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Solo 401(k) for Real Estate FAQs

What is a Solo 401(k)

A Solo 401(k) plan is not a new type of retirement plan. It is a traditional 401(k) plan covering only one employee. In general, to be eligible to establish a Solo 401(K) plan, one must be self-employed or have a small business with no full-time employees (over 1000 hours during the year) other than a spouse or other owner(s).

 

As the name implies, the Solo 401(k) plan is an IRS-approved qualified 401(k) plan designed for a self-employed individual or the sole owner-employee of a corporation. It works best when there are no other employees or a very small number of employees. 

What is a Roth Solo 401(k) Plan?

Employers can also establish a special type of 401(k) plan called a Roth 401(k). This plan is like a traditional 401(k) plan in that it allows employees to defer salary into the plan. A Roth solo 401(k) plan is not a separate 401(k) plan but simply a Roth component built into the solo 401(k) plan. The difference relates to the tax treatment. Contributions to traditional 401(k) plans are tax deductible, contributions to Roth 401(k) plans are not tax deductible. Whereas the tax benefits for Roth 401(k)s come when you take distributions, which will be tax-free so long as certain requirements are satisfied (a Roth account was opened up at least 5 years and the individual is over the age of 59/12). The IRA Financial Group’s Solo 401(k) Plan allows for Roth-type contributions.

What are the eligibility requirements for a Solo 401(k) Plan?

A Solo 401(k) plan is well suited for businesses that either do not employ any employees or employee certain employees that may be excluded from coverage. A Solo 401K plan is perfect for any sole proprietor, consultant, or independent contractor. To be eligible to benefit from the Solo 401(k) plan, investor must meet just two eligibility requirements:

 

  1. The presence of self-employment activity.
  2. The absence of full-time employees.

 

The business owner and their spouse are technically considered “owner-employees” rather than “employees”. The following types of employees may be generally excluded from coverage:

  • Employees under 21 years of age
  • Employees that work less than a 1000 hours annually or three consecutive years of 500 hours or more
  • Union employees
  • Nonresident alien employees
Can I Buy Real Estate with a Solo 401(k)?

The Solo 401(k) plan documents essentially control what a solo 401(k) plan can invest in.  Not all solo 401(k) plans are the same.  For example, only a Self-Directed Solo 401(k) plan will allow you to buy real estate with your plan funds.  Whereas, a solo 401(k) plan provided by a traditional financial institution, such as Vanguard, would not permit the plan to invest in alternative assets, such as real estate/

 

When it comes to making investments with a self-directed solo 401(k), the IRS generally does not tell you what you can invest in, only what you cannot invest in.  The types of investments that are not permitted to be made using retirement funds are outlined in Internal Revenue Code Sections 408 and 4975.  These rules are generally known as the “Prohibited Transaction” rules.  Other than collectibles, and transactions that involve or directly or indirectly benefit the plan participant or a “disqualified person,” one can use their 401(k) to make the investments.  A “disqualified person” is generally defined as the plan participant and any of his or her lineal descendants and any entities controlled by such persons.

Hence, so long as the plan documents allow for real estate investments and the real estate investment does not directly or indirectly benefit a “disqualified person,” real estate is a permissible solo 401(k) investment.

Can I use Roth Solo 401(k) funds to buy real estate?

Yes.  The IRA Financial self-directed solo 401(k) plan will allow a Roth solo 401(k) to buy real estate.  The advantage of using a Roth solo 401(k) plan to buy real estate, is that once the plan participant is over the age of 591/2 and the Roth 401(k) has been opened at last 5 years, all Roth solo 401(k) distributions will be tax-free.

How Real Estate Investors Can Reduce Taxes & Maximize Savings with a Solo 401(k)?

The Solo 401(k) can help real estate business owners generate tax deductions as well as sock away a significant amount of money each year.

Under the 2024 solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum annual employee deferral contribution in the amount of $23,000 ($22.500 for 2023). That amount can be made in pre-tax, after-tax or Roth. On the profit-sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) annual profit-sharing contribution based on the amount of the net Schedule C amount or W-2, as applicable, up to a combined maximum, including the employee deferral, of $69,000 ($66,000 for 2023).

For plan participants over the age of 50, an individual can make a maximum annual employee deferral contribution in the amount of $30,500 for 2024 ($30,000 for 2023). That amount can be made in pre-tax, after tax, or Roth. On the profit-sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) annual profit-sharing contribution based on the amount of the net Schedule C amount or W-2, as applicable, up to a combined maximum, including the employee deferral, of $76,500 for 2024 ($76,500 for 2023).

Why Buy Real Estate in a Solo 401(k)?

