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Correcting a prohibited transaction

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Under Internal Revenue Code a penalty tax is assessed equal to 15 percent of the amount involved in the prohibited transaction. After the prohibited transaction has been identified, it must be corrected immediately - certainly within the taxable year. However, if the prohibited transaction is not corrected during the taxable year, then an additional penalty tax in the amount of 100 percent of the prohibited transaction amount will apply.

Correcting the prohibited transaction means to undo the transaction to the extent possible and in any case to make good to the plan or affected account any loss resulting in the transaction, by restoring to the plan or affected account any profits made through the use of the plan assets. The plan must be placed in a financial position no worse than if the disqualified person had acted under the highest fiduciary standards (IRC Sec. 4975(f)(5) and ERISA Sec. 502(i)).

Having precious metals in my personal possession

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Can I hold precious metals that are owned by my Solo 401k Trust in a safe at home?

Answer:

No, as this would raise a number of problems. As trustee, the individual may not use plan assets for his or her own benefit. If the coins are held in the individual’s safe – that would look like a distribution from the plan. Plan assets must be held in a trust and not in the individual’s personal possession. You should use a third party depository.

IRC Section 408(m) clearly states that gold, silver, or palladium bullion must be held in the physical possession of a U.S. trustee, otherwise known as a U.S. bank or financial institution. This poses the question:  if a plan holder holds precious metals in a safety deposit box at a U.S. bank in the name of the 401k Trust, are the metals in the “physical possession” of a U.S. trustee or bank?

The argument is that the metals are being stored in the bank; they are not in the physical possession of the plan holder. Although the plan trustee controls the safety deposit box in which the metals are stored, the metals are not in the possession of the plan trustee. The metals are arguably in the possession of the bank since they are being held in the bank, although they are not in the control of the bank.

From a legal standpoint, possession is not defined by control, meaning one can be in possession of an item but not control or ownership. Hence, many tax practitioners take the position that holding metals in a safety deposit box in the name of the 401k Trust satisfies IRC Section 408(m) required of “physical possession”.

Although there is little IRS guidance on holding IRS approved coins personally, it’s fairly safe to assume that they should be in physical possession of a trustee (U.S. bank or financial institution). In fact, most tax practitioners believe they should be held by a trustee, as coins may also be bullion.

Paying for training from the Solo 401k plan

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I want to expand real estate holdings in my Solo 401k into another sector, but that would require me to take a 3-day course with someone who will be a mentor to teach me this business model in order for me to do this. My question is: can I use the cash that I have accumulated in my Solo 401k to pay for this class?

Answer:

No, you can only use your 401k funds to make investments or to pay for expenses directly related to the investments owned by the 401k. Paying for training courses or classes is a personal expense and cannot be paid out of the 401k.

Can I invest my Solo 401k funds in an Airbnb business?

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I would like to invest my Solo 401k funds in Airbnb rental units. Can I occasionally stay in one of the units? The lease would be is under my name. Is it a violation of the Solo 401k rules?

Answer:

It is allowed to invest in in rentals using Airbnb model or any rental properties with your Solo 401k funds. However, as the plan owner and a disqualified person, you cannot personally benefit from the investment. This means, if the plan owns the rental units, you and any other disqualified person cannot stay in these units. Doing so will be considered a prohibited transaction.

Since these units are owned by the Solo 401k plan, the titles and leases should be under your plan’s name. You cannot put your name on any paperwork, because doing so you will be providing a personal guarantee. This would also be a prohibited transaction.

Please also note that short term rentals are considered "active business", therefore income from this activity might be subject to Unrelated Business Income Tax. Be sure to consult with a knowledgeable CPA about tax implications for your 401k.

While you could possibly manage long term rental property in your 401k, managing short term rentals such as AirBnB would required significantly more work and likely to be considered "providing services", which is prohibited by the IRS.

Titling of assets in the Solo 401k trust

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When dealing with all plan assets, whether a bank account or a title to real property, always use the Solo 401k Trust.

  • All assets purchased by the retirement account should be titled in the name of the Solo 401k Trust
  • Always use the Solo 401k Trust EIN for any 401k transaction
  • Check the Solo 401k Trust EIN for the correct wording ("ABC 401k Plan" or "ABC 401k Trust")

The Solo 401k Trust EIN document was provided to you in your set of plan documents.

Do NOT use the EIN for your business nor your personal Social Security Number when providing a tax ID for a 401k transaction.

