Partnership using Self Directed IRA.

NY · Member since 2015 · 101 posts · 43 votes

If I were to convert my 401k to a Self Directed IRA would it be possible to use those funds to partner with someone and If possible how would that work?

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Steven Hamilton IIPro Member

Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes

10y

Originally posted by @Dmitriy Fomichenko:

Originally posted by @Bob Malecki:

... this way I can start to build equity in the new 401k to move my house flipping operation into that tax advantaged shelter. Thoughts?

Bob, full tax advantage in your 401k is achieved by making passive investments. If however you engage in an active business with your 401k (flipping properties is an active business) - the income from that activity would be subject to Unrelated Business Income Tax (UBIT) which tops at about 40%. In this case your 401k would have to report and pay taxes on this income. Then when take distributions at retirement you will pay ordinary income tax at that time again. So in essence you are taxed twice, which still might be worth it depending on returns you are generating and comparing that with current returns your retirement account is receiving. You just need to be aware of this and be sure to consult with an experienced tax-professional before engaging in a transaction like this (I am not one and this is not a tax-advice).

That said that would depend upon how often said investments are made and what other investments are made alongside them. one or two flips, there was even a case where three were allowed without issue. Lending for an equity stake is always good.

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Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
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@Kevin Darrell I will let others chime in about doing the conversion part. As far as a partnership that is absolutely doable. I am in a three way partnership using my SDIRA. One thing to think about is what the purpose and time frame are of that partnership - meaning there is a cost involved, and what format do you need. In our case, all three of us had the goal of long term buy and hold rentals. This might require something different than say a partnership for a flip or two.
As a side note, our partnership is what would normally be considered 'prohibited parties' as far as SDIRAs go - my father and my brother and I. We were VERY careful in how we set this up with a lawyer that specializes in SDIRAs. The main thing for anyone thinking this route is that the partnership can NEVER (until it is dissolved) change as far as the percent ownership, so it takes a LOT of thought going in how you want to structure it.
Good Luck,
Dan Dietz
[email protected]608-524-4899
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Kevin Darrell
OP
NY · Member since 2015 · 101 posts · 43 votes
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@Dan Dietz, Thanks. Definitly something I want to look into.
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Chris Soignier
Real Estate Broker · North Richland Hills, TX · Member since 2013 · 1k+ posts · 607 votes
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Look into a Solo 401K as an alternative. If you qualify, it's a much more flexible plan. You can borrow money from it w/o restrictions as to usage, and you won't be subject to UBIT/UDFI for leveraged investments.
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Brian EastmanPro Member
Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
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@Kevin Darrell
Generally speaking, a self directed retirement plan can partner or joint venture. The concern is avoiding disqualified parties, which includes lineal family like parents, grandparents, children and grandchildren. As Daniel points out, there are ways a joint venture with a disqualified party can be structured, but it can be very restrictive.
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Cameron Skinner
Investor · Panama City, FL · Member since 2015 · 378 posts · 183 votes
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solo 401k is much better for real estate transactions, and you don't need a costodian which keeps your cost to administer down, good luck
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Kevin Darrell
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NY · Member since 2015 · 101 posts · 43 votes
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@Daniel Dietz, thanks for the detailed description. @Brian Eastman, this is an in-law I'm thinking about a partnership with so i'm good on that front then, thanks for the info about lineal family, definitely something to keep in mind.
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Kevin Darrell
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NY · Member since 2015 · 101 posts · 43 votes
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@Chris S and @Cameron Skinner, i never heard of the solo 401k, thanks for the info, I'm realizing I have many options where as earlier I thought my only option was really saving for the down payment. Thanks again to all that responded.
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Mark Nolan
Professional · Carlsbad, CA · Member since 2012 · 12k+ posts · 1k+ votes
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@Kevin Darrell
Another option is to enter into a tenancy-in-common transaction. This would be even allow you to personally invest alongside the solo 401k. Certain and specific rules apply under this type of arrangement, though.
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Logan Hicks
Business Owner/Investor · Millersville, MD · Member since 2015 · 191 posts · 71 votes
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What are the maximum contribution amounts per year for a sole 401k? Also, does it Impact the amount i can contribute to a SEP-IRA?
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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
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Originally posted by @Logan Hicks:

