A question regarding self-directed 401(k) disqualified persons

9 Replies

                  Hello friends!

                  I have a self directed 401(k) question that pertains to disqualified persons. Here's the scenario, my father wants to invest in real estate with his 401(k) self directed and he wants to hire the general contractor's company that I work for as a 1099 employee. Would he be able to hire this company knowing that I might possibly be sent there to work? (I will add that I have zero control over the contractors business entity.)

                  • I might as well ask a related question. While listening to a BiggerPockets podcast, the guest speaker mentioned that he started his business with a self directed 401(k), then he also said that he himself worked on the property to fix it up. Is this within the rules that govern the account? I would think that as long as a person doesn't pay themselves a salary to work on a project or manage it, and they also don't co-mingle funds, then it should be legal? Any opinions? To take this question one step further, can that plan participant acquire the materials with 401(k) funds or must those acquisitions be handled by a non-disqualified 3rd party?

    Thanks for your time sharing the knowledge and wisdom to help us on our paths! =)

There should be no issue with that as he is not hiring you. That said if he says to the contractor he wants you specifically working on the project that could be an issue. 

Typically you cannot work on your own property. There is some argument that getting 3 quotes averaging them and paying yourself that rate to do the work is justifiable. This has not yet been tested in tax court. I would recommend shying away from that direction just to be safe. 

@Dmitriy Fomichenko @Mark Nolan can give you some great input on disqualified persons as well. 

The person referred to in the podcast could have started a Roll-over Business Startup (ROBS) with their 401K funds. In this system you establish a C Corp with a 401K plan. You roll-over existing 401K and/or IRA funds into the new C Corp 401K plan. The 401K plan then invests in the C Corp, thereby funding the C Corp with your 401K plan funds.

With a ROBS you can work in the C Corp funded by your 401K plan. You can work on houses that you purchase and resell. You CAN NOT live in the house(s). Similar to a self-directed plan you also need to be cognizant of transactions with disqualified persons, including yourself.

It is commonly said that for investing you should only use LLCs; however I believe, for fix-n-flip investing a C Corp is a good organizational structure. The ROBS method is a viable way to fund a fledgling company.

I did listen to that podcast. The person did not use ROBS, he used self-directed IRA. Apparently he was ignorant of the IRS rules... which is not an excuse, you must know the rules, they are pretty straight forward. As disqualified person you are not to provide any services or anything of value to the IRA nor can you benefit from the IRA in any way (directly or indirectly).

I have a similar question.  I rent short term rentals as PM for others charge standard % of what I can book in revenue.  Can I buy property after setting up self directed 401k and hire my company as property manger for the standard % rate I charge others?    

I understand all revenues Must go into 401k less the operating cost of hired PM (most hire an outside mgr but not really many in my market, and none w/interest I have in making profitable through rental).

@Jan Ferry-Axman

You may not do that.

IRS rules stipulate that there may be no direct or indirect benefit, in either direction, between a plan and a disqualified party.  You and your business are disqualified to your retirement plan.

Your property management may not provide services to the plan and get paid for doing so, nor can your company provide such services for free and thereby gift value to the plan (which would be akin to making un-documented contributions to the plan).

As the account holder, you are allowed to perform very basic administration of investments. Property management for a long term rental, including the occasional lease signing, paying the bills and receiving the rents on behalf of the plan for a a few doors would not present an issue. The volume of activity necessary to operate a short term rental would very likely cross the line of providing services to the plan.

Thank you very much Brian Eastman.  Very interesting (an disappointing to me)  But better safe than sorry!  Thanks for clarifying that. 

I have also looked at ROBES plans (Roll Over to Business Start up)  and it was suggested to me that I could use this  to purchase homes (business short term rental, equipment needed is homes and others with homes).      But it is suggested to create a C- corp business when doing this and issue stock.  Stock + any assets owned by business are the self directed 401k's and constitute its value.    Will I run into the same issue??   As the investment is a business who may have a homes (owned and others homes too) to produce revenue?   More complex for sure.    My head is spinning on this all.   Simply trying to use my skills to best invest my 401k for growth.    Frustrating when you know you can invest in VR homes make $ but mostly for others!        

@Jan Ferry-Axman

The Rollover as Business Startup is designed for operating a true business, not passive investment holdings.

If you have multiple properties on short term rental, and are providing services to tenants above and beyond just a place to stay (access to gym, meals, laundry, etc.) then vacation rentals are considered a business (like a hotel) and not passive real estate rentals.  In this case the ROBS plan would be appropriate.

In the ROBS program, you can and must be directly involved in the operation of the business for the structure to work.  Your current business would not provide services, but the C-Corp that is part of the structure would operate as the property owner/management service.

@John Kinlaw  

It would be okay for your father to hire the company that you work for as long as you are not an owner of that company, you do not perform the work on property, and the company does not provide you with a referral fee for referring the company to your father.

Lastly, all expenses in connection with the property have to be paid using 401k funds since the 401k owns the property.