Solo 401k and personal funds - Arms length question

[Purnell C.]

I'm interested in lending both solo401K funds as well as personal funds to the same borrower. He's a flipper.  He wants to record one deed for his personal residence as opposed to recording a different deed each time he acquires a different property.  I've verified there is enough equity for my pennies.

If two deeds against his property are recorded, one in my name and one in the name of the solo401K, would this negate the arms length rule? 

[Jordan Thibodeau]

*Bump*

Hopefully the lawyer cats at BP will have an answer :)

[Ellis San Jose]

Be careful lending to a borrower on his personal residence.  You are opening yourself up to much more risk.

Research Dodd Frank regulations. 

[Jeff S.]

Originally posted by @Purnell C.:

If two deeds against his property are recorded, one in my name and one in the name of the solo401K, would this negate the arms length rule? 

Strictly speaking it won't negate anything, but I think you really mean self-dealing, not arms length. You're allowed to partner with your retirement plan, Purnell.

Before everyone jumps all over loaning to an owner occupant, it's legal. The use of the money, in this case, is for a business purpose – the real criterion. Dodd-Frank won't apply. Talk to a good lending attorney, but you'll need a document from the borrower describing the use of the money in detail (flipping). This document, and your note, should indicate that the money will not be used for personal, household, or family use.

In sum, you can do all of this, but why?

"He wants to record one deed for his personal residence as opposed to recording a different deed each time he acquires a different property."

I assume you'll charge and annual interest rate? Your proposed arrangement will prevent you from charging points with each deal, unless you have an arrangement in the note to charge these periodically. More importantly, it will also prevent you from approving each flip.

With the shortage of good deals, my observation is that many rehabbers are taking some unnecessary (i.e. dangerous) risks. Whether they like it or not, you always want your borrower to be financial healthy and your arrangement precludes your approval of his deals. Foreclosing on a flip is one thing. Could you foreclose on his personal residence?

What's wrong with recording a different deed each time he acquires a property? You'll use a broker to do this and the fees and inconvenience should be minimal.

Your money, your rules, Purnell. 

[Pat L.]

This is what we do...(up here)

If the two properties are in the same county we can record one note against both the principal residence & the flip for the full amount of the loan. Now you have a first on both properties & it's usually a lower o/all LTV, especially when the flip is rehabbed & hopefully has a higher market value.

Once the flip is sold & you are reimbursed that property can drop off the note but the note can remain in force on the principal residence if the rehabber wishes to borrow again.

I just did one on 2 freehold investment properties for $37,000 with an immediate assignment of rents, tax/ins escrow. The investor has been a 'client' for many years & we have a good relationship & regardless of my high interest rates he has made a lot of money.

Just be aware that if you foreclose on a note held within a 401(k) you cannot deduct the high costs of the foreclosure (on your tax return). These expenses are to be paid out of monies held within the 401(k) & will just deplete same. However, the foreclosed property (if you take possession) then becomes an asset of the 401(k). Furthermore, a note held jointly by your 401(k) & yourself personally may end up with interesting consequences if there is the need to foreclose.

good luck

[Purnell C.]

Thanks all.  I wanted to make sure this would not put me in a position to have to submit an explanation to IRS.  I've decided to have him separate the funds. 

I am so happy to have found out about the soloK.   You all are great.