Active income LLC tied to a Solo K also used for passive income

5 Replies

Hi everyone, there's something I'm still confused about after talking to different people and reading through BP posts. I have a Solo K tied to an LLC, taxed as an S-Corp, that I set up for active income purpose - meaning I'd like to contribute active income from the LLC into the Solo K. Can I also use that income to generate passive income by buying rentals? Or should I have 2 different Solo Ks? In the future, if I also plan on creating a separate LLC for passive income purpose - can the 2 LLCs co-use the single SoloK? Or should I, in the future, have 2 LLCs and 2 SoloKs - one each for active, one each for passive?

Gabrielle,

you don't need to Solo Ks. You just need one. Contributions to your Solo 401k are based on your self-employed compensation. Income from passive investments such as rental income can not be used to contribute to Solo 401k. You could use the same entity that you use for your active business activity to hold rentals, but that is not a good practice. The reason you put rentals into the LLC is to limit your liability protection. You are doing the opposite by mixing your business with passive investments. Seek guidance from a qualified expert.

Hey Dmitriy, thank you for your response. I guess that's where I'm confused. I originally thought that we'd create a SoloK, roll over some traditional IRA funds into it, so that we can take a loan out of it to use as gap funding. But since there's a limit on how much loan you can take, I thought I'd use the rest to buy rental. Does it mean I really can't be using the rest of it to buy rental properties? Say we have a total of $500K to roll over. The active business LLC is for myself and my husband so the two of us can take a total of $50K*2 = $100K loan out. The other $400K: it seems that my original plan to use this to buy rental properties will not be a good idea?

@Gabrielle T.

I think you are confusing the difference between the business that sponsors the Solo 401(k) plan and the plan itself.

One has to have an active business that creates earned self-employment income in order to establish a Solo 401(k), as a 401(k) is an employer sponsored retirement plan. The business can be a sole-proprietorship, LLC, corporation, etc. What matters is that the business is actually a business creating earned income, not simply a holding company for passive investments. It sounds like your S-Corp is engaging in some form of active business, so you should be OK sponsoring a Solo 401(k) from that business. What you can do is make new tax-sheltered contributions from your S-Corp W-2 wage income into the Solo 401(k). This is quite similar to an employee of Apple or Ford making a contribution to their company 401(k) plan.

How you invest the Solo 401(k) must be entirely separate from you and your business, and may be into various assets that can be passive or active in nature - so long as they are engaged in at arm's length.  The thing is, however, that using the 401(k) plan to engage in passive income producing assets such as rentals, lending, etc. works best.  When a tax-exempt retirement plan starts acting like a business (venture capital, flipping houses, etc), then there is a tax that applies to level the playing field for tax-paying businesses.

Borrowing from a 401(k) can serve you and your personal business, but is not the highest and best use of your 401(k) plan.  The best thing you can do is to put your Solo 401(k) plan into a passive, solid-performing asset such as a rental property.

Please go back to your Solo 401(k) plan provider or your CPA and get a better handle on how the plan you have works.

Hi Brian, I think your explanation did it for me. I feel clear about this now. Thank you very much.

Originally posted by @Gabrielle T. :

Hey Dmitriy, thank you for your response. I guess that's where I'm confused. I originally thought that we'd create a SoloK, roll over some traditional IRA funds into it, so that we can take a loan out of it to use as gap funding. But since there's a limit on how much loan you can take, I thought I'd use the rest to buy rental. Does it mean I really can't be using the rest of it to buy rental properties? Say we have a total of $500K to roll over. The active business LLC is for myself and my husband so the two of us can take a total of $50K*2 = $100K loan out. The other $400K: it seems that my original plan to use this to buy rental properties will not be a good idea?

Gabrielle, you can rollover IRA funds into your Solo 401k and then take personal loan from your 401k. However, the formula you are using is not exactly accurate. Each plan participant can take a loan from their respective account, so let's say that each of you have $250K each in your respective accounts then you are correct, you potentially could access up to $100K total via loan. However, if let's say your balance is $450K and your husband's is $50K (total of $500K), then you can borrow up to $50K and he can only borrow up to $25K (50% of his balance).

If you have a truly self-directed Solo 401k plan then the rest of the funds can be invested in rental properties, or any other assets. 

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