Prohibited Transactions

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.

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:

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

When I buy investment property in my Solo 401k trust, I will engage the services of a realtor.  I would like to use my wife.  I understand that many spouse transactions are prohibited.  But in this case, the seller pays the commissions so I want to confirm if that would be allowed.

Answer:

No. Your spouse is considered to be a "Disqualified Person." Your 401k is prohibited from engaging in any transaction between the plan and a disqualified person. While sales commissions will be paid by the seller and not by the 401k, your wife would be representing your 401k in this transaction, and that is not allowed.

I now have my Solo 401k Plan and would like to use 401k funds to partner with myself on investment.  How can I do that? Can I also partner with someone else's IRA or 401k?

Answer:

Your 401k can always partner with other people individually or with other people’s IRAs.  Under certain circumstances you personally may be able to partner with your 401k.  However, the burden of proving that you received no impermissible benefit from your IRA’s participation in the investment will be on you if the IRS ever questions the transaction.  The transaction still must be an arms-length transaction, and the investment remains subject to the same restrictions as if the entire investment were in your 401k.  In general it is better to separate your 401k investments from your own investments.

If you co-invest with yourself, you cannot get a non-recourse loan. A non-recourse loan is only possible if the 401k is the only investor or if it invests with other, non-disqualified parties. Once you combine personal funds, leverage is out of the equation. This is cross-collateralization and it is prohibited.

One important rule to keep in mind is to be able to partner with your 401k you must have no NEED to do it. Meaning if you can do the deal without the 401k you can partner with it and if the 401k can do the deal without you then it can partner with you. So basically the main reason people want to partner with the 401k (to be able to use "all" your money to do a deal that you might not be able to otherwise) is an exclusion.

Such transaction is also known as "enabling" and is prohibited. Enabling means using IRA/401k funds to enable a personal investment (or vice versa). If you are ever audited you will be asked to prove you did not need personal fund to make the investment - that you had enough cash in your retirement account that you could have used, but chose to use personal funds to include it in a good investment opportunity.   If, on the other hand, you've pulled together all cash in your retirement account and are still short of the amount needed, so are using your personal funds to cover that gap, then it would be considered enabling.

If enabling is a non-issue, there are a couple of other things to keep in mind:

1. Expenses generated by the property must be paid proportional to ownership.  If there is a tax bill due, the bill has to be paid by you and your IRA/401k, proportional to ownership percentages.  Similarly, any income generated by the property need to be split proportionally between you and your IRA/401k ownership.  If you don't have a property manager collecting the rent, your tenants will have to write out TWO rent checks each month - one to you and the other to your IRA/401k.
2. You and any disqualified parties are prohibited from using the property, living in the property, or making any repairs or doing maintenance or upkeep on the property.  You'll need to hire outside vendors for these items.
3. You will not be able to obtain financing to acquire this property, it must be paid in cash.

Now that I have my Solo 401(k) Trust set up, I would like to move investment properties that I personally own into my Solo 401(k) yearly, of course, taking into value the maximum contribution per year. What is the procedure to move properties into my Solo 401(k) instead of contributing in cash form?

Answer:

You are considered a Disqualified Person to your 401(k). Therefore what you described above is a Direct Prohibited Transaction:

"4975(c)(1)(A): The direct or indirect sale, exchange, or leasing of property between a Solo 401k Plan and a Disqualified Person"

Be sure that you have a good understanding of Prohibited Transaction. Violation of the rules will result in your entire account deemed distributed.

There are many financial experts who adamantly state that qualified plans funds (e.g., 401k) should never be used to purchase life insurance. Although it is restricted, you could use your Solo 401k to invest in life insurance. This makes sense in the following cases:

• You may not otherwise qualify for life insurance because of health reasons;
• You don’t have other disposable funds; or
• Your want more protection for your beneficiaries.

If you are interested in purchasing life insurance with your Solo 401k, note the following:

General guidelines for investing in life insurance with Solo 401k

In general, no more than 50% of Solo 401k or Individual 401k plan contributions may be used to purchase “whole” life insurance (i.e., policies with both nondecreasing death benefits and non increasing premiums), and no more than 25% may be used to purchase term life insurance.

Different treatment for Solo 401k contributions used to purchase life insurance

When a self-employed business owner invests her Solo 401k in life insurance, he does not receive a tax deduction for Solo 401k contributions attributable to the purchase of a life insurance benefit.

Ownership of life insurance policies

The Trustee of the Solo 401k is the owner of any life insurance policies purchased under the Solo 401k plan. Further, any life insurance policy purchased under the Solo 401k Plan must designate the trustee as owner and beneficiary under the policy. The insurance premiums are paid with funds from the Solo 401k’s checking account.

Reasons not to invest Solo 401k plan assets in life insurance

Although IRC 501(a) provides tax-exempt status to a qualified plan, including a Solo 401k, resulting in tax-deferred investment accumulation on the Solo 401k plan assets, a life insurance vehicle is tax-deferred on its accumulation outside of the plan as well. As such, the assets in the Solo 401k plan that are used to purchase life insurance are not getting any special income tax benefit on the accumulation in the contract by being held in the Solo 401k plan. The purchase of life insurance will reduce the amount available for investing in other assets such as real estate. Although life insurance may have an investment element (i.e., cash value accumulations), you may be foregoing higher returns by not investing all your Solo 401k plan in other investments.

This information is provided is for educational purposes and it is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice.  One must always consult with their respective professional in all such matters.