Plan Asset Rules: Read This Before Investing Your Retirement Funds!

by | BiggerPockets.com

When it comes to your retirement accounts, you don’t just to answer to your pals at the IRS. Whether you know it yet or not, you’ve got buddies at the Department of Labor (DOL), too. The Department of Labor’s Plan Asset Rules were made to limit you from using retirement funds to transact with your own investment funds or assets.

The Plan Asset Rules list the circumstances which cause assets owned by an entity (such as an LLC) to be deemed assets of a 401K or an IRA. Under the Plan Assets Rules, if your account owns more than a quarter of an “investment” company, the profits and assets of that entity are considered assets of your IRA or 401K. This concept is frequently referred to as the look-through rule.

In plain English, this means that if your IRA owns a quarter or more of the membership interests of a business structure that invests in “traditional” things like mutual funds, bonds, hedge funds, or any other similar types of investing options available to the public, the assets of the company can reasonably be considered the property of the retirement account.

Why does this matter for you as a real estate investor? Well, real estate is a passive investment that would be covered by the rules in the previous paragraph. In short, any exchange involving your real estate LLC and someone who isn’t allowed to participate (more on this below) will be a prohibited transaction. Prohibited transactions come with hefty penalties. Of course, this is a scenario you don’t want to find yourself in. Unless, of course, you derive some bizarre masochistic pleasure from handing over extra money to the taxman.

What Are the Plan Asset Rules?

The DOL’s Plan Asset Rules define what types of assets are considered “Plan” assets. Because IRAs are usually viewed as pension plans, they are governed by the Plan Asset Rules. You may control your IRA, but you don’t own it. The Man does.

The Plan Asset Rules will come into play if:

  • All of an “operating company” is owned by any combination of IRAs or 401Ks — or even in part by someone who is disqualified. If this happens to you, the company’s assets become plan assets. That means, they officially belong to the IRA or 401K.
  • One-fourth or more of an “investment company” is owned by those same types of retirement accounts and anyone who isn’t allowed to per disqualification rules. If this happens to you, the same consequences apply as in the first scenario. When the DOL is figuring out whether the one-fourth limit is met or passed, they take all plan owners into consideration. This holds true even if the owners aren’t related.

Ways Around the Plan Asset Rules

There are several exceptions that can cause the Plan Asset look-through rules to not apply. For instance, if the entity is an operating company, this can be an exception. Similarly, if partnership interests or membership interests are available to members of the general public, this may also exempt you from Plan Asset Rules. If that’s a lot of legalese to wrap your head around, don’t worry. I’ll break down this information below.

For exception purposes, an “operating company” refers to a partnership, LLC, or other business structure in which the main goal and method of money-making is via venture capitalism, real estate investments, or making or providing goods and services. This last category can include everything from fast-food joints to car washes. But if the operating company is 100 percent owned by a Plan and/or disqualified persons, the exception doesn’t apply.

Related: Beyond Prohibited Transactions: The Plan Asset Rule

In other words, if one — or any combination of — your retirement accounts owns less than 100 percent of an LLC that is engaged in an active trade or business (such as a coffee shop or clothing store) you can’t be hung out to dry based on Plan Asset Rules.

However, the IRA or 401K investment may still be treated as a prohibited transaction. Let’s not forget the threat of Unrelated Business Taxable Income (UBTI). UBTI is the penalty that discourages prohibited transactions. This may apply to the earnings or profits directly made from the business.

How Can the Plan Asset Rules Impact my Retirement Plan’s Investments?

The Plan Asset Rules are often only triggered if your IRA/401K assets will own greater than one quarter of a passive investment company (see above for examples) — or will own the entirety of an operating company (restaurant, boutique, nightclub, etc.).

Most investments involving IRA/401K funds will not kick in the Plan Asset Rules. This means you won’t be running afoul of prohibited transactions or be hit hard with the subsequent UBTI. For example, any direct purchase of real estate, commodities like gold or silver, or lending transactions to a qualified individual will not likely trigger these rules or their steep penalties.

