When to form a Solo 401k: before, or after leaving a W2 job?

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When to form a Solo 401k: before, or after leaving a W2 job?

Veronica Ivy
Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes

Hi y'all. I'm about to leave my W2 position and basically be a full time professional real estate investor. I am super sold on the benefits of rolling over my 401k into a Solo 401k and then buying rentals with it.

My question is, the end of my work contract is May 15. I want to be able to put offers on properties asap. I know the rollover will take time. Should I set up the Solo 401k NOW before I leave my W2 employment? Or should I wait until immediately after I leave my job?

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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
5y

@Veronica Ivy,

Leaving your W2 position has nothing to do with your ability to establish Solo 401K plan.

To qualify for this, you must have legitimate self employment activity or business without FT employees. Do you have that in place?

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  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    @Veronica Ivy,

    Leaving your W2 position has nothing to do with your ability to establish Solo 401K plan.

    To qualify for this, you must have legitimate self employment activity or business without FT employees. Do you have that in place?

    5Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    Yes, I have 3 self-employment businesses.

    Question: is there a way to use the Solo 401k set up fees as a tax deduction?

    0Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    Then you should be able to set up the plan now.

    Set up fees are considered business expense and are tax deductible.

    0Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    But they'd only be deductible for the Solo 401k LLC, which doesn't have to worry about taxes, right? Or can I somehow claim them as pass-through on my personal return?

    0Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    You don't need LLC with Solo 401K.

    It is tax-deferred vehicle.

    Set up fees are tax deductible because your business will pay them. 401K can only pay for the expenses DIRECTLY related to investments it owns. These are expenses of the 401K.

    3Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    OH. So it's the Self-Directed IRA that needs an LLC, but the Solo 401k doesn't need an LLC?

    So my paying the set-up fees for the Solo 401k are tax-deductible on my personal taxes as 'legal fees,' I imagine? Or should I have my rental property LLC pay for the set up and deduct that way? The LLC is single member and pass through, anyway.

    0Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    Correct, you don't need LLC with Solo 401K.

    No, the set up fees are not personal expenses, they are business expenses. You must have legitimate business with earned income to qualify.

    Rentals produce passive income and are considered investments not business.

    Do you have business or self employment activity with earned income?

    3Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    Yes, remodeling. I do actively repair and remodel my rentals. My remodeling LLC is separate from the LLC that owns the properties.

    2Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    I've looked at the tax requirements, and I think that I'm involved enough with my rentals to qualify as a real estate professional, which means it's active, not passive income. No?

    So I could have my FFH LLC that owns 4 of the properties create the Solo 401k and write it off as a business expense?

    1Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    Your remodeling LLC should be able to adopt the Solo 401K plan.

    You and your LLC can't do any work on properties your 401K owns.

    0Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    Real Estate Professional designation is irrelevant here. 
    Rental income is passive income regardless!

    1Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    Oh yes, I'm entirely aware that I can't lay a finger on the property to do any improvements. I have a whole team of people to do that work without me (a residential builder/remodeler, plumber, electrician, handyman, junk removal, etc.). The rental housing company pays them and I coordinate.

    For the Solo 401k, obviously the payments will come via the 401k account ONLY. The 401k held properties will be treated totally differently than my other held properties (5 SFHs).

    0Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    Your understanding is correct!

    1Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    I thought being an 'active' real estate investor, including rental income, does make a huge difference:

    Real" class="redactor-autoparser-object">https://support.taxslayerpro.c... Estate Professional

    Activities of real estate professionals are not treated as passive activities."

    Further:

    "Real property trades or businesses include property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business."

    No?

    0Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    Rental income is passive income in its nature. There are certain benefits of being RE professional, but that can’t change rental income designation (this is to my knowledge and I’m not a CPA)

    1Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    The link doesn’t work BTW

    0Reply
  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    5y
    Originally posted by @Veronica Ivy:

    I've looked at the tax requirements, and I think that I'm involved enough with my rentals to qualify as a real estate professional, which means it's active, not passive income. No?

    So I could have my FFH LLC that owns 4 of the properties create the Solo 401k and write it off as a business expense?

    That is not true. Your rental will not produce income that can be qualify for the next earned income.


     You can create a management company and convert your passive income to non passive income, but have to be ask your tax advisor to run numbers if this works for you. 

    [email protected]941-914-7779
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    3Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    Thank you for confirming @Ashish Acharya.

    1Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    Thanks. I'll look into it. What I've been reading is that 'Real Estate Professional' election on Schedule C makes the rental income into active. But there are requirements to make it active...like putting in enough hours actively in managing it and making decisions about repairs (which unit gets a new roof and when, coordinating the tradies, etc).

    1Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    Sorry, here's the link. For whatever reason some HTML code got inserted to the end of it.

    https://support.taxslayerpro.c...

    1Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    @Veronica Ivy, be careful what you read online, there is a lot of misinformation out there, or you may misunderstand the information. Like I mention earlier RE Professional does offer some benefits (it also comes with high audit risk), but it can't change the income designation. Rental income will continue to be rental income and is passive in it's nature. 

    I suggest you hire a CPA experienced with rentals who can provide proper guidance in your particular situation. 

    2Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    I will. I appreciate all y'all's time and responses.

    ETA: (I'm actually Canadian with a PhD, and I just really like using southern phrasings like 'all y'all's').

    0Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    I'm sorry for getting hung up on this and not just paying a CPA, but here's the IRS website:

    https://www.irs.gov/instructio...

    Section:

    Activities That Are Not Passive Activities

    "Activities of real estate professionals. If you were a real estate professional for 2020, any rental real estate activity in which you materially participated is not a passive activity." (Bold in original.)

    The key text is:

    "A real property trade or business is any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. Services you performed as an employee are not treated as performed in a real property trade or business unless you owned more than 5% of the stock (or more than 5% of the capital or profits interest) in the employer." (Bold, underline, and italics added.)

    No?

    ETA: See also explanation of the relevant tax code: https://eformrs.com/Forms10/Fe...

    0Reply
  • Dmitriy Fomichenko
    Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
    5y

    @Veronica Ivy

    The text you are quoting explains how to qualify for Real Estate Professional status. Nothing in this text says that rental income stops being rental and becomes earned income. 

    2Reply
  • Veronica Ivy
    OP
    Rental Property Investor · Charlotte, NC · Member since 2020 · 47 posts · 17 votes
    5y

    The IRS guidance says that a Real Estate Profession making such an election (you have to attach a statement of such, and probably a log of the hours to satisfy the 750), and then you report the INCOME from that activity on your regular 1040 as self-employed income.

    0Reply
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