Structuring a partnership investment using a 401(k) loan

15 Replies

My next investment purchase will use a 401(k) loan from myself or my wife’s account. I want to structure it in a way so that we are paid back so that the loan balance can be reduced quickly. The point of this is to simply have the funds back so that we can move onto our next investment. The target property almost definitely has to be a value add minimally distressed property that can be refinanced after repairs, or a straight up fix and flip.

Where I am confused is to how to best word a partnership agreement to be reimbursed and how that would affect my cost basis in relation to my partners?

In full disclosure, I have no intention of charging my partners interest since the 401(k) interest will be paid back to us ourselves only (no need to justify charging interest to counter the bank interest we’d be paying had it been a traditional bank loan).

Thank you in advance.

Talk to the company servicing your IK.  They probably have some language you can use.  There are also strict rules around using your 401k. 

@Jeff Piscioniere

Here are the general considerations regarding 401k loans.

401k Participant Loans

  • If your 401k plan allows for 401k participant loans, the maximum loan amount is equal to 50% of the balance up to $50k. The repayment terms for a 401k participant loan are equal monthly/quarterly payments of principal and interest (typically prime plus 1%) over a 5 year term (longer if used to acquire your principal residence).
  • Please note that if you take a full $50,000 and then pay back the loan, you can't take another $50,000 until 12 months after the first loan was fully paid back.
  • Per the loan offset rules that went into effect with the 2018 Tax and Job Act: if you leave your job and the loan is current at the time you leave your job but then the loan goes into default because you left your job, you will have until your tax return deadline (including any timely filed extension) to make the loan current by depositing the outstanding balance into an IRA (and thereby avoid the taxes and penalties that would otherwise apply).



Please keep in mind the multiple loan rules:

Under those rules, the sum of the balances of a participant's outstanding 401k loans under a single 401k plan (using the highest outstanding balance of each loan over the last 12 months) can't exceed 50% or $50,000 whichever is less. Thus, if you took a $50,000 loan and paid it back within 6 months, you would need to wait another 6 months before you could take another $50,000 loan.

@George Blower outstanding input! Thank you! So regarding the $50,000 loan and not being able to take another loan for 12months once paid back, what if I were to only take $20,000 or less? What happens once it’s paid back? Is there a specific waiting period?

Thank you again.

If you have at least $100k and you take a $20k loan (regardless of whether you pay it back or not) you can still take a second $30k loan (provided that your 401k plan allows for multiple loans).

If your plan only allows one outstanding loan at a time (and with the same facts as my last post), you could take a $30k loan right after you payoff the $20k loan.

@George Blower I had some more time to think over my post and while I definitely valued and found interesting the input, I think I got side tracked from my original question.

If we’ve established an understanding of using a 401(k) for a real estate investment, the real thing I’m curious to understand is how a partnership can be structured in such a way where one of the partners, such as myself, is using their 401(k) but the other partner or partners are just using regular funding which they already have and may not necessarily need or want reimbursement? And as I said, if I desire to be paid back from the partnership with cash flow while others may not be looking to get paid back, how might the legal wording of that best be made?

Originally posted by @Jeff Piscioniere :

@George Blower I had some more time to think over my post and while I definitely valued and found interesting the input, I think I got side tracked from my original question.

If we’ve established an understanding of using a 401(k) for a real estate investment, the real thing I’m curious to understand is how a partnership can be structured in such a way where one of the partners, such as myself, is using their 401(k) but the other partner or partners are just using regular funding which they already have and may not necessarily need or want reimbursement? And as I said, if I desire to be paid back from the partnership with cash flow while others may not be looking to get paid back, how might the legal wording of that best be made?

In short:

  • One partner is your 401k and the other partner is the other investor.
  • This could be accomplished via an LLC (i.e. one member is your 401k and the other member is the other investor).
  • This means that partnership will have to file partnership tax returns (1065 at the federal level) and issue k-1's to the partners (e.g. one would be issued to your 401k under the ein of the 401k).
  • The terms of the agreement (including the payment flows you mention) would be negotiated and documented in the operating agreement where you sign as the trustee of the 401k.
  • The standard rules regarding investing in real estate apply (i.e. you can't use the property for personal use, you can't work on the property, etc.).

 

Here's what I did. I pulled out a $50,000 loan from my Solo 401k. This money is now mine, for me to use however I want. Buy a car, go on vacation, pay off credit cards, buy a house, etc. It's just like borrowing money from a bank, except I'm paying back my 401k and the interest goes to myself instead of the bank.

In this instance, I bought a home with a partner using the money I borrowed, and my partner and I formed an LLC using our own names, not my solo401k name. That way I can work on the house, I can live in the house, and I can earn cashflow from the house. It is my understanding that this is correct and accurate, please correct me if I'm wrong.

The second issue is separate. You would have to write up the terms as to how each partner is paid out so that you can use the cashflow from the property to pay back your 401k loan. 1) You could use the monthly cashflow. 2) you could cash out refinance after repairs are done and pay back your 401k. or 3) you could cash out refinance, buy another home with your partner, and just pay your 401k back monthly with other income, which is what I'm doing.

I've done a lot of reading and understand this to be legal and within "tax guidelines", but please speak up if you see any holes in my plan.

@Jeremiah J Rosa this is EXACTLY what I’m looking to do! I’m just looking for a chunk of cash out of my 401k to invest with and view as an open line that I pay back and keep using as it grows.

Just wondering how an agreement might be worded in an instance where I might be taking money each month to pay back myself where a partner might just let it sit in the property's bank account? Wondering if you or someone might understand that from an LLC operating agreement and/or tax standpoint?

Thank you!

Originally posted by @Jeremiah J Rosa :

Here's what I did. I pulled out a $50,000 loan from my Solo 401k. This money is now mine, for me to use however I want. Buy a car, go on vacation, pay off credit cards, buy a house, etc. It's just like borrowing money from a bank, except I'm paying back my 401k and the interest goes to myself instead of the bank.

In this instance, I bought a home with a partner using the money I borrowed, and my partner and I formed an LLC using our own names, not my solo401k name. That way I can work on the house, I can live in the house, and I can earn cashflow from the house. It is my understanding that this is correct and accurate, please correct me if I'm wrong.

The second issue is separate. You would have to write up the terms as to how each partner is paid out so that you can use the cashflow from the property to pay back your 401k loan. 1) You could use the monthly cashflow. 2) you could cash out refinance after repairs are done and pay back your 401k. or 3) you could cash out refinance, buy another home with your partner, and just pay your 401k back monthly with other income, which is what I'm doing.

I've done a lot of reading and understand this to be legal and within "tax guidelines", but please speak up if you see any holes in my plan.

 The above is correct. Once this process is done, you and your partner or partners in a real estate transaction should have an entity with an operating agreement specifically spelling out how profits/losses are distributed, when, and in what order. In such a situation, your 401k has nothing to do with that investment and as such, you may life in it, work on it, and make profits on it outside your 401k plan. These profits would of course be taxable to you via a K1 from the entity to your personal return (a flow through entity).

You personally (not your partnership entity) would be responsible for paying back your 401k loan.

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