Below are the main advantages of investing in real estate with retirement funds:

Tax-Deferral: In general, all income and gains from a Solo 401(k) real estate investment will be tax-deferred or tax-free in the case of a Roth Solo 401(k) IRA.

Inflation protection:  Having the ability to invest in certain hard assets, such as real estate is viewed as a good way to protect your retirement account from inflation since real estate is a hard asset and rental income can generally be adjusted annually to consider an increase in inflation.

Diversification: Most American’s savings are tied to the stock market. Investing in alternative assets, such as real estate offers your retirement accounts a great way to diversify from the equity markets and gain access to a hard asset that can offer steady cash flow as well as asset appreciation. 

Hard Asset: Real estate is a tangible hard asset that you can see and touch. For some, that’s important psychologically especially in times of financial instability, inflation, or political or global upheaval.

How real estate investors can borrow from their Solo 401(k) plan tax-free?

With a Solo 401(k) plan, you can borrow up to $50,000 or 50% of your account value, whichever is less.  The loan can be used for any purpose, including finding a real estate project or helping build your real estate business. The solo 401(k) loan must be paid back at least quarterly over five years.  The lowest interest rate allowed for the loan is the Prime interest rate, which as of January 25, 2024, is 8.50%.   For many small businesses, the 401(k)-loan feature is very attractive and can come in quite handy when there is a cash flow crunch.

What type of IRA funds can be used in a Solo 401(k) for real estate?

All pre-tax IRA funds, such as a traditional IRA, SEP IRA, and SIMPLE IRA can be rolled over tax-free to a solo 401(k).  Once the solo 401(k) has been funded with the rollover, the plan can then use those funds to buy real estate.

 

Can I use my employer 401(k) plan to fund a Solo 401(k) for real estate?

You are permitted to roll over your 401(k) plan assets into a self-directed solo 401(k) without tax or penalty. However, you must have a plan triggering event to move funds out of a 401(k) plan. In general, you need a triggering event to roll funds out of a 401k plan, which typically consists of one of the following: (i) you are over the age of 591/2, (ii) you leave your job, or (iii) the company terminates the plan. If funds are rolled directly from a 401(k) plan to a solo 401(k) there is no tax or penalty. 

Is a Solo 401(k) Plan subject to the same UBTI rules as a Self-Directed IRA LLC?

 

Yes and No.

The type of income that generally could subject a Solo 401(k) to UBTI or UBIT is income generated from the following sources:

  • Income from the operations of an active trade or business – i.e. a restaurant, gas station, store, etc.
  • Business income generated via a passthrough entity, such as an LLC or partnership
  • Using margin on a stock purchase
Am I subject to UBTI Tax on Unrelated Debt Financed Income in a Solo 401(k) Plan?

No. Unlike a Self-Directed IRA LLC, when a Solo 401K Plan uses nonrecourse leverage to purchase real estate that is leveraged, it is exempt from paying any Unrelated Business Taxable Income (UBTI) tax on the income or gain generated.  Whereas, when an IRA buys real estate that is leveraged with mortgage financing, it creates Unrelated Debt Financed Income (a type of Unrelated Business Taxable Income) on which taxes must be paid. A Solo 401(k) plan is exempt from UDFI under Internal Revenue Code Section 514(c)(9).

Why does the UBTI Exemption for Using Leverage in a Solo 401(k) Apply to 401(k) Plans and Not IRAs?

When Internal Revenue Code Section 514(c)(9) was enacted in 1980, it applied only to qualified pension, profit sharing, and stock bonus plans, but its scope was broadened in 1984 to include schools, colleges, and universities. The provision brings the history of Internal Revenue Code Section 514 full circle by exempting some organizations, such as 401(k) Qualified Plan, from tax on income from the very sort of leveraged real estate deals that provoked the enactment of the predecessor of Internal Revenue Code Section 514 in 1950. As per the legislative history, the only reason given in the committee reports for the exemption is that some people wanted it: “Trustees of these plans are desirous of investing in real estate for diversification and to offset inflation. Debt-financing is common in real estate investments.”

How does IRC Section 514(c)(9) exempt 401(k) plan from tax on using leverage?

Under Code Section 514, if an exempt organization, such as a charity or a retirement account, owns “debt-financed property,” some portion of each item of gross income from the property, and a like portion of all related deductions, are included in unrelated business taxable income. Property is debt-financed if it is held for the production of income, its use is not substantially related to the organization’s exempt purposes, and there is acquisition indebtedness with respect to the property. Because a retirement account does not have an exempt purpose like a charity, all debt financed income generated by the IRA or 401(k) investment would be potentially subject to the UDFI rules.

