A few years ago I converted a few 401K's into one self-directed/checkbook IRA. I setup an LLC that facilitates the financial transactions on behalf of the IRA.
I recently purchased a vacation rental via the LLC, from which the proceeds will go back into the IRA account. My question:
Assuming all purchases are made via the IRA LLC, I'm assuming I can furnish the rental, and this would not be considered a "prohibited transaction"?
Thanks in advance.
@Brian Leonard , congrats on your first forum post! I see that you have been a member since 2016, what took you so long to finally participate in this awesome resource? :-)
If you wish to furnish a vacation rental that your IRA LLC owns, the LLC must pay for it, this would not be prohibited transaction. Think of it this way: if your rental needed a new furnace or water heater - LLC would pay for that expense and it would not be prohibited transaction. On the contrary, paying for expenses related to the investment of your IRA with the personal funds would violate IRS rules.
@Dmitriy Fomichenko it took me so long because it took me awhile to find the right piece of property. :)
Nonetheless, I have been lurking on this forum for a while, as it is a great source of knowledge on what can be a complicated subject. I've learned a lot, and appreciate everyone's input.
Thanks for your response. I figured that was the case, but I didn't want to be bitten in the posterior because I didn't ask, and do my homework.
Brian and Dmitriy, I have considered doing this exactly. But wanted to be the PM for the property. I was told this was not proper. I could neither act as PM or donate time to act as PM. I find this frustrating. But do understand after looking at the rules. Interpretation of unqualified parties -no family, self interest etc. You must be hiring a PM for the property, correct? The profit on the property decreases so much by hiring a PM instead of doing it myself it makes me crazy. It seems some people do this for long term rental? -act as PM for property that their 401k purchased, but not for short term rental. I am confused by this as we are getting into (intensity of PM work). Yes Vacation Rental is more intensive management. Can you lend any clarity. Should you never act at PM for a self directed checkbook 401k or just for Vacation or short term rental, or am I confusing something.
Self-management of IRA owned properties (LLC or otherwise) is generally viewed to be acceptable in a limited fashion. There is no specific set of guidelines from the IRS, and just the general prohibition against providing services to the IRA.
We and most in the industry are comfortable with a client managing a handful of long term rentals. The basic acts of screening tenants, signing leases, paying the bills and receiving the rents are administrative in nature, and if in a modest amount would not likely be viewed as providing services. You can, after all, spend time researching investments and pushing the buy/sell button on your stock trading IRA, as a comparison.
The issue becomes one of scale. If I had a client with a 25 unit apartment full of long term rentals, I would encourage hiring a separate property manager. Even the administration at that level becomes a part-time job. The same is true of vacation rentals. If you start putting many hours a week into directly interacting with the property, that could be viewed as providing services.
Your understanding of the rules is correct, as 'disqualified person' you are not allowed to provide any services to a qualified plan. Managing a vacation rental or 25-unit apartment building would fall into the category of providing services as Brian correctly explained because of the amount of work it would require from you.
But instead of focusing on negative (not being able to manage vacation rental yourself) why don't you focus on positives. I always tell my clients: instead of being frustrated by the rules or certain limitations, you should understand the rules and embrace them for your benefits. There is so much more you can do with the truly self-directed Solo 401k plan (or self-directed IRA)! Vacation rental may not be the best investment for your 401k, and because you can't manage it yourself should you live your money in the mercy of the stock market or in the money market account losing it's purchasing power to inflation? No! Instead you could invest in a syndication or become a private lender and buy some notes (and many other options...), those investments are truly passive and offer nice returns, this way your money will truly work for you to the fullest. After all managing vacation rental is like having another job, the ultimate goal for every investor should be to create enough "passive" income without having to work to earn it.
Management of IRA or Solo 401k-owned properties by the IRA account holder or 401k participant is generally allowable as long as that management is administrative or decision-making in nature. Screening tenants, collecting rent, deciding on renovations and repairs, etc usually fall into that category. Doing the actual repairs would not be allowed, but you could determine what needs to be fixed, who will do it, at what cost, etc. The management of vacation or short term rentals tends to gravitate toward the active business side of the equation and that is the real problem with you taking on that level of involvement for your IRA or 401k.
