Limited Returns Business Startup - ROBS v Solo 401k

6 Replies

Hello BP community.  I have spent the last couple of weeks researching my start up, meeting with Attorneys and CPAs trying to find the strategy the best suits me.  I have lurked in the forum and done loads of research online. Unfortunately, the folks that I am meeting locally aren't familiar with ROBS or the ins and out of Solo 401ks.  

Here is a quick summary:

I currently operate a Sole Prop for my Architecture and Real Estate sales business and would like to start a REI business that I plan to keep separated from my Sole Prop. The main goal  is to limit my realized annual income and keep investment deals tax deferred to help grow the investment company. I do not want to take salary or distributions from REI company for at least 5 years (unless forced to in case of C Corp.) The REI business will work between 3-4 flip projects and 1 buy and hold per year. The first 5-7 years are not about generating passive income, rather building networth through real estate holdings.

I have a 401k from a job I have left that I would like to use to start the REI business. I have been looking at both ROBS and Solo 401k. The CPAs I speak to are very concerned about the "double taxation" that would occur within a C Corp of the ROBS (even though I look to keep profits reinvested, through 1031 exchanges when it makes sense) It seems that the Solo 401k would provide me more freedom but I am not clear about the non-recourse loan options in Massachusetts and if this is even a viable option. This 401k I am looking to rollover has about $60k and I wanted to invest about $20k from savings. What are folks' experience with going this route?

Mark, you can get a non-recourse loan for a Solo 401k plan for a property in any state. You might be limited as to the choice of lenders who will lend in that state, but there are some who will. Here is a list of lenders offering non-recourse financing to retirement accounts that you should check out and contact about their loan offerings: 

https://www.biggerpockets.com/blogs/2810/50272-lis...

You can rollover your entire balance from existing retirement account and contribute up to $55,000 per year into Solo 401k plan. 

@Mark Terry

Will you have any employees in either business? 

You will be using a 401k for either option.  

I would think your best option for the amount you have and your goals would be to have a solo 401k if you don’t have employees but you should be making salary from your company and making contributions to your plan solo or not. Talk to your provider so you don’t create a sham 401k.  You have to have a business to have a 401k and your sole proprietor architecture company should qualify. 

Get cpa that understands 401ks and or ROBS OR Get the cpa and ROBS or 401k plan provider talking together educating your cpa. 

Maybe consider an IRA as an alternative but that also will have UBIT taxes, due to the flipping business.

@Mark Terry

Retirement funding is not likely to fully align with your goals.

Option A: Solo 401(k)

Your current architecture & real estate sales business could sponsor a Solo 401(k) plan so long as you remain in an owner-only business format across all enterprises you control. Such a plan would give you the benefit of deferring income you generate from architecture and real estate sales. The plan could invest into real estate, but must do so fully at arm's length. You cannot be actively involved such as by doing architectural design or being the agent of record on plan transactions. All gains would go to the plan. However, gains from passive income such as rentals and private lending are fully sheltered to a retirement plan. Gains from a trade or business such as repeated house flipping as you propose would not be fully sheltered. UBIT taxation which can max out at 37% trust rates federally would apply.

Option B: ROBS

The ROBS program would be well suited to acting as a real estate developer/flipper.  Such a plan format requires that there be an active product/service business such as an active real estate development company.  You would need to be actively engaged in that business and draw a reasonable salary in order to participate in the C-Corp retirement plan.  So, not drawing income is not an option.  While there are no taxes or penalties for rolling your existing tax-deferred retirement savings into such a structure and capitalizing the C-Corp - the corporation will pay normal corporate taxes (at 21% federal currently) and you would also pay income tax on any salary you take from the company.  You can generously defer some of that salary into the plan, however.

So...

If your goal is to grow your existing tax-sheltered retirement savings by investing in an asset class you understand, the Solo 401(k) would be a good fit, with limitations on your involvement and a shift to passive real estate strategies such as rentals or hard money lending as opposed to flipping.

If your goal is to create and be actively engaged in a real estate development company, and have access to existing retirement funds to capitalize that business, then the ROBS structure will be the better fit.

@Brian Eastman

@Carl Fischer

@Dmitriy Fomichenko

Thank you all for the robust and helpful responses.  Upon further reflection I have developed an alternative method. To Brian's point I need to pick which strategy best works for me: development and ROBS or Buy and Hold via Solo 401k. Here is a thought I have to get the best of both worlds.

I crunched the numbers on the C Corp taxation that would be required under the ROBS. The $25k benefit that I got by executing a ROBS versus the 401k early distribution, evaporates after two years in my model.  Let's disregard the ROBS then.

However, I can rollover $60k into a Solo 401k and then generate a loan of 50% of the value. This loan would only be about $4k less than net gains after taxes and penalties on a 401k early distribution but I get to keep the Solo 401k invested. This initial loan of $30k would be used to fix and sell homes via an LLC. Gains from the sale of flips could then be recontributed to the Solo 401k in the tune of $60k/yr. After some accumulation the Solo 401k can then invest in Buy and Holds in a tax sheltered environment while the LLC works separately on active development. Am I missing something? This solution seems too good to be true.

@Mark Terry

At the structural level, the plan works.  

The numbers themselves may be optimistic.  I'm not sure how you create about $193K of net business income from $30K of seed money.  That is about what it takes to max out contributions to a Solo 401(k).  But, even if you make $100K in a year and drop $43K into the Solo 401k as new contributions, that is pretty good progress in the direction you are seeking.

@mark 

@Mark Terry you will be paying some tax on the earned income from the LLC. Go over the scenario with your cpa just so you know exactly what happens.