Can I use my plan to construct a multifamily rental investment property- In partnership with my Defined benefit plan and myself?
In addition to outright investing a solo 401k plan in real estate where solely solo 401k funds are invested in the property, a solo 401k may partner with other investors including one’s own defined benefit plan (DBP) as well as personal funds, but specific rules apply which are discussed below.
Option 1: Tenants in Common
All investors to the transaction pool funds and take title to the property listing their percentage of ownership with each investor’s ownership to the property based on how much funds each investor invested in the property.
Example: 25/25/50 Split Between a Solo 401k, Defined Benefit Plan (DBP) and Personal Funds
How deed is recorded: John Smith, Trustee of ABC Retirement Trust, Undivided 25% Interest; John Smith, Trustee of ABC Defined Benefit Plan, Undivided 25% Interest; And , John Smith, Undivided 50% Interest
-All expenses are divided 25/25/50 among the solo 401k plan, DBP and John Smith
-Any profit is divided 25/25/50 among the solo 401k plan, DBP and John Smith
Specific Rules to Know Before Deciding to Proceed with a TIC (Tenants in Common) Transaction
All Cash: Has to be an all cash purchase- so no debt financing can be used.
Simultaneous: The real estate property has be purchased at the same time by all investors,
New Property: Can’t purchase the property from you or your business or any of your retirement plans.
Challenge: If the transaction is later scrutinized by the IRS, you must prove the investment could have been done without using your retirement accounts. See DOL Opinion Letter 2000-10A.
Option 1: Pool Funds in an Limited Liability Company (LLC)
The rules described above apply in a similar fashion when pooling your retirement funds and personal funds in an LLC instead of investing in real estate under a TIC arrangement; however, title to the property is solely taken in the name of the LLC so that make it easier from a logistics side of things.
When solo 401k funds, Defined Benefit Plan (DBP) funds and personal funds are pooled in the same LLC for investing in real estate, title to the property is taken in the name of the LLC.
For example, if the name of the LLC is LA Ducks LLC, title on the real estate deed will read LA Ducks LLC.
Similar to the TIC transaction described above, the retirement account and personal funded LLC cannot obtain a loan and the solo 401k and DBP owner and other disqualified individuals are prohibited from using the LLC owned property for personal use.
The LLC has to be funded for the first time (i.e., units cannot have previously been issued), otherwise prohibited transaction implications arise.
The LLC operating agreement must include specific language pertaining to the 401k, DBP and investment rules.
The LLC will be deemed a multiple member LLC so it will be treated as a partnership. Therefore, you will need to file a federal tax return (Form 1065 and K1’s–one for each member) on an annual basis.
The LLC will require its own bank account and EIN.