Can I MAKE a participating loan from my SD 401k?

Question

I know that I would have to pay UBIT if I BORROWED to purchase a property in my SD 401k using a participating loan. But is there any restriction regarding UBIT or other aspects if I were to MAKE a participating loan from my 401k funds?

Shera Gregory · Answer

Thanks @Dmitriy Fomichenko. The part that I was asking about does have to do with UBIT, not a participant loan. My understanding is that the 514(c)(9) exemption for UBIT for debt-financed property in a 401k depends on a few factors including that the non-recourse loan made to the 401k is not a participating loan. So if I wanted to do a flip in my 401k I could get a non-recourse loan at, say, 12% interest to cover the cost of the flip and I would pay no UBIT. But if I got a non-recourse loan and I agreed to pay, say, 8% interest plus 15% of the profits then I would have to pay UBIT.

My question was then whether or not the reverse applies .. is there any issue if I want to lend out of my 401k to another investor and receive interest plus a percentage of the profits. So far with my SD 401k I have done lending at just a straight interest rate but no portion of profits.

Dmitriy Fomichenko · Answer

Shera, I think you might be confusing the terms, let me clarify:

Participant loan - a loan that you personally can borrow form your 401k. The loan is limited to 50% of the balance or $50,000 whichever is less. Usually this feature of the 401k would be utilized when you have some personal short term financial need and can pay the loan off within few years. The terms of the loan are as follow: 5 year amortized payments at the rate Prime+1%. This is nice feature to be able to have access to your retirement funds tax-free and penalties free at any time (if you were to pull funds from the IRA you would be taxed and penalized if it was early distribution). When you take participant loan from your 401k all you pay is set interest rate with principals back to your 401k, there is no UBIT here.

If you are buying a property inside of your 401k then participant loan would not be applicable. You can pay cash for the property from your 401k or you can use leverage. If you use leverage - the loan must be non-recourse (meaning you can not provide personal guarantee for the loan). While leveraged real estate would result in UBIT in an IRA, the 401k is exempt from this tax if it owns financed real estate.

If you need any further clarification please feel free to contact me directly - would be happy to help!

George Blower · Answer

@Shera Gregory

UBIT does not apply to promissory note investments. UBIT applies to a solo 401k if it buys equity in a business that offers goods or services and is not structured as a C-corporation. And UDFI does not apply to a solo 401k plan but does apply to an IRA.

Dmitriy Fomichenko · Answer

@Shera Gregory,

Retirement accounts are designed to be invested passively (i.e. lending money). Income from passive investments would be sheltered from taxation in a 401k. I participated in a few dozen notes both personally and in my retirement accounts and the way it was done I have a promissory note which spells out the terms of the loan (interest rate, length of the loan, etc.) and the deed of trust or a mortgage securing my interest.

You would have to speak with an attorney to see if it would be possible to structure the loan with equity participation, but it must be loan to avoid UBIT. If you enter into joint venture with another party and get interest plus equity on your investment this would not be considered passive and will result in UBIT.

Carl Fischer · Answer

@Shera Gregory

Talk with your accountant and if necessary a tax attorney because there are ways to structure “agreements/notes” to achieve your goals.

Shera Gregory · Answer

Thanks @Carl Fischer. My understanding is that the exception for UBIT in a 401k does not apply if you get a loan where the amount paid in interest, points, etc is somehow dependent on the profit you make in the deal. That would be a participating loan. So I was wondering if there is some issue if I make a loan to a non-disqualified party that does get a share of the profit, not just a set interest rate.

Carl Fischer · Answer

@Shera Gregory

I’m not sure what you are asking but you probably would NOT have to pay UBITon a 401k receiving a loan like you would on an Ira receiving a loan.

UBIT would not be required if your 401k or IRA provided the loan to a non disqualified person/entity.

Can I MAKE a participating loan from my SD 401k?

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