 

The term “acquisition indebtedness” generally includes any liability incurred before, contemporaneously with, or after the acquisition or improvement of the property if it arose because of the acquisition or improvement or if the need for the indebtedness was foreseeable at the time of the acquisition or improvement

 

However, under Code Section 514(c)(9) an exemption to the UDFI rules exist for a 401(K) plan that satisfies the following conditions:

 

 Except as provided in subparagraph (B) of Code Section 514, as per Code Section 514(c)(9)(A), the term “acquisition indebtedness” does not include indebtedness incurred by a qualified organization (a charity or a retirement account) in acquiring or improving any real property. For purposes of this paragraph, an interest in a mortgage shall in no event be treated as real property.

Code Section 514(c)(9)(B) holds that the exception to the UDFI would not apply if:

  • the price for the acquisition or improvement is not a fixed amount determined as of the date of the acquisition or the completion of the improvement.
  • the amount of any indebtedness or any other amount payable with respect to such indebtedness, or the time for making any payment of any such amount, is dependent, in whole or in part, upon any revenue, income, or profits derived from such real property.
  • the real property is at any time after the acquisition leased by the qualified organization to the person selling such property to such organization or to any person who bears a family
  • the real property is acquired by a qualified trust from, or is at any time after the acquisition leased by such trust to, any person who—
  • bears a relationship which is described in subparagraph (C), (E), or (G) of section 4975(e)(2) to any plan with respect to which such trust was formed, or
  • bears a relationship which is described in subparagraph (F) or (H) of section 4975(e)(2) to any person described in subclause (I);
  • any person described in clause (iii) or (iv) provides the qualified organization with financing in connection with the acquisition or improvement; or

(vi) the real property is held by a partnership unless the partnership meets the requirements of clauses (i) through (v) and unless—

  • all of the partners of the partnership are qualified organizations,
  • each allocation to a partner of the partnership which is a qualified organizationis a qualified allocation (within the meaning of section 168(h)(6)), or
  • such partnership meets the requirements of subparagraph (E).

 

The above portion of Code Section 514(c)(9) that was put in bold was done for the purpose of illustrating that a 401(k) or solo 401(k) that invests in a real estate partnership that has acquisition indebtedness would be able to avail themselves of the exemption under 514(c)(9) so long as the partnership allocation is a qualified allocation. As per Code Section 168(h), the term “qualified allocation” means any allocation to a tax-exempt entity which— (i) is consistent with such entity’s being allocated the same distributive share of each item of income, gain, loss, deduction, credit, and basis and such share remains the same during the entire period the entity is a partner in the partnership, and (ii) has substantial economic effect within the meaning of section 704(b)(2).

 

Therefore, a 401(k) or a solo 401(k) can be a partner in a partnership with non-retirement account owners and still qualify for the UBTI exemption under Code Section 514(c)(9) so long as the allocation of income, gains, or losses is qualified.  Note – Code Section 514(c)(9)(vi), which is bolded above, uses the term “or” versus “and” when identifying the three requirements for a partnership holding real estate to be covered by the UBTI exemption under 514(c)(9).  It is for this reason, that using a 401(k) or a solo 401(k) to invest in a real estate partnership using leverage is so tax-beneficial. If the same investment was done with a self-directed IRA, the IRA could be subject to up to a 37% tax on a portion of the income or gains from the real estate partnership.

What do I need to know about the Solo 401(k) real estate leverage exemption?

Internal Revenue Code (“Code”) Section 514 requires debt-financed income to be included in unrelated business taxable income, also known as UBIT or UBTI.  For self-directed IRA or 401(k) investors seeking to use retirement funds to invest in real estate investment funds, the UBIT tax becomes a major investment hurdle.  However, an exemption to the UBIT tax exists under Code Section 514(c)(9) for 401(k) plans, but not IRAs. 

Does the IRA Financial Solo 401(k) Plan allow for Roth Contributions?

Yes. The IRA Financial Solo 401(k) Plan allows participants to elect to treat contributions under the plan that would otherwise be elective deferrals, employer profit sharing, or after-tax contributions as Roth.

Using a Solo 401(k) Plan, what type of transactions may trigger the UBTI tax?

In general, most passive investments that your Solo 401(k) Plan might invest in are exempt from UBTI. Some examples of exempt type of income include: interest from loans, dividends, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate.

The type of income that generally could subject a self-directed Solo 401(k) plan to UBTI or UBIT is income generated from the following sources:

  • Income from the operations of an active trade or business – i.e. a restaurant, gas station, store, etc.
  • Business income is generated via a passthrough entity, such as an LLC or partnership.
  • Using margin on a stock purchase
What is the UBTI tax rate?

