is only possible in the custodial model. See here: http://online.wsj.com/news/articles/SB100014240527...)

    Either way, there are plenty of people successfully using checkbook control SD IRAs and not running into PTs. If you go that route look for a company with a top BBB rating, which indicates that they can help you make sure you don't run into any PTs. 

     Could be propaganda.  I was just a bit taken aback when I asked about the pros and cons between SDIRAs and Solo-401K, the answer given to me was I would be assured to be audited by IRS if I were to go with Solo-401K.

    Not that I have anything to hide, but an IRS audit is worse then a dentist visit, hence my question.

    0Reply
  • Sam Leon
    Investor · Fort Lauderdale, FL · Member since 2012 · 1k+ posts · 465 votes
    12y

    Just so to clarify, so there are custodial or checkbook control for both SDIRA and Solo-401K plans?  Essentially four variations?

    Is it a good idea to go with a custodial option first, just so you have someone validating your spending and once you have experience, then to move into checkbook control?

    I see one possible drawback on the custodial option is a delay?  Say you have an emergency sewer backup and you called a plumber to the property.  The plumber quoted you $500 and say it's due when job is finished.  You tell him the check will be issued by so and so company once the job is completed and the invoice is remitted and they don't see the money until 2 days later...is this going to be an issue?  Or the plumber say OK if you pay me later it will cost $750.

    I am sure you the landlord footing the bill at that moment, and then asking the custodian to "reimburse" yourself later is a big no no.

    Is this a valid concern that a custodial oversight will have these issues?

    0Reply
  • Jeff Astor
    Spring Valley, NY · Member since 2014 · 34 posts · 6 votes
    12y

    2 types of SD IRAs: custodial and checkbook control (CBC)

    1 type of Solo 401k: checkbook control

    No, I don't believe it is better to go with the custodial model first just because you are afraid of PTs. Again, a good CBC company will educate you and hold your hand.

    One of the main considerations in choosing between the two is how active you will be or how check-intensive will your investment be. The more active you are and/or the more you check you will be writing the better a CBC model will work for you. Generally, real estate deals require a lot of check writing. 

    The other consideration is timing. The custodial model, even with good-rated companies (some of the big one are notoriously poor in customer service), there is going to be significant lag time between knowing what you want and being able to act on it. Your plumber example is definitely valid and common. There are a lot worse scenarios (such as losing out on that big deal to begin with), but that is one of them. 

    0Reply
  • Roman McIntosh
    Investor · Houston, TX · Member since 2013 · 23 posts · 1 vote
    11y

    Being that I cannot move my Roth IRA into a solo 401k can use funds from the solo40k and Roth SDIRA together in the same deal?

    Can anyone recommend a company that help set up both a solo 401k and SDIRA?

    0Reply
  • Adam Hershman
    Las Vegas, NV · Member since 2015 · 237 posts · 107 votes
    11y
    Originally posted by @Roman McIntosh:

    Being that I cannot move my Roth IRA into a solo 401k can use funds from the solo40k and Roth SDIRA together in the same deal?

    Can anyone recommend a company that help set up both a solo 401k and SDIRA?

     Hey Roman,

    I can't recommend a company, but that's because I work for one. You will want to do your due diligence and find a custodian that fits your needs in terms of fees, investment options, etc. There is no reason that your solo 401k plan and your Roth IRA wouldn't be able to invest as joint owners.

    That being said, most of the self-directed custodians could open both accounts for you, again you should do a little research on reviews BBB rating etc. Find a few custodians that you think will fit your needs and give them a call to discuss the process.

    Adam

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  • Brian EastmanPro Member
    Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
    11y

    @Roman McIntosh

    The answer is yes, you can joint venture a Roth IRA LLC and a Solo 401k plan to make investments.

    0Reply
  • Mark Nolan
    Professional · Carlsbad, CA · Member since 2012 · 12k+ posts · 1k+ votes
    11y

    Here is some solo 401k and IRA comparison information.

    Contributions: A solo 401k allows for $53,000 plus $6,000 for those age 50 and older (these are year 2015 figures). The maximum contribution to an IRA is $5,500 ($6,500 if you are age 50 or older). (these are year 2015 figures)

    Income Limits: The solo 401k Roth solo designated account has no income limitation regarding contributions , whereas the Roth IRA does : married $191,000/single $129,000 modified AGI for tax year 2015.