What are the maximum contribution amounts per year for a sole 401k? Also, does it Impact the amount i can contribute to a SEP-IRA?
Logan, the contributions to a SEP IRA and Solo 401k are both at $53,000, but Solo 401k also has a $6,000 catch up contributions for those who are over age 50. Also, Solo 401k has employee elective deferral contributions of $18,000 which could enable to maximize your contributions sooner than with SEP. Solo K has number of other advantages over SEP.
Since both are employer sponsored plans you can not contribute to both and in most cases it would make sense to go with Solo K.
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Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
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In addition to what others have mentioned including the exemption to unrelated debt financed income tax on leveraged real estate, the Solo 401k also allows a spouse to participate in the same plan. This can cut setup and ongoing fees in half when compared to having 2 separate investment vehicles in place. All together, it's a pretty healthy list of reasons to go the Solo 401k route over a self-directed IRA if you are or can become eligible.
@Kevin Darrell
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Logan AllecBusiness Member
Accountant · Los Angeles, CA · Member since 2014 · 1k+ posts · 980 votes
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Let's say I find a couple partners on BP who want to invest in a local multi-family with 25% down. Could we form an LLC with me contributing money through a self-directed Roth IRA in exchange for an X% interest in this LLC? I would not be a managing member and would just get a K-1 with Line 2, Rental Real Estate on it, which I understand is not subject to UBTI.
And then could we allocate tax deductions, both cash (maintenance, etc.) and non-cash (depreciation), to the taxable guys to sweeten the deal for them in exchange for perhaps a bigger piece of the profits for me so we're all whole in the end (i.e., their additional tax benefits cancel out their surrendering some profits to me so everything ends up having substantial economic effect)?
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Kevin Darrell
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NY · Member since 2015 · 101 posts · 43 votes
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@Cameron Skinner, do you have to be self employed to be eligible for a Solo 401k?
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Kevin Darrell
OP
NY · Member since 2015 · 101 posts · 43 votes
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@Brian Eastman, would I be able to convert a portion of my 401k? Say put $50,000 into a Solo 401k to be used just for real estate? I'm relatively new to all of this.
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Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
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@Kevin Darrell
Yes, you do need to have at least some self-employment activity to be eligible for a Solo 401k. The second eligibility requirement is the absence of any full time non-owner W2 employees. Your business or self-employment activity can be on a part time basis. It's also ok for you to be employed elsewhere, even full time, and still have a Solo 401k.
Yes, as far as the Solo 401k is concerned, you can rollover or transfer a portion of your existing retirement accounts and use those funds to invest in real estate. Depending on what type of retirement account you have now, there may be restrictions on what you can access and rollover. For instance, a 401k with a current employer may not allow for "in-service distributions" meaning you would not be able to access that money to transfer to the Solo 401k while working. As another example, a previous employer plan may not allow for a partial rollover and may require you to rollover all of your funds. Even if this is the case, you may be able to accomplish your desired outcome here. The Solo 401k allows for investment into real estate, but it's not a one trick pony (assuming we're talking about fully self-directed self-trusteed Solo 401k plan documents here). You can also invest into stocks, bonds, and mutual funds as well. For instance, if you rolled over your entire existing retirement plan, you could invest the $50k you mentioned into real estate and invest the rest of the funds into your desired products in the brokerage of your choice all within the Solo 401k.
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Kevin Darrell
OP
NY · Member since 2015 · 101 posts · 43 votes
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@Justin Windham, thanks. My wife just left her job last month and is possibly in the process of getting another job so this may be the perfect time to transfer funds.
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Brian EastmanPro Member
Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
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@Kevin Darrell
Justin has provided a good answer to your question about partial rollovers, but thanks for directing the question my way. The Solo 401k is a great tool and may be a nice vehicle for you. I'll be honest that is is often over-promoted here on BP and in many cases an IRA based program is a better fit for an individual situation - employment status, funding source, investment goals, age etc. Until you speak with a professional who can help you make the decision as to which plan format will be best for you, keep an open mind. Focus on finding the right opportunities and partners to diversify some of that tax-sheltered retirement savings into real estate.
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Robert Hetsler
Qualified Intermediary for 1031 Exchange" · Jacksonville, FL · Member since 2015 · 239 posts · 84 votes
10y
Just as a practical matter, I partnered with someone/his self directed IRA and while it was a cash transaction of a self service Carwash so there were no lenders to deal with; however, there were a few practical concerns that we never anticipated. The first was the simple process of opening a business bank account was so aggravating that it became impossible. Ultimately the path of least resistance was to amend the operating agreement to remove the self directed IRA as owner as well as amending the online filing to remove it as a member of the LLC entirely. Fortunately, my partner and I had a great working and trusting relationship so we did what was required to make it happen. Finally, because it was an income producing property that required opening a merchant service account, we had to go through a similar process to accept credit cards. Those little things become challenging because many financial institutions do not understand the concept of a self directed IRA or any type of retirement plan owning private companies. We did not foresee these issues, going into the project, and it ultimately caused a lot of extra headaches.
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Bob Malecki
Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
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Dmitriy, I have self directed Roth and I'm over 59.5 yrs old so I can take distribution from the Roth tax free. I'm thinking of taking distributions from my Roth to fund a new Solo K. Any thoughts on this?
Bob
Originally posted by @Dmitriy Fomichenko:

