401k rollover to purchase rental property
Rental Property Investor · The Woodlands, TX · Member since 2014 · 345 posts · 288 votes
I would like to hear feedback from anyone who has successfully used a Rollover as Business Startup (ROBS) or a Business Owners Retirement Savings Account (BORSA) to use assets in a 401k to fund investment real estate purchases. Has it been a positive experience or overly cumbersome? I am aware of the potential to roll assets in to a self directed IRA, however that option doesn't appeal to me since I wouldn't be able to use the rent income until 59.5 (my goal is to resign from my current job and would like the income to replace my salary). Thanks, jeff
I opened a BORSA with an accounting firm here in Houston this past May. It's too early to tell how really cumbersome it is with regard to accounting, taxes, annual filing, etc., because I haven't worked through most of it yet in practice, but it seems relatively straightforward. The main thing is to avoid triggering a "distribution" by following all the federal rules for maintaining and managing your new 401K. Still worth it of course, but the main drawback for me is the extra hassles of managing a C-corp vs. a sole proprietorship or LLC, e.g. double taxation on FICA and Medicare, paying workers comp tax, and having to buy general liability insurance for lawsuit protection. I priced $1,000,000 per occurance GL insurance recently, and it will cost me almost $5,000 per year (based on rehabbing 10 houses per year). Keep in mind that under the BORSA arrangement, your new 401K actually owns the C-corp because it holds all the shares of stock, which seems to me more vulnerable to lawsuts than operating as a LLC. So, I am investigating a way to form a LLC under the BORSA C-corp to do business. As I understand it, you can't form a stand-alone LLC and borrow funds from the C-corp to do rehabs or it will count as a distribution/withdrawal of your 401K funds, and you will have to pay the income tax and early withdrawal penalties on the entire 401K. Finding an attorney or CPA to form the LLC under the C-corp is proving to be challenging as most of them aren't familiar with the BORSA set-up and don't want to be held liable if a distribution event is triggered.
Any Feedback is appreciated
I opened a BORSA with an accounting firm here in Houston this past May. It's too early to tell how really cumbersome it is with regard to accounting, taxes, annual filing, etc., because I haven't worked through most of it yet in practice, but it seems relatively straightforward. The main thing is to avoid triggering a "distribution" by following all the federal rules for maintaining and managing your new 401K. Still worth it of course, but the main drawback for me is the extra hassles of managing a C-corp vs. a sole proprietorship or LLC, e.g. double taxation on FICA and Medicare, paying workers comp tax, and having to buy general liability insurance for lawsuit protection. I priced $1,000,000 per occurance GL insurance recently, and it will cost me almost $5,000 per year (based on rehabbing 10 houses per year). Keep in mind that under the BORSA arrangement, your new 401K actually owns the C-corp because it holds all the shares of stock, which seems to me more vulnerable to lawsuts than operating as a LLC. So, I am investigating a way to form a LLC under the BORSA C-corp to do business. As I understand it, you can't form a stand-alone LLC and borrow funds from the C-corp to do rehabs or it will count as a distribution/withdrawal of your 401K funds, and you will have to pay the income tax and early withdrawal penalties on the entire 401K. Finding an attorney or CPA to form the LLC under the C-corp is proving to be challenging as most of them aren't familiar with the BORSA set-up and don't want to be held liable if a distribution event is triggered.
Thank You. That is exactly the type of info i'm looking for. I'm sure we are both dealing with the same accounting firm.... I had no idea coporate liability insurance would be so high. Hopefully, It will be a bit less for me as I plan to buy and hold a few as opposed to flipping. I planned to take the tax and penalty hit and proceed anyway... so, I guess I can handle a ton of fees and expenses associated with the BORSA before it reaches the point of taxes and a 10% penalty... I just don't want to go through the trouble and expense of setting everything up only to find out that it is almost impossible to follow all of the guidlines... From my research, it seems like "discrimination" is the biggest hurdle for the true small business using the ROBS/BORSA, since they have to provide the same 401k options to all employees.... luckily, I don't plan on having any employees.
Have you considered the Solo 401k option yet? I learned of it here on BP and I am considering going that route myself. It eliminates many of the issues with BORSA, ROBS and Self-Directed IRA's that I have read about although you are limited to 50% or $50k (whichever is less) on the loan you can take out against it but it can be used for anything including REI without any restrictions. At least this is my understanding, I just wanted to mention it in case you haven't heard of it before.
I haven't investigated the "solo 401k". I definitely will.
after more reading and looking at the difficulty of getting the proceeds out of my C-corp (paying ss, medicare, etc on salary or paying double tax on dividends) i might just take the penalty and tax hit up front and keep the rentals in an LLC ... in the long run i think i can make up the initial loss with smart buys and good rental income.