    0Reply
  • Cameron Skinner
    Investor · Panama City, FL · Member since 2015 · 378 posts · 183 votes
    11y
    Wait! You mentioned you would be getting a loan you will have to pay Unrelated business income tax UBIT which is brutal. Also if your using leverage with depreciation you might have better tax benefit keeping it out of self-directed, Don't get me wrong self directed ira or 401s are great for real-estate but only when you don't have a loan.
    0Reply
  • Account Closed
    Investor · Cary, NC · Member since 2014 · 213 posts · 31 votes
    11y

    It is my understanding that you need to hire the contractors and that you cannot do the work yourself. I have many clients that equity share with me and we split net profits. The 401k or IRA becomes a member of the llc that takes title to the property. Then you become a manager of the LLC. Then we mentor you through the process. The reason I bring this up is that you must hire all the work done for the IRA or 401k. This accomplishes that and still gives you control.

    Also to avoid securities issues. Your must be active in the process.

    A castodian such as Dmitriy, Brian or Jim Hitt from American IRA (Google him) are all good options. These guys know what they are doing.

    This is all advise I have received from my attorney, IRA, 401K professionals. I am not an attorney and these guys can help. Feel free to chime in. I know Jim Hitt has over 300 million under management. I don't know what Dmitriy and Brian have. I would assume they are just as strong.

    0Reply
  • Adam Hershman
    Las Vegas, NV · Member since 2015 · 237 posts · 107 votes
    11y

    I would certainly not look for a RE attorney, that would be like going to your estate planner to have him represent you in a small claims case. I would look for an attorney with experience in employee retirement plans. Most of the SD IRA firms offer a 401k plan, and most of those firms were started by tax attorneys, in my experience this is a less expensive route than hiring an attorney, but you should certainly explore your options to find out what service will work best for your individual situation. Full disclosure I work for a SD IRA custodian, so my thoughts are obviously a little biased.

    Adam

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  • Kristy Towson
    Real Estate Agent · Baltimore, MD · Member since 2015 · 18 posts · 0 votes
    11y

    @Adam- you make a good point, however I think you may have overlooked one detail in my post. Real Estate attorneys are far more valuable than estate planning. David should seek an attorney who understands business, and real estate investing; by doing so he will have the best of best worlds. All attorneys are not created equal therefore it will require some homework to find a good match. When establishing a solo 401k, there are many variables to take into consideration such as: who will fund the account, having enough funds in the account for the real estate transaction ( purchase price plus rehab cost), will a spouse be contributing as well, what is the most strategic method to maximize annual contributions...... PS- I'm not a real estate attorney nor do I work for a 401k or SD IRA company, my feedback comes merely from 13 years of working in real estate, both as a broker and investor : )

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  • Brian EastmanPro Member
    Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
    11y

    @Kristy Towson

    I'm with Adam on this one. Tax attorneys and CPA's understand retirement plans, and frankly very few of those understand self directed IRA and Solo 401k plans. This is a very specialized field and going to a specialist makes sense.

    A real estate attorney could be a valuable member of your team once you go out and start investing with your plan and engaging in transactions, but in 10 years in this field I have yet to meet a real estate attorney who has the type of in-depth knowledge of the tax law that is required for implementing and supporting a self directed retirement plan.  That is not to say they are not out there, but it would be a rare find.

    We offer such plans and our tax attorney also holds CPA licensing.  This type of legal background is most common industry-wide.  Many of our clients are CPA's and attorneys with focus areas other than tax law - including a good number of real estate attorneys.