Originally posted by @Logan Hicks:

What are the maximum contribution amounts per year for a sole 401k? Also, does it Impact the amount i can contribute to a SEP-IRA?
Logan, the contributions to a SEP IRA and Solo 401k are both at $53,000, but Solo 401k also has a $6,000 catch up contributions for those who are over age 50. Also, Solo 401k has employee elective deferral contributions of $18,000 which could enable to maximize your contributions sooner than with SEP. Solo K has number of other advantages over SEP.
Since both are employer sponsored plans you can not contribute to both and in most cases it would make sense to go with Solo K.
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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
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@Bob Malecki
You can't use Roth IRA distributions to fund a Solo 401k. 401k can be funded in one of two ways:
1) Rollover from another qualified retirement plan (except Roth IRA)
2) New contributions
In order to establish a Solo 401k plan you need to own a small business without full time employees or be self-employed. Contributions to the plan can be made only from the earned self-employment income.
Hope this helps!
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Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
10y
Originally posted by @Dmitriy Fomichenko:

@Bob Malecki
You can't use Roth IRA distributions to fund a Solo 401k. 401k can be funded in one of two ways:
1) Rollover from another qualified retirement plan (except Roth IRA)
2) New contributions
In order to establish a Solo 401k plan you need to own a small business without full time employees or be self-employed. Contributions to the plan can be made only from the earned self-employment income.
Hope this helps!
Dmitriy is correct. That's the biggest caveat in my opinion to being able to setup a Solo 401k and transfer in your existing retirement funds. What is generally, great portability and flexibility between IRAs and qualified plans falls flat on its face when it comes to the Roth IRA. It can only go to another Roth IRA.
Dmitriy, do you have any hope for this changing at some point?
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
10y
Originally posted by @Justin Windham:

Originally posted by @Dmitriy Fomichenko:
@Bob Malecki
You can't use Roth IRA distributions to fund a Solo 401k. 401k can be funded in one of two ways:
1) Rollover from another qualified retirement plan (except Roth IRA)
2) New contributions
In order to establish a Solo 401k plan you need to own a small business without full time employees or be self-employed. Contributions to the plan can be made only from the earned self-employment income.
Hope this helps!
Dmitriy is correct. That's the biggest caveat in my opinion to being able to setup a Solo 401k and transfer in your existing retirement funds. What is generally, great portability and flexibility between IRAs and qualified plans falls flat on its face when it comes to the Roth IRA. It can only go to another Roth IRA.
Dmitriy, do you have any hope for this changing at some point?
I'll tell you now, the IRS won't be changing it any time soon.
[email protected]224-381-2660
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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
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I don't think so either.
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Bob Malecki
Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
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Guys, I have my own business and have earned income to contribute to a Roth 401k. My thought is to, lets say take $40K in distributions from my Roth and then contribute $40K of earned income from my single member LLC from flipping homes, to get the 401k funded. This way I can start to build equity in the new 401k to move my house flipping operation into that tax advantaged shelter. Thoughts?
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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
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@Bob Malecki
You can contribute the max allowed to the 401k and use Roth IRA distributions to live on. But like I said you have to have enough earned income from your LLC in order to contribute $40K into your Solo 401k.
Also, contributions into a Roth Solo 401k can only be made in the form of elective salary deferrals and are limited to $18,000 (plus $6,000 in catch up if you are over 50). So the total max. you can contribute to a Roth 401k is $24,000. The rest can be contributed in the form of profit sharing contributions, which is deduction for your business and can be only made pre-tax. But if your plan allows - those contributions can be later converted into Roth if you wish.
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