Disqualified Persons in Solo 401k

10 Replies

I am a realtor, My mother has a high value 401k she is looking to roll into a solo 401k in order to purchase rental properties for her portfolio.  Am I prohibited from acting as the agent on these transactions?? I understand I cannot own any portion of the real estate, nor share in the profits, but I cannot find anything definitive on whether or not I can act the agent.

As a disqualified person, you cannot provide services to the plan.

@Ryan Walker ,

You should not act as the realtor for your mother's plan.  You can advise her with respect to using her plan, and she can take advantage of your expertise in the asset class.

You are, as a lineal descendant, a disqualified party to her plan.  As such, there can be no direct or indirect benefit - in either direction - between you and the plan.

You could not act as her plan's realtor and receive a commission.

You could not act as her plan's realtor for no commission, as that would constitute you providing a service of value to her plan.

Thanks for the replies. If I am unable to be compensated for transactions in a Solo 401k as a disqualified person are there any other ways for me to partner with my mother in an IRA or 401k? Perhaps a ROBS 401k in which I am an employee or Partner of the newly created Corporation? Any Other suggestions?

Originally posted by @Ryan Walker :

I am a realtor, My mother has a high value 401k she is looking to roll into a solo 401k in order to purchase rental properties for her portfolio.  Am I prohibited from acting as the agent on these transactions?? I understand I cannot own any portion of the real estate, nor share in the profits, but I cannot find anything definitive on whether or not I can act the agent.

Ryan, you are considered to be a 'Disqualified Person' and are prohibited from providing any services to your mom's retirement plan. 

@Ryan Walker

A ROBS plan is not a "workaround" for self-dealing rules.  It is a different structure that is aimed at capitalizing a business and comes with a good bit of legal and administrative overhead.  

If you and your mother were serious about creating a real estate development company and actively engaging in new home development or flipping houses, such a program could work.  

Unlike a self-directed IRA or Solo 401k, the business activities themselves are taxed - but you can perform the initial funding of the business using retirement funds without taxes or penalties.

I have seen others use this.  If you have a best friend or another investor you trust with another 401K that you are not related to and you trust, that person can loan you there funds and your mother can loan her funds to that investor/friend that is unrelated.  That investor pays your mother interest on the loan and you pay interest to the investor.  In this sense, you are both initiating a 3rd party transaction.  The other investor is liable on the note to your mother and you are separately liable to the other investor. Beneficial to your mother, the other investor and you if the trust is there.

Curious if others have seen this type of arrangement?

@Ed Caldwell

While it would be difficult for the IRS to track down such an arrangement, they certainly could.  If they did, they would view this as an indirect benefit between a plan and a disqualified party and a prohibited transaction.  

The fact that loan A is contingent upon the existence of loan B creates a tie between the lender on loan A and the borrower on loan B - who are disqualified parties to each other.

We often see folks recommend party A lend to party B from their IRA, while party B lends to party A from their IRA. Any such kind of quid pro quo arrangement would be at risk and therefore inadvisable.

There are a whole lot of ways that one can put their IRA or 401k to work without having such risk, so why go there?

Good point Brian.  I think you give the IRS WAY too much credit on the ability to track anything.  Take it from a CPA, I wonder how the IRS functions half the time as does most of the country ;-) Why to you think the subject of Flat tax keeps arising with politics and the IRS is always under scrutiny.

However, if you get on their radar things can go south pretty quickly.

That said, I never said one loan was contingent on the other, thus true third party relationship.  This is why I prefaced that you would have to have a great relationship and trust with the parties involved.  The contracts would have to be mutually independent of the other. Of course, I am not an attorney and I would advise anyone to consult a good tax attorney to be on the safe side before going forward with any such arrangement.

@Ryan Walker

You won't find any language in the code that specifically says a solo 401k owner's son is a disqualified party when acting in a real-estate agent capacity. However the IRC does specifically state that a son or daughter is a disqualified party.

Originally posted by @Ed Caldwell :

Good point Brian.  I think you give the IRS WAY too much credit on the ability to track anything.  Take it from a CPA, I wonder how the IRS functions half the time as does most of the country ;-) 

Yes and no.  I think in some ways, people don't give the IRS enough credit as well.  About 20 years ago, I watched the IRS pick apart an entire family of high net worth individuals.  It started with the audit of one family member's business.  Many deposits into the business were deemed as "income" from the IRS.  The business owner said no, those were loans from my parents and came up with some signed documents to prove out the deposits.  Auditor says ok, what interest rate did you pay?  Business owner gapes a bit, has nothing to say.  Auditor discusses imputed interest and business owner admits no interest was paid.  Auditor then opens an investigation into the parents.  No interest income there (and we're talking millions of dollars flowing through the first person's accounts.)

My client was a cousin in the family and I came into this about five years after the original audit.  Essentially, this one IRS auditor uncovered a vast tax dodge where the grandparents were running several million dollars through shell corporations set up and owned by children and grand children, paying zero taxes along the way with deliberate obfuscations, magic hand waving and smoke.  Took about nine years for the auditor to go through the whole family as well as some friends and business associates of the family.  In the end, several people went to jail.

I've also had state agencies come after issues that are 7-10 years old.  Taxing agencies are notoriously slow, the IRS particularly slow since their budget got slashed in the last budget cycle, but they are particularly good about filing paperwork and documentation to make sure that they come in under the statute of limitations.  Many people breathe a sigh of relief thinking they got away with something, only to get a letter of inquiry 3-6 years later.

Remember - the IRS can only audit you back 7 years in a random audit.  But if they suspect fraud, they can go back as far as they like.

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