Starting a real estate investment business with a ROBS 401k

I am thinking about using my 401k funds to start a real estate investment business using the ROBS plan and have a few genereal questions about it…the business would be involved in flipping houses and
also purchasing rental properties. My wife and I would be the only employees of the company…at least to start.

QUESTION:

Typical real estate start up.1. First, I would like to know if this type of company qualifies to use a ROBS strategy to fund it? (I’m just learning about ROBS)

ANSWER:

You can use the ROBS strategy (i.e. ROBS 401k Business Financing plan) to fund a real estate operating company. Below are the real estate operating company requirements.

Real Estate Operating Company 1) The corporation that you invest your retirement funds in may invest in real estate that satisfies the following requirements:

a. At least 50 percent of the assets of the business, valued at cost, must be invested in real estate which is managed or developed and with respect to which such entity has the right to substantially participate directly in the management or development activities.

b. Such entity in the ordinary course of its business must be engaged directly in real estate management or development activities.

2) Expenses related to the real estate will be paid by the corporation.

3) The real estate will not be used for personal use.

4) There may be periods of time when the 50% test described in 1(a) above is not satisfied. This confirms that it would be acceptable as long as the 50% test is satisfied on the following dates: (i) the "initial valuation date" or the first date on which the corporation makes an investment that is not a short-term investment of funds pending long-term commitment; and (ii) at least one day during each annual valuation period. An “annual valuation period” is an annually recurring period of not more than 90 days that begins no later than the anniversary of an entity’s initial valuation date. For example, if the corporation’s first long-term investment is made on October 3, 2015, that date is its initial valuation date. The first annual valuation period can commence as late as October 3, 2016. An annual valuation period that commences on October 3, 2016 would end onDecember 31, 2016and recur eachOctober 3 through December 31thereafter. Once an annual valuation period is established it may not be changed except for good cause.

QUESTION:

When can I begin taking a salary from the company? Purchasing, renovating, and selling a property can take a few months even if all goes well. Do I have to wait until my first flip is sold for the company to be considered to be generating revenue and then be able to take some salary from it? Is that how it works and if so, if I need to do crazy things like eat and pay my mortgage during that time, can I take a personal loan from the company similiar to taking a loan from my 401k or something like that? (Obviously I need to be very clear on this to figure out if I can last long enough to turn a profit!) .

ANSWER:

(1) You should wait to receive w-2 compensation (e.g., salary, bonuses, etc.) until the C-corporation funded with your retirement funds is generating income to justify your salary and then your salary should not be unreasonably high (i.e., no more than what the company would have to pay someone else to do all of the things that you do). Any compensation that you receive should be paid to you as W-2 wages (i.e. not as 1099 income). As such, it will be prudent to coordinate with your business tax adviser. (2) While technically you can take a 401k loan before the C-corporation commences business, the more conservative/prudent approach would be to wait until the C-corporation has commenced operations. For example, if you take a 401k participant loan and the C-corporation never commences business and ultimately the C-corporation is wound down, if there is an outstanding balance on the 401k loan at that point the loan will need to be repaid in full or considered to be a taxable distribution.

QUESTION:

How would reasonable compensation be arrived at for this type of company? Seems like comparing to other owners of similiar companies would have a swing from gazillionares to barely getting by….so where would one get acceptable metrics?

ANSWER:

What is important from a 401k perspective is that any w-2 compensation that you receive is not unreasonably high (i.e., no more than what the company would have to pay someone else to do all of the things that you do). To that end it would prudent to document your functions and any market research that you have showing how much it would cost to hire someone to perform those same functions (e.g. online salary info, etc.).

QUESTION:

 Prior to completing and selling the first flip, could company funds be used for things like training courses…required real estate license coursework and yearly renewal training, appraisal 101 for dummies etc…?

ANSWER:

The funds invested in the C-corporation can be used for legitimate business expenses.

Visit HERE to learn more about the ROBS 401k business financing rules.