There is certainly less headaches to deal with by going with an LLC. In my case, the $ amount saved through the tax and penalty avoidance was significant enough to clearly outweigh the extra hassles of running the C-corp. In fact, I couldn't have gone into real estate investment (flipping) as a full-time career without it.
Good luck!
Yes, I would also be throwing away a pile of $ initially in taxes and penalties. What are you doing with the proceeds from the flips? Are you collecting a salary, or reinvesting? Since you are flipping, you can be actively involved, and therefore able to pull a large salary from the Corp. I have been told that the IRS frowns on upon a Corp wich mainly generates passive income paying a high percentage of the profit as a salary... and further, that passive income incurs an additional 20% tax for a corporation... Any thoughts or experience?
Yes, I would also be throwing away a pile of $ initially in taxes and penalties. What are you doing with the proceeds from the flips? Are you collecting a salary, or reinvesting? Since you are flipping, you can be actively involved, and therefore able to pull a large salary from the Corp. I have been told that the IRS frowns on upon a Corp wich mainly generates passive income paying a high percentage of the profit as a salary... and further, that passive income incurs an additional 20% tax for a corporation... Any thoughts or experience?
Here is where the solo 401k pays off.
I have a LLC that holds my rental properties that are in my name. Strictly passive income, and no issues with being classified as a dealer. If you flip and do buy and hold from the same entity you are asking for trouble.
I have a LLC that does my renovations and flips, and is the business that has my solo 401k attached. So that much of the profits that would be regular income is able to go into the 401k. I sub out all of the rehabs to this LLC from the holding company. The rehabs from the 401k can not be done by that LLC, but for me that is irrelevant since my brother's company can do them and he gets the profits and gives me good rates.
Originally posted by @Jeff W.:
Yes, I would also be throwing away a pile of $ initially in taxes and penalties. What are you doing with the proceeds from the flips? Are you collecting a salary, or reinvesting? Since you are flipping, you can be actively involved, and therefore able to pull a large salary from the Corp. I have been told that the IRS frowns on upon a Corp wich mainly generates passive income paying a high percentage of the profit as a salary... and further, that passive income incurs an additional 20% tax for a corporation... Any thoughts or experience?
I pay myself a salary to cover my living expenses; it basically replaces the income from my old job which I quit in order to flip houses full time. Any profits beyond my salary will be invested back into the corporation to grow the flipping business. Since this is all active income, the chances of the IRS disapproving are much less than if I were buying and holding. I have not heard about an additional 20% tax for passive income.
Thanks, I will have to get a little more creative to access that profit as a salary. Maybe the Corp will buy and hold as well as partner with my LLC to flip... Thanks again for the input.
Sure, no problem. Hope it all works out great for you.
Hey @Jeff Wallace how did everything work out for you?
I opened a BORSA with an accounting firm here in Houston this past May. It's too early to tell how really cumbersome it is with regard to accounting, taxes, annual filing, etc., because I haven't worked through most of it yet in practice, but it seems relatively straightforward. The main thing is to avoid triggering a "distribution" by following all the federal rules for maintaining and managing your new 401K. Still worth it of course, but the main drawback for me is the extra hassles of managing a C-corp vs. a sole proprietorship or LLC, e.g. double taxation on FICA and Medicare, paying workers comp tax, and having to buy general liability insurance for lawsuit protection. I priced $1,000,000 per occurance GL insurance recently, and it will cost me almost $5,000 per year (based on rehabbing 10 houses per year). Keep in mind that under the BORSA arrangement, your new 401K actually owns the C-corp because it holds all the shares of stock, which seems to me more vulnerable to lawsuts than operating as a LLC. So, I am investigating a way to form a LLC under the BORSA C-corp to do business. As I understand it, you can't form a stand-alone LLC and borrow funds from the C-corp to do rehabs or it will count as a distribution/withdrawal of your 401K funds, and you will have to pay the income tax and early withdrawal penalties on the entire 401K. Finding an attorney or CPA to form the LLC under the C-corp is proving to be challenging as most of them aren't familiar with the BORSA set-up and don't want to be held liable if a distribution event is triggered.