@Justin Windham , I'd be curious to see whence that rationale comes.....I have heard it oft said that managing a rental "without swinging a hammer" is OK, but I've never seen the reasoning.
My reasoning for telling clients to not manage a rental, especially in SDIRA's and other accounts that are killed by Prohibited Transactions is as follows:
4975(c)(1)(C) makes providing a "service" a PT. We have no idea what a "service" is, there is no definition at present. Given the consequence of being wrong (i.e. - managing a rental ends up being viewed as a "service" means we have a PT and a busted IRA) , I advise clients not to do anything that "could be a service". I think managing a rental without swinging the infamous hammer "could" be a service. I also do not think that the exceptions under 4975(d)(2) or 4975(d)(10) apply to managing a rental.
Is my reasoning flawed?
Thanks much for your info. to all. Great learning for me, and special thanks to Brian for clarifying and Dmitriy for making me look at it differently. Great info. Thanks again all. Great group for learning.
I wouldn't call your reasoning flawed, no. I do think there is some room for interpretation on what can be a "service" and the most conservative approach is indeed to advise clients not to manage properties owned by their IRA or 401k. That particular interpretation does seem to be a bit more conservative than the average among the self-directed industry, however.
I agree, 4975(d)(2) does not cover managing a rental, but that exemption seems to apply to the plan or IRA actually contracting with and possibly compensating a disqualified person for services necessary for plan operation. Similarly, 4975(d)(10) also deals with transactions between the plan and the disqualified person while the root of the issue here, I think, is what is considered a "service."
There is at least some amount of additional input and research that can (maybe, should?) be done with these "self-directed" retirement accounts when people choose to venture outside of the more common brokerage-type accounts. With that comes varying levels of comfort with regard to many of the decisions that need to be made. I think each person should make those decisions based on their own understanding of the rules and risk tolerance. As @Brian Eastman pointed out, one could spend time researching investments and deciding what to buy and sell in traditional accounts as well. Is that a "service" that is being provided if all autonomy is not surrendered to an investment advisor?
I understand your position, though. I wonder if it might be helpful if we seek a DOL opinion in the matter. I'd be interested to hear your thoughts on that.
There are no clear cut guidelines regarding managing a rental owned by a qualified plan. Therefore there are different views on this issue.
If you are paid for your services by your retirement account, that would clearly be a prohibited transaction. However, even without payment, there would still be a concern that you are receiving indirect compensation because you are performing services that would otherwise have to be paid for. Managing multi-family apartment or vacation rental would clearly fall into category of services in my opinion. Managing single rental property would probably be OK but as I mentioned earlier as an investor I do not want to do the 'job' of a property manager and would rather pay someone to do it.
Unfortunately, you will not know this until the IRS/DOL walks in the door and tries to find a problem. It depends on how conservative you wish to be.
Great point @John Hyre , many are unaware that PT can be corrected with Solo 401k without blowing it up! I usually don't like to 'advertise' that so people are not tempted but it is possible.
@Jan Ferry-Axman To be clear, although I own the property through my LLC, I do NOT manage it myself, for all the reasons defined by the brilliant people on this thread. I have a third party property manager, and yes, they do take a healthy chunk of the rental profits, but it's less than what I would likely pay in fines from the IRS if I were to manage it myself...:)
Hope that helps!
A disqualified person who participated in a prohibited transaction can avoid the 100% tax by correcting the transaction as soon as possible. Correcting the transaction means undoing it as much as you can without putting the plan in a worse financial position than if you had acted under the highest fiduciary standards.
similar questions to initial post re furnishing and fixing an LLC owned property. Is bartering allowed? For example if i want to hire a craftsman to build island for kitchen reno and he'd like to stay in property for the week instead of payment... is that prohibited? he's not a disqualified person... we just know a lot of tradespeople who like to barter their skills for intangible benefits. Another question... can the LLC accept donated furnishing for the property? if owner or anyone, essentially has lamps, table etc that we're heading to goodwill, could i take it for the property? Final question—if LLC buys a lot of furniture for properties, what is the proper way to get rid of it in 10 years if we decide to get out of the rental game? if we're 60+ do we just take it as a distribution, music we sell it or give it away?