Can I use my Solo 401k plan to acquire a business? Can I run it myself?

Answer:

This is a two part question so I will provide a two part answer.

First, all retirement plans, according to the IRS rules, are to be invested passively. When you use your 401k to invest in an active business, the income from this business activity will be subject to Unrelated Business Income Tax of 40% inside of your retirement account. Your 401k (not you personally) must file a special tax form to report this income and pay the taxes. Then, when you take a distribution, you will be paying income tax as well. Be sure to consult with a qualified tax professional to fully understand all tax consequences if you are considering this direction.

Second, if you invest in a business with the 401k, you will not be allowed to run it yourself.  Doing so would violate the prohibited transaction rules and would incur severe penalties.

Can I receive income personally from my Solo 401k investment?

Answer:

No. This violates the prohibited transaction rules.  The main purpose of these prohibited transaction rules is to prevent you from benefiting from your Solo 401(k) without paying taxes.  401k plans have special tax benefits that allow us to save and invest money for retirement. Because of this singular purpose, there are restrictions on what can be done with this tax-favored money before retiring and taking the money out in the form of a distribution.

Keep in mind that you are the first person on your list of disqualified persons.  Although you are able to manage your 401(k) plan, you cannot benefit yourself with any of these investments or their returns.  All retirement account investments must be for the benefit of the retirement account.

Things you can do

Solo 401(k)s can be used to make passive investments for the purpose of benefiting and growing the Solo 401(k).  There are many more investments you can make than there are investments you cannot make.  Simply put, you can do anything that is not illegal.

Things you cannot do

You cannot engage in prohibited transactions with your Solo 401k.  Examples include:

• Buying an asset with the Solo 401(k) from a disqualified person
• Selling an asset in the Solo 401(k) to a disqualified person
• Extending credit to a disqualified person
• A disqualified person extending credit to the Solo 401(k), such as
  • You guaranteeing a loan made to your plan
• Pay any disqualified person for work done on plan-owned assets, such as
  • You receiving income for managing real property in your Solo 401(k)
  • Paying your mother or son or daughter-in-law to mow the lawn on Solo 401(k)-owned property
• Investing 401(k) funds into your business (or the business of any other disqualified person)
  • Note: There is an exemption for participant loans that works well for this situation
    
• Run a business owned by your plan

It is helpful to understand the reason behind prohibited transaction rules when you are making investments.  Ask yourself, “Who do I intend to benefit with this investment?”  If your motives aren't clearly for the benefit of the retirement account, not only might you be making a bad investment for the account, but you also might be breaking the law.  Steer clear of these prohibited transactions.

Can I manage properties owned by my retirement account? And if so, what can I do and not do when it comes to managing my property?

Answer:

The answer is going to be vague as there are no clear cut guidelines when dealing with prohibited transactions. There are different views on this issue.

If you are paid for your services by your retirement account, that would clearly be a prohibited transaction. However, even without payment, there would still be a concern that you are receiving indirect compensation because you are performing services that would otherwise have to be paid for. On the other hand, it can be argued if you are performing minimal services, e.g. collection of rent, etc., it should not be considered at the level of a prohibited transaction.

Unfortunately, you will not know this until the IRS/DOL walks in the door and tries to find a problem. It depends on how conservative you wish to be. However, if you do decide to manage the property, you should not receive compensation for your services as a manager.

The easiest way to think of managing your account AND any property you buy is this: white collar activity is fine; blue collar activity is prohibited.

For your plan, white collar activity would include:

• Managing your account
• Making transfers
• Consulting your accountant
• Writing checks
• Paying bills

As long as you are not reimbursing yourself for the above activities, you are fine.

The same holds true for the properties your plan may own. You can hire and negotiate with contractors, you can fire them when they don't perform, etc. You can place ads in the Penny Saver and Craig's List.  (Note that if you buy ads anywhere, the money must come from your 401(k) Plan). You can screen tenants, collect rent, and do evictions. Consequently, your 401(k) can hire a property manager, and you can then interact with the property manager the same way you do your contractors.

You cannot participate in blue collar activity for your 401(k) investments.  For example, you cannot paint the property personally, fix the plumbing, mow the lawn, or any other repