Help me figure out the Solo 401K Real Estate procedure

18 Replies

I appreciate everything I have read here about buying investment real estate with a Solo 401K, but am still a little confused about a couple things that I haven't read about.

First, I own a Sole Proprietorship which my wife helps with. Most of our current IRA investments are in her name. Can we roll her IRA into a Solo 401K attached to my business?

Second, I'm a little confused about how the accounts are structured. The advice here that makes the most sense to us is to keep "the accounts" separate for ease of accounting. Does this mean separate Solo 401K accounts, or separate bank accounts? Can we have two separate Solo 401Ks or is just one allowed between us? Or is there any simple way to combine her larger IRA money with my smaller amount, or do we just use hers and leave mine in my existing IRA?

Third, I am about to change the structure of my company from a Sole Proprietorship to an S Corp. Should this be done before setting up the Solo 401K, or doesn't it matter?

Thanks a lot for any help with figuring all this out.

David

You should setup the S-corp before setting up the Solo 401K for the S-corp.

You can setup a master account at a bank and create sub-accounts under the master account for you and your wife.

I hope he takes a day off once in a while!

David

I just got an e-mail from Dmitriy saying that I had an opportunity to comment! That just proves what a great guy he is. If you haven't read any of his posts before, you should check him out. (I'm pretty good too! Thanks again, Dmitriy.)

First let's address the question of forming an S-Corp. I don't pretend to be a lawyer, but I believe I can give my opinion on this. And in terms of this opinion, I believe this is more of an accounting issue than a legal one. As always, consult an informed attorney and CPA before pursuing any course of action.

LLCs typically are superior to S-Corps for a variety of reasons. They are easier to establish and maintain. Since an S-Corp is really a C-Corp that has elected preferential tax treatment, you must maintain the Corporation correctly. This means you must have a board of directors and hold annual meetings with all the correct documentation. Failure to do so negates the corporation, and in the event of a law suit, the asset protection of the Corp disappears.

Furthermore, if you or your wife were to be sued personally, from a car accident for example, and the award exceeded the limits of your liability insurance, your personal assets could be attached in the suit. Since shares of stock are an asset, your S-Corp could be part of an award, and the suit could cost you ownership of the Corporation.

Since LLC have members, and stock is not issued, the best a winning litigant could get is a CHARGING ORDER. Properly managed, a charging order can result in a litigant wanting to negotiate his way out of it, leaving your business and your LLC intact. (Please research LLC charging order. It's too long to explain here.)

Since you're married, you can defer some self employment tax without filing as an S-Corp up to a certain income level. Based on the Proposed Treasury Regulations section 1.1402(a)-2(h)(2), there is a strategy that will effectively reduce your self employment tax up to $60,000 - $70,000 with your wife as a limited partner. You MUST check with an account about this as the tax code changes almost weekly.

After $60,000 or so, you'll have to file to be taxed as an S-Corp. This is not something to rush into, as to take advantage of the favorable tax treatment, you must do payroll. If you haven't done payroll on your business yet, you'll only have to do it a few times before you regret having to do it. This is why it's best to defer making this election for as long as possible.

Once it becomes necessary to adopt S-Corp taxation, you simply file IRS Form 2553, and VOILA! your LLC gets taxed like an S-Corp. Notice I didn't say "It becomes an S-Corp," because it doesn't. It stays an LLC! For a more thorough explanation of this, please go to http://www.bizfilings.com/toolkit/news/tax-info/llc-plus-scorp-equal-best-of-both.aspx.

So to answer question 3: No, don't change your structure to an S-Corp. Change it to an LLC. When the income of your business merits it, adopt S-Corp taxation for your LLC by filing form 2553.

One final note: Payroll is a really, really, really counterproductive waste of your time (and your wife's), so when your LLC merits the switch to S-Corp taxation, consider having a Virtual Assistant do your payroll for you. I know people that have VAs in the Philippines do it @ $6.00 per hour. As always, check with your accountant.

Originally posted by @David B. :
I appreciate everything I have read here about buying investment real estate with a Solo 401K, but am still a little confused about a couple things that I haven't read about.

First, I own a Sole Proprietorship which my wife helps with. Most of our current IRA investments are in her name. Can we roll her IRA into a Solo 401K attached to my business?

Second, I'm a little confused about how the accounts are structured. The advice here that makes the most sense to us is to keep "the accounts" separate for ease of accounting. Does this mean separate Solo 401K accounts, or separate bank accounts? Can we have two separate Solo 401Ks or is just one allowed between us? Or is there any simple way to combine her larger IRA money with my smaller amount, or do we just use hers and leave mine in my existing IRA?

Third, I am about to change the structure of my company from a Sole Proprietorship to an S Corp. Should this be done before setting up the Solo 401K, or doesn't it matter?

Thanks a lot for any help with figuring all this out.

David

Her IRA assuming it is traditional account can be rolled over. A Roth IRA cannot be rolled over to anything else. IRAs and 401k are owned individually. There is no such thing as a Joint 401k or IRA account. They can partner on an investment though.

Do this after you go the Corporation route.

My last message was pretty lengthy, and I apologize for that, but to answer questions thoroughly, it's necessary. Let's tackle the 401K questions. I won't answer your questions in order, since the answers will make more sense ordered differently.

When you establish your LLC, you'll make your wife a 1% owner (this can be changed at any time, but you want her as a limited partner until certain income levels are reached).

Once you establish your LLC, it can adopt a 401K. Your wife's Traditional IRAs and your Traditional IRAs can be rolled to the 401K. Please note, I emphasize TRADITIONAL. Roth IRAs may NOT be rolled to a Solo 401K. You will have just one 401K. Think of a large corporation. They have 100s or even 1000s of employees with only one 401K. You'll have only two participants, you and your wife.

So yes, your wife will roll her larger amount to your 401K, and the 401K will reflect that it is her money. You then will roll your smaller amount into your 401K,and your 401K will reflect that amount as yours.

The next question results in two schools of thought. You could have separate bank accounts, each titled to your 401K - YOUR BUSINESS 401K, Mr. David B, participant, and YOUR BUSINESS 401K, Mrs B, Participant. Just make sure that neither account is small enough that bank charges eat them alive.

The second school of thought is to open one bank account within your 401K, roll all the money into the account, then use ledger entries to keep track of everything (this is how mutual fund companies do it.) If this confuses you, or your accountant isn't comfortable with it, then use the two separate accounts.

Once your accounts are established, you can use the money to co-invest in projects. For example, your account is $5,000 whereas your wife's is $75,000. You buy a house for $60,000 and the renovation costs $20,000. You sell it for $100,000. When the gets sold, your 401K receives $6,250 and your wife's gets $93,750 (the profit is exactly proportional to the amount invested.)

What's really great is developing the Roth provisions of your 401K. You and your wife can contribute some of the profit from your business to your Roth 401K, and that money can piggyback on your traditional investments as well, similar to the example above. This is NOT an accounting nightmare, as some would have you think, but your accountant should be on board with you so that he isn't surprised when you walk in the door at the end of the year with this.

So again super simple: Form an LLC with your wife. The LLC sponsors a 401K. Roll Traditional IRAs into the 401K (You can have two separate accounts for each, or you can use ledgers with one account). Make great returns in real estate that puts Wall Street to shame.

Thanks, Steve and Mike for your replies.

Mike, you've given me a lot to digest here. I really appreciate all the help.

My accountant was who got me thinking about going the corporation route, mostly for the sake of eliminating the Self Employment Tax. I wonder why he suggested a Sub S rather than LLC. From reading I got the impression that avoiding the SE Tax is more difficult with an LLC; maybe that's what he was thinking. Unfortunately, I think I'll have to wait until after April 15 to sit down with him.

We'll have to sit down and study your replies thoroughly. I may have follow-up questions.

Thanks, again.

David

To Whomever may be able to answer this question. Is the profit sharing idea available for the Roth Solo 401k or only for the regular Solo 401k?

To clarify a couple of points - Your company will have one Solo(k) plans with two participants - you and your wife. Your wife does not have to have any ownership in the company to participate. Solo(k)s are structured for company owners and their spouses as participants (regardless of if the spouse actually has any ownership in the company). Your two Solo(k)s would then simultaneously co-invest either in a piece of property directly, with percentage of ownership dictated by percentage of investment - OR - you can form a new LLC just for the RE investing. Your Solo(k)s would simultaneously invest in this new LLC - the LLC would have its own bank account to be used for expenses, purchases, income generated, etc. Net proceeds of the LLC would flow back to your respective accounts based on percentage of ownership.

