Solo 401K Questions

11 Replies

Hello everyone, I have been busy learning from these forums and decided that it was time to create my first post. I have questions regarding the Solo 401K and starting a small business. Here goes:

Where I am currently at:

1. I am a W2 with traditional 401K that is pretty close to maxing out the 15K per year contribution (in my 40's). Not looking to touch this setup.

2. Have around 75K in a traditional IRA that was rolled over from previous employer traditional 401K plans. Generally used to invest in mutual funds, currently. Looking to play with this.

Where I want to go:

1. I want to rollover that traditional IRA into a Solo 401K, but I do not have a current business that would qualify me for the Solo 401K, currently.

2. I would like to first setup a small business that manages the passive income from the rent payments of an initial SFH purchased, and any subsequent SFHs to follow after being acquired. After small business is setup, then rollover the traditional IRA into this new Solo 401K account.

What the the best way to go here? Sole proprietor LLC?

3. After small business is established, and the Solo 401K account is established and funded with rollover traditional IRA, I am curious if it is possible to use a 5 year loan to myself from the Solo 401K plan to fund the 20% on purchasing the first SFH in order to rent? It would be with a 5 year repayment at prime plus 1%.

4. My goal is to start with (1) SFH to buy and hold so that I can rent it out. After loan is repaid then buy house number 2 using the same strategy.

5. My goal is to keep the rental property outside of the Solo 401K, while using the self loan to put a down payment on the house to purchase. After 4 years of ownership of the rental property, then sell it for appreciation and roll those profits back through the management company and into the Solo 401K.


Is this possible to do?

@Jimmy Wilson ,

I can't advise you which entity would be best in your situation sole-proprietor or the LLC, but it would not matter as far as the Solo 401k concern. Solo 401k plan can be adopted by any type of business: corporation, LLC, partnership, sole-proprietorship, etc.

You can obtain participant loan from the 401k for up to $50,000 or 50% of the balance, whichever is less. The loan can be used for any purpose (including down payment on rental that you personally buying).

Since you planning on purchasing property personally, not inside of your 401k, when the property is sold and you realize profit – you would have to declare it on your personal tax return and pay taxes on it (or do 1031 tax-deferred exchange to postpone paying taxes). You can’t deposit those funds or “roll them over” into Solo 401k, because you personally own the property. The definition of a rollover is when you transfer funds from one retirement plan into another without any tax consequences.

Hope this helps.

@Dmitriy Fomichenko is correct. The only funds you can put into your Solo(k), aside from rollovers from other retirement plans, is 1099 income you earn from the business that holds the plan, and profit sharing funds from that business. Since the property is to be owned personally, outside of both the Solo(k) and the company, any profit from sale of that property is ineligible to be contributed to the Solo(k). Additionally, the Solo(k) personal loan must be repaid within 5 years to the Solo(k), with regular (generally quarterly) and level payments. You need to make sure you'll have the cash flow to meet those loan payments or the entire unpaid balance will be deemed an early distribution, subject to taxes and penalties.

@Jimmy Wilson , interesting plan despite the issues addressed by @Dmitriy Fomichenko and @Doreen Chaisson. I'm new here as well and I haven't yet made my first investment. My plan is also to invest in SFH's and I had planned to use personal savings to do so. I do however have a 401k from a previous employer and after learning about Solo 401k's from the Podcasts the idea of using this vehicle to potentially fund some REI's appealed to me as well. Taking a loan and paying it back with interest would add to the retirement fund, I assume the interest rate would need to be reasonable, anyone know the IRS guidelines on this? I would probably want to charge myself the highest interest rate I could that would pass the test. I would presume that the interest payments on the loan would be deductible on the REI's books so it would be a way to defer taxes on some of the CF profits from the rental units. I would more than likely have a long-term buy and hold strategy.

@Mike Moles  

the interest real on the 401k participant loan must be reasonable (prime + 1%, which is currently 4.25%). The interest payments go back into your 401k, so yes, your help your retirement account grow.

I don't believe the interest rate on the 401k loan would be tax deductible since this is a personal loan not the mortgage. However, if you take the loan for purchase of the primary residence the interest can be deducted.  You need to consult knowledgeable tax expert on this before you start deducting interest payments. @Steven Hamilton II  might offer some help, he is very active here in BP community.

@Mike Moles  to the extent that the interest is a legitimate investment expense, it is deductible. the deduction for interest on a personal residence is a totally different issue.

@Jimmy Wilson  a few issues with your plan.  

you have to have some earned income from the self employment activity (1099 income) to open a solo 401K. that's not hard to arrange but it must be done. rental income is not earned income.

 you can contribute 20% of your earned income from self employment to a solo 401K.  the income you anticipate in your narrative will be passive income and long term capital gain income, which don't count.  that just means that you have to keep the money outside the 401K. 

keep in mind that you can only borrow half of what is in your 401K.  the other half can stay in mutual funds or actually any other type of investment.

Thanks @Katharine Chartrand , that's what I figured. If it wasn't deductible then it would be taxed twice, once as my W2 income and then again when I retire and withdraw the interest portion from the 401k.

@Katharine Chartrand  

you have to have some earned income from the self employment activity (1099 income) to open a solo 401K. that's not hard to arrange but it must be done. rental income is not earned income.

you can contribute 20% of your earned income from self employment to a solo 401K. the income you anticipate in your narrative will be passive income and long term capital gain income, which don't count. that just means that you have to keep the money outside the 401K.

Hi Katharine,

My husband and I are interested in becoming landlords in order to generate income to save within a solo 401k. You wrote that rental income is not earned income and therefore does not count. But you also wrote that it is not hard to arrange earned income.

Could you give examples of how a couple who owns one or two SFH rental properties might generate earned income from their investment properties? I'm new here and have a great deal to learn before we actually put in offers, but we finally have the capital to start investing, and we want to save 100% of the income earned in tax-sheltered accounts if at all possible.

Thanks for any advice!

@Kristen M.  

I am not a tax professional. I generally prepare my own taxes, but when I get into new space as did with this solo 401K, I had a professional prepare the first return. With that in firmly mind ...

earned income is either wages from a job or self-employment income. The solo 401k requires that you have earned income in the form of self-employment income. IOW from your own business. Any self-employment income. Consulting, babysitting are clearly self-employment. I am guessing if you sold stuff on craigslist that would count.  But my understanding is that if you accept any money for a business activity outside of your job and you report it, they you are eligible for a solo 401K.   

Anything where you performed work and got paid for it counts, as I understand it. It doesn't have to be a lot of money. But dividends, for example, do not count.

Have you thought about a self-directed IRA coupled with a non-recourse loan to purchase property?

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