Internal Revenue Code Section 511 taxes “unrelated business taxable income” (UBTI) at the rates applicable to corporations or trusts, depending on the organization’s legal characteristics. Generally, UBTI is gross income from an organization’s unrelated trades or businesses, less deductions for business expenses, losses, depreciation, and similar items directly connected therewith. A Solo 401(k) Plan subject to UBTI is taxed at the trust tax rate because an IRA is considered a trust. For 2024, a Solo 401(k) Plan subject to UBTI is taxed at the following rates:

  • $0 – $2,900: 10%
  • $2,901 – $10,550: 24%
  • $10,551 – $14,450: 35%
  • $14,451+: 37%
What are some of the factors the IRS or the Courts may consider when determining whether a real estate transaction may be subject to UBTI?

In general, the determination of whether a transaction or series of transactions involving a solo 401(k) plan will trigger the unrelated business taxable income (UBTI) tax is based on the facts and circumstances.  The maximum tax rate for UBTI is 37% so it is important to have a good handle on whether the tax could be triggered.

In general, the following the IRS and the courts will look at the following factors to determine whether the retirement account transaction triggered the UBTI tax:

  • Frequency of transactions
  • Level of continuity
  • Level of improvement
  • Intent
  • The proximity of sale to purchase
  • The purpose for which the asset was acquired
  • Personal activities of the taxpayer
What are the tax filing requirements for UBTI?

In computing UBTI, a specific deduction of $1,000 is permitted. If a Solo 401(k) Plan has gross UBTI of $1,000 or more during its fiscal year, it must file a completed IRS Form 990-T to report such income and pay any tax due. Form 990-T is due at the same time as Form 990; however, if the Solo 401(k) Plan expects its annual UBIT (after certain adjustments) to be $500 or more, then it must make estimated tax payments throughout the year. Form 990-T is not subject to public disclosure like Form 990.

Can I convert a 401(k) Plan to a Roth 401(k) Plan?

Yes. The Small Business Jobs Act of 2010, signed by President Obama contained a little-known provision, which went to effect on Sept. 27, 2010, allowing for the conversion of a traditional 401(k) or 403(b) account to a Roth in the same plan if the plan documents include this option. The IRA Financial self-directed Solo 401(k) plan documents allow for after-tax contributions and Roth conversion options.  Note – Roth conversions are subject to income tax.

Can I do a Roth conversion of real estate in a Solo 401(k) plan?

Yes. One can convert real estate in a solo 401(k) plan.  The tax on the conversion would be based on the fair market value of the real estate.  The amount of the Roth conversion would be added to the federal income tax return of the plan participant on IRS Form 1040.  Note – there are strategies to \use a discounted Roth conversion strategy to potentially reduce the taxable impact of the conversion.

How do I title real estate in the case of a Solo 401(k)?

In general, the following would be the way a Solo 401(k) would take title to real estate owned by a solo 401(k) plan:

John Doe Trustee of the ABC LLC 401(k) Plan

Can I take a distribution of real estate from my Solo 401(k)?

Yes.  So long as you are over the age of 591/2 or you close your plan, you will have a triggering event and will be eligible to take a distribution of the real estate from the plan.  Note – if the real estate is owned by pre-tax solo 401(k) funds, the distribution would be subject to tax.  Whereas, if the real estate is owned by the Roth portion of the plan, the distribution would be tax-free so long as the plan participant is over the age of 591/2 and the Roth has been opened at least 5 years.

How can I use the real estate in my Solo 401(k) plan?

Technically one cannot derive any personal benefit from any real estate owned by a retirement account. However, if the real estate was owned by a Roth solo 401(k) plan, once the plan participant was over the age of 591/2 and the Roth 401(k) was opened at least 5 years, the plan participant can take the Roth solo 401(k) plan owned real estate as a tax-free distribution.

Why Should I Choose IRA Financial to Set-up My Solo 401(k)?

IRA Financial “literally” wrote the book on the self-directed Solo 401(k).  Our founder, Adam Bergman, Esq, has written 8 books on self-directed retirement plans and over the last 15+ years has helped over 24,000 self-directed clients invest over $3.2 billion in alternative assets.  IRA Financial is the leading provider of self-directed solo 401(k) plans with “checkbook control.  Our expertise and experience in designing and customizing solo 401(k) plan solutions for entrepreneurs and small businesses are unmatched.

IRA Financial’s Self-Directed solo 401(k) solution is specifically designed and customized for each type of investment.  Whether it is real estate, private equity, venture capital, hedge fund, private business, cryptos, precious metals, hard money loans, or much more, our solo 401(k) tax experts will work with you to design the perfect self-directed solo 401(k) plan solution for your business and investment goals, including tax optimization, Roth maximization, and UBIT protection.  Additionally, IRA Financial is the only self-directed retirement company that provides annual consulting, IRS tax reporting/filings, BOI FinCEN reporting, and a full IRS audit guarantee.