Your Solo(k) can have 4 "buckets" - pre-tax salary deferral, post-tax salary deferral (Roth "bucket), profit sharing , and rollover. Please note that Roth IRA funds CANNOT be rolled into a Solo(k). Only traditional IRAs, old 401(k)s, etc, can be rolled in. The only way to add Roth funds is via post-tax salary deferral. The Profit Sharing "bucket" is always with pre-tax dollars. Profit Sharing cannot be done post-tax, since it's profits from the company flowing directly to your account, not being paid to you as income.

Originally posted by @Barry M. :
To Whomever may be able to answer this question. Is the profit sharing idea available for the Roth Solo 401k or only for the regular Solo 401k?

Unlike Salary Deferral, the Profit Sharing component is part of the business expense and can only go into pre-tax bucket. Those contributions however can be converted into Roth at a later time.

@Mike McDermott great and detailed answers as always. Thanks for plugging in the Roth provision, I love that too! What can be better than tax free investing!?

I would recommend you give Adam at IRA Financial Group a call. They are CPAs & attorneys specializing in 401k, solo, etc.

@Doreen Chaisson is correct. Your wife doesn't HAVE to be an owner of the business to participate in the 401K. I suggested your wife have 1% ownership so that she could have a different class of ownership so that you could defer some taxable income to her as a limited partner, thereby reducing SET until you reach a higher income level. This would allow you to avoid filing for S-Corp taxation and having to run payroll to get that benefit. This recommendation was made independent of anything to do with 401Ks. Again check with your accountant.

Since your accountant seems to prefer S-Corps to LLCs, it might be a good idea to check with a number of accountants. Again I encourage you to follow this link to get a more thorough understanding: http://www.bizfilings.com/toolkit/news/tax-info/llc-plus-scorp-equal-best-of-both.aspx .

Thanks for all the help. I'm still a bit confused, but realize that whoever I use to set this up will know all these technical details.

For instance when Doreen says: "Your company will have one Solo(k) plans with two participants - you and your wife...", but then later says "Your two Solo(k)s would then simultaneously co-invest...", this confuses me. Is it one, or two? I think I understand it to be one.

I am going to discuss with my CPA again the LLC vs. Sub S thing, as soon as he's done with tax season. It was a couple years ago that he suggested the Sub S to me, and I am guessing maybe he was concerned that the IRS rules on SET and an LLC were a little vague. I'm just guessing at this, because it seems like some still are unsure about what the IRS says about it.

Regards,

David

Originally posted by @Mike McDermott :
@Doreen Chaisson is correct. Your wife doesn't HAVE to be an owner of the business to participate in the 401K. I suggested your wife have 1% ownership so that she could have a different class of ownership so that you could defer some taxable income to her as a limited partner, thereby reducing SET until you reach a higher income level. This would allow you to avoid filing for S-Corp taxation and having to run payroll to get that benefit. This recommendation was made independent of anything to do with 401Ks. Again check with your accountant.

Since your accountant seems to prefer S-Corps to LLCs, it might be a good idea to check with a number of accountants. Again I encourage you to follow this link to get a more thorough understanding: http://www.bizfilings.com/toolkit/news/tax-info/llc-plus-scorp-equal-best-of-both.aspx .

In some states such as IL LLCs are OUTRAGEOUSLY cost prohibitive.

You are still subject to Employment taxes on a reasonable salary.

Originally posted by @David B. :
Thanks for all the help. I'm still a bit confused, but realize that whoever I use to set this up will know all these technical details.

For instance when Doreen says: "Your company will have one Solo(k) plans with two participants - you and your wife...", but then later says "Your two Solo(k)s would then simultaneously co-invest...", this confuses me. Is it one, or two? I think I understand it to be one.

I am going to discuss with my CPA again the LLC vs. Sub S thing, as soon as he's done with tax season. It was a couple years ago that he suggested the Sub S to me, and I am guessing maybe he was concerned that the IRS rules on SET and an LLC were a little vague. I'm just guessing at this, because it seems like some still are unsure about what the IRS says about it.

Regards,

David

You have ONE Solo(k) plan with two individuals each having an account under that plan. That is how the two Solo(k)s - meaning the accounts - reference in that quote arises. So one plan, with two accounts.

Join the Largest Real Estate Investing Community

Basic membership is free, forever.

By signing up, you indicate that you agree to the BiggerPockets Terms & Conditions.