Example

If your 401k trust is named DBM Solo 401k Trust and investing in a note:

  • The agreement should list DBM Solo 401k Trust as the buyer
  • The title company should list DBM Solo 401k Trust as lienholder
  • Your bank accounts and/or brokerage accounts should be in the name of DBM Solo 401k Trust

For specifics of how to take the title to real estate please read Titling Real Estate in the Solo 401k Trust

What can a Solo 401(k) invest in?

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Contrary to the vast majority of 401(k)s and even some Solo 401(k)s, your Solo 401(k) from Sense Financial can invest into anything allowed by law. Our plan documents don’t place any additional restrictions on your activities. This leaves you free to invest in real estate, private businesses, mortgage notes, and more. The acquisition of traditional assets such as stocks, bonds, and mutual funds is also permissible.

The main restriction is on “self dealing” which means you cannot direct your Solo 401(k) to transact with (or benefit) you or most of your family members. Such a transaction is called a prohibited transaction.

Fixing incorrect transaction on my 401k debit card

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I opened up a bank account with a debit card for the Solo 401k account. I just realized that I gave the debit card number to a wrong vendor who has charged me twice for a personal transaction. How do I fix this?

Answer:

First, let me remind you to treat your 401k transactions with greater caution. The 401k checkbook/ debit card and the personal debit card should be clearly identified. Also, you should not carry the 401k debit card in your wallet along with your personal debit and credit card. Keeping the 401k checkbook and debit card separately would help you to avoid mistakes such as these.

Second, review the following article on how to correct the prohibited transaction:

Correcting a prohibited transaction

 

 

What is the limit of interest payments that can be deposited into my retirement account?

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I invested my Solo 401k funds in notes. When the interest payments are made, should I deposit the payments into my Roth IRA? Is it correct that I cannot deposit more than the limit of $6,500? After the interest payments add up to $6,500, should I send the interest payments elsewhere?

Answer:

First of all, all gains and profits from investing funds from the Solo 401k plan must be deposited back into the Solo 401k. If the Solo 401k plan paid for and now owns the notes, you cannot send the interest payment to any other account, even if it is your IRA. Plus, you cannot transfer funds from a regular Solo 401k account to a Roth IRA. The first only accepts pre-tax amount, while the latter takes after-tax amount only.

If your Solo 401k account owns notes and receives interest payments, all interest should be deposited into the plan. The limit you mention is contribution limit, which is different from investment earnings. Every year, you can only deposit a maximum of $6,500 into an IRA, and $54,000 into a Solo 401k account. However, once these contributions are  in the plan and earning interest, there is no limit on how much interest can be deposited. In fact, all interest amounts have to be deposited back into the Solo 401k.

Can I use the Solo 401k plan to pay for the investment expenses?

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All expenses for my rental units, including renovation and furniture cost, are paid for by the Solo 401k plan. I also made transactions from the plan to pay for check orders, personal credit check, and tax planning. Are these legitimate?

Answer:

The investment expenses should be paid for by the Solo 401k plan. However, it is important to differentiate which expenses are related to the investment, and which are personal. Renovation costs and furniture purchases are investment expenses and can be paid for by the plan, as long as the plan owns these units. You cannot use funds from the Solo 401k plan to pay for expenses of any property which you personally own or stay at.

The cost of ordering checks for your Solo 401k bank account is considered a cost related to operating the plan. Therefore, you can also use your Solo 401k plan to pay for that.

Examples of personal expenses that cannot be paid for by your retirement account are tax-planning expense and credit checks. These costs are not related to the plan operation or investment, and should be paid from your personal account.

Peer to peer lending using Lending Club

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I'd like to check with you if participating as a lender in peer-to-peer lending platform such as Lending Club will be okay in my Solo 401k. They do support opening a Self-directed IRA account, but I would like to be able to invest directly out of my 401k without opening new self-directed IRA account.

Answer:

Yes, you can invest using Lending Club platform with your Solo 401k Trust.

You will need to establish a trust account in the name of your 401k trust:

https://www.lendingclub.com/public/investment-account.action

  • Name of the trust:  Name of your 401k trust
  • Tax ID of the trust:  EIN of your 401k trust
  • Grantor:  Plan sponsor/Adopting business of the 401k

https://kb.lendingclub.com/investor/articles/Investor/What-are-Lending-Club-s-investment-account-options/?l=en_US&fs=RelatedArticle

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