There are ways to lend to disqualified individuals without steep penalty. As long as someone who isn’t clearly barred from being involved in a transaction with the investment entity, you’re still in the clear. Why? Because even if the Plan Asset Rules kick in, the prohibited transaction rules and penalties won’t.

Consequences of a transaction falling under the Plan Asset Rules can be quite serious. If your self-directed IRA LLC or 401k investment involves an investment that violates the Plan Asset Rules, you’re going to have a rough time. First, all assets of the entity will now be owned by the IRA/401K. This means all transactions between the company, its capital, and the disqualified individuals we’ve been discussing would be prohibited. That’s where the UBTI comes in — just to make matters more difficult.

Plan Asset Rules in Action: Some Examples

To clarify how these concepts might work in the real world, here are three examples that illustrate some common real-life scenarios involving the Plan Asset Rules.

Example 1

Your self-directed IRA LLC invests in Chase Bank. The plan is to purchase a convenience store. Using the definitions at the beginning of this article, this counts as an operating company. You will take an annual salary of $18 per hour to run the store, because it’s hard work, after all. Let’s say this only adds up to $40,000 for the whole year: You cannot pay yourself out of your IRA LLC.

Why? Because paying yourself, even for a legitimate salary, would be a prohibited transaction. The Man calls this “self-dealing,” and it’s a big no-no. This means the income you’ve worked for could be subject to a hefty tax.

Example 2

Imagine you’re a partner in a hedge fund and wish to invest your self-directed IRA LLC in the hedge fund you manage. If the percentage of IRA ownership hits or passes the bright red line of one-fourth the profits or interests, then that mutual fund’s assets now revert to the IRA. The first consequence you’ll face is being branded “disqualified.”

And that just sets the ball rolling. After that point, any exchange of cash between you and the fund could be declared prohibited because the assets of the fund are viewed as assets of your IRA. You may remember from earlier that once you’re disqualified, you can’t make any exchanges between your plan or the assets it’s holding.

You cannot receive benefits from your IRA investment into the fund. So you would not be permitted to receive any salary or earnings. Again, this comes back to prohibited transactions: because of the IRAs involvement, you aren’t allowed to pay yourself out or otherwise receive any direct personal benefit from your IRA-owned assets or accounts.

Related: Great Portfolios Don’t Happen by Chance: Here’s How to Put Together Your Plan

Example 3

Bill’s self-directed IRA LLC owns 15 percent of Excellent Adventure LLC, an investment company. Ted’s IRA owns 20 percent of Excellent Adventure LLC. Bill and Ted, while both excellent, are a couple of single guys with no blood connection. Since their combined plans own over a quarter (35 percent to be precise) of Excellent Adventure LLC, an “investment company,” assets of Excellent Adventure LLC are considered Plan Assets and, you guessed it, now the property of each of their individual IRAs.

So, if Excellent Adventure LLC makes a loan to Bill’s dear sweet mother, the loan would be a prohibited transaction. The result, as you have likely gathered by now, wouldn’t be excellent for anyone involved.

As a bonus to those of you who’ve made it this far into this article, here’s a video that gives even more tips for protecting your IRA:

Avoiding prohibited transactions is just the first step. Watch now to learn more ways to protect your IRA.

Hopefully this clears up the basics of the Plan Asset Rules that you will need to know as an investor and an eventual retiree.

Do you have any questions about the information here?

Ask them in the comments below!

About Author

Scott Smith

Scott Smith helps clients nationally and internationally from his office in Austin, Texas. With over 5 years experience in the litigation, Scott works on proactively building defense in anticipation of future lawsuits for real estate investors. Scott is one of the few attorneys in the nation that structures companies for maximum protection with minimum taxes.

What You Want the Text to Say

2 Comments

    • Scott Smith

      So glad those helped you out! Yes, these rules can seem very abstract without clear examples. Feel free to ask any questions if there’s anything in the article that didn’t make sense to you. Thanks for checking it out!

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here