401K Dist, reduce income tax through cost segregation v. ROBS?

Question

Before exploring this concept with a qualified legal and tax professional, I wonder if any of the community has anecdotal experience around taking a distribution from a 401K and balancing the earned income taxes with paper losses from doing a cost segregation study. I haven't been able to find much information around this topic so I admittedly may be searching for a unicorn.

My scenario: I have a (2-4) unit multifamily with serious rehab that falls very close $1M ARV. My goal with the property is to execute the BRRRR strategy and hold for the long term, so I think a cost seg might make sense. I'm also considering a 401K distribution or perhaps a ROBS strategy to free up more capital to scale and the purpose of the post is to weigh the pros, cons and feasibility of these options. Ultimately, I'm considering the ROBS or distribution options to eject from the corporate world.

If the cost segregation shows $100K of paper loss/bonus depreciation, etc., can I balance this loss against earned income of $100K from a 401K distribution? I realize there will an unavoidable 10% penalty to take out the 401K, but I'm curious about the potential income tax avoidance.

Can any of you see major flaws in either path? I won't take any comments here as legal or tax advice.

Brian Eastman · Answer

@Mark Doty Flipping yes, apartments no. Apartments produce passive rental income. If you had a legitimate business under a ROBS it could also hold rentals, but would be entirely the wrong structure for doing so. You don't want to hold rentals in a C Corporation and turn rental income into corporate taxable income.

Kevin DeVargas · Answer

Hi Mark,

There are a few steps involved to use the ROBS strategy. Is doesn’t necessarily have to be high volume but you do have to demonstrate that the 401K made sound investments and that the transactions are business related. It’s a bet more tedious setting up the ROBS.

* Must create a C Corp

* You must be on the C Corp as an employee

Among other details.

Basit Siddiqi · Answer

@Mark DotyIn general, Real Estate rentals are considered passive income. That means you are limited to taking $25,000 of losses if you make less than $100,000.If you are a real estate professional, you would be entitled to take the losses from real estate activities with no limitation.In this case, you would be able to offset $100,000 of 401K distribution with $100,000 of rental losses.however, you would still be liable for the 10% penalty.

Eamonn McElroy · Answer

@Mark Doty

"Thanks to both of you for the responses! How do I identify if the real estate losses are non-passive?"

Ideally, you would work with your tax advisor to determine (1) if you are a real estate professional and (2) if you materially participate in the rental real estate activity which you referred to in your OP.

Brian Eastman · Answer

@Mark Doty

What @Eamonn McElroy said with respect to the 401(k) distribution.

A ROBS would not be suitable for BRRRR activities. That vehicle requires that the retirement-funded business be an active trade or business, not passive holdings.

We have clients using the ROBS for active property development or high volume property flipping, which are the only ways such a structure really fits into real estate.

Eamonn McElroy · Answer

It's a valid strategy if the rental real estate losses are non-passive to you.

If the 401(k) distribution is an early distribution with no known exception, you're going to get hit with the 10% penalty tax regardless.

Mark Doty · Answer

@Brian Eastman , @Eamonn McElroy

Thanks to both of you for the responses! How do I identify if the real estate losses are non-passive? I'm basically acting as an owner-builder and hiring out the contractors for the current project (the BRRRR).

For the ROBS to work, I read that "high volume" is in the 3-5 flips per year. Does that sound accurate? Could you flip and or run apartment buildings (5+ units) under the ROBS structure?

Mark Doty · Answer

@Brian Eastman, @Eamonn McElroy

401K Dist, reduce income tax through cost segregation v. ROBS?

401K Dist, reduce income tax through cost segregation v. ROBS?

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