    0Reply
  • Kristy Towson
    Real Estate Agent · Baltimore, MD · Member since 2015 · 18 posts · 0 votes
    11y

    David- you have a lot of feedback to consider. I suggest you do your homework and find a professional who indeed understands your real estate objectives. Clint Coons (http://clintcoons.com), is a real estate attorney and business advisor, it may be worthwhile to reach out for a free consultation, he even has a book on asset protection and this video may also help you make a decision on the best direction to take: https://www.youtube.com/watch?v=IudMEkQHcrU

    Disclaimer: I have no affiliation with Clint Coons or Anderson Business Advisors

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  • Leonard L.
    Investor · Newport Beach, CA · Member since 2012 · 129 posts · 102 votes
    11y

    Beware of solo 401k if you are thinking about working for someone else in future.   I think it was @Jeff Astorabove who mentioned this, and unlike others here I am not an expert on this topic, but I do have a solo 401k and have been told if I rejoin workforce I would have to roll it over. I have had several occasions where friends were considering rolling their IRA into a solo 401k because they now worked for themselves or were between jobs. But for each of those that thought they were likely to become a W-2 employee in the near future, rolling to solo 401k was a bad idea.

    So lots of advantages to solo 401k, but this downside can get missed by some. 

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  • Brian EastmanPro Member
    Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
    11y

    @Leonard L.

    You may have a mis-understanding of the situation, I believe.

    One may have a Solo 401k so long as they are to some degree self employed and creating self employment income - even if they also work for another employer. Yes, if you were to entirely shut down the self employment activity that was sponsoring the Solo 401k, it would need to be rolled over to a self directed IRA.

    We have many clients who have a full time job but also do something like work as a part time realtor on the side, or have a personal real estate business where they flip multiple houses per year.  That self employment can establish a Solo 401k.  If they participate in an employer 401k, they will impact their overall contributions, but they can still have both plans.

    The Solo 401k is a wonderful plan, but it is not for everyone. By speaking with an experienced advisor, you can determine if a self directed IRA or 401k willl provide you with the right tool for your specific situation and goals - not just for today but for the long term.

    I will say that a lot of folks in the industry and the real estate investing community tend to have a bit of bias towards the Solo 401k vs an IRA based program - for good reasons. When it is a good fit, it is a great plan, but is has to be a good fit first.

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  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    11y
    Originally posted by @Leonard L.:

    Beware of solo 401k if you are thinking about working for someone else in future.   I think it was @Jeff Astorabove who mentioned this, and unlike others here I am not an expert on this topic, but I do have a solo 401k and have been told if I rejoin workforce I would have to roll it over. I have had several occasions where friends were considering rolling their IRA into a solo 401k because they now worked for themselves or were between jobs. But for each of those that thought they were likely to become a W-2 employee in the near future, rolling to solo 401k was a bad idea.

    Leonard, Brian is correct, you been either misinformed or misunderstand the qualification criteria for the Individual 401k (or Solo 401k). Having W2 job or working for someone else full time in no way will trigger your Solo 401k to be distributed. As long as you maintain self-employment activity and make occasional contributions to your plan you are totally in compliance. 

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  • Adam Hershman
    Las Vegas, NV · Member since 2015 · 237 posts · 107 votes
    11y

    Just have to throw my confirmation in there as well. @Brian Eastman and @Dmitriy Fomichenko are right on the money. You solo 401k would only be affected by your "self employment status" which has very little to do with how much work you actually perform for your company or for a W2 job, or both or either. 

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  • Lawrence Groves
    Canton, NC · Member since 2009 · 11 posts · 3 votes
    11y

    Just remember that there has to be an existing company to sponsor the Solo-k plan. If you go to work in a W-2 position and quit your self employmentr you need to retain your solo-k plan sponsorship, which includes keeping the company and the Solo-k documents etc up to date. Otherwise terminate the Solo-k plan and roll the fuinds to an individual IRA so you can continue your investment opportunities

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  • Lisa Lanza
    Clearwater, FL · Member since 2015 · 4 posts · 0 votes
    11y

    Please explain the tax consequences for the beneficiary (s) of a SDIRA which is invested in a vacation rental property.  After the owner is deceased how long can the beneficiary(s) continue to take an annual RMD?  If there is more than one beneficiary how will they split up the RMD's?  If the rental property is not profitable or there is a special assessment, can monies be added to the SDIRA to cover the expenses?  If the SDIRA beneficiaries want to sell the property will they be responsible for the taxes due on the final sales price or only on the initial investment price?  Is a beneficiary permitted to remove the vacation rental property from the SDIRA, pay the taxes due and then make use of the the property?

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