Have you considered forming an LLC that your C-corp then acquires and becomes the sole member/owner of instead of trying to borrow from the C-corp to fund the LLC? You could go a step further and make the LLC a Series LLC instead of a traditional LLC, which should provide you with an additiional layer of liability protection. I am in the process of using a ROBS to acquire a real estate franchise that specializes in buying homes from homeowners looking to sell their homes for cash. If I choose to buy their homes I have the freedom to treat them as flips, assignments, or buy and holds. Because I'm using rollover funds to purchase the franchise, I will need to use a third party to do all my rehabs in order to maintain compliance with the ROBS structure. As an employee of the C-corp I will be able to draw a salary, receive bonuses, and make tax-free contributions back into the 401k plan for future profit sharing. I can also lease assets to the C-corp. All of the above will written off as corporate expenses come tax time to reduce the C-corp's tax liability. Also, just as with the Solo 401k my ROBS 401k has a participant loan feature built into it that allows me to obtain a personal loan up to 50% of the value of the plan. These funds can then be used to pay off virtually anything, personal or business. The plan also has a Roth sub-account option (same as Solo 401k) that will allow me to make pre-taxed investments and let the profit grow as it would in a Roth. No income restrictions on this account either. The main issue with this setup is the buy and holds. By using the C-corp to hold an asset that generates passive income, I'm going to incure UDFI if I've used debt for acquisition. If I use cash to acquire rentals then I'm fine. So to overcome this, I'm going to either acquire the rentals with the 401k instead of the C-corp, or use the C-corp for acquisition and then transfer the asset to the 401k via tax-free contribution of stock shares. The rentals can then be held individually in shares of the C-corp stock. Only drawback here is that I can't touch the income without taking a distribution and penalty. So to overcome this issue I will simply increase my salary under the C-corp by the amount the 401k grows each month. Additionally, holding rentals in the C-corp is not out of the question since the impact of UDFI is minimal after depreciation come tax time. So to summarize and hopefully give some insight to the issues of rollover funding: use a ROBS if you're starting a business or buying a franchise and want to draw a salary. Also, if you're not planning on investing more than 50-100k it might not be worth it. Use a Solo 401k if you just want to do real estate, ie. flips, rentals, etc. Use the loan feature if you need cash. Use a SDIRA LLC if you want to be a passive investor and invest with an active investor. Hope some of this helps.
@Geo Gondzur Just wanted to follow up and inquire of the ROBS- did it work best for you for acquiring the real estate business?
yes. The ROBS is the best entity to use for an active operating business. I use it to flip houses, do development and valu-add apartment complexes. Works great.
@Jeff Wallace what do you mean you wouldn't be able to use rent money until 59 1/2? I am looking at using a borsa to fund areal estate purchase for a rental. My husband has an early lump sum offer from old employer (GE) can we use that towards buying a rental property that we will rent out? We were just about to form an LLC and go with a loan to buy property. I will use half our cash and half his early pension payout to pay cash for house. I already have an agreement to lease it out long term at a really good profit. How is the profit of company handled in this case?
59 1/2 referred to holding property in an IRA - it wouldn't pertain to a lump sum pension payout
Got it. I just got of the phone with the company doing the BORSA. I think it makes sense to go this route. I was concerned it has to be a c-corp but learned the tax laws changed in 2018 and Ccorp has only one tax tier of 21%. Which is lower than income tax rates I pay on my other company that is an S corp.
@Misty Monk if you are getting paid out in a lump sum and mixing with cash - you wouldn’t need to use the BORSA at all - unless they are paying out to another retirement account??
Moving the lump sum to a Borsa was the only way to get 100% of the payout. No taxes but yes the early penalties were waived. We moved it to the BORSA 401k account we set up and from that to corporate account to by real estate. Quite a bit of paperwork but just paperwork and process. It was worth it.
I am leaving my current job at the end of the year to help my wife with her business. I will have approximately $185,000 between my 401k and profit sharing plan. I would like use this money to purchase income generating rental properties. Initially I thought I would be able to do so with a ROBS but the more I read about it, it may not be the best way to go. What would be the most cost efficient way of setting up a business to do this? Thanks in advance for any and all feedback.
A ROBS plan is not suitable for holding passive income properties. That program only works for an active business, which might include real estate development, flipping, or running a hotel.
You could establish a self-directed IRA or Solo 401(k), but that would mean all income produced goes back to the plan. It is not entirely clear, but it seems your intent is to produce spendable income today. If so, that simply is not possible within an IRA or 401(k) unless you are over age 59 1/2.
If you want to use that capital to hold rentals and be able to draw the income personally, you would need to take a taxable distribution. Speak with your CPA and listen to the dozen or so reasons they will tell you not to do that.
Thanks for the quick reply. If I purchase houses/condos through a ROBS and use them for short term rentals (VRBO/Air BnB) how would that differ from purchasing and running a hotel? And to take that one step further, if I am actively managing the a long term rental property (responding to renter issues, ongoing repairs) would that not qualify under a Real Estate Operating Company?
Multiple vacation rental properties could be done with a ROBS. That is a services business.
A real estate operating company concept will not work. Well, technically yes, but it makes zero sense and no reputable provider would setup such a structure. You might require $20K or so to setup the property management side of things, but would not want to purchase and hold rental properties in a c-corporation, which is what is required to align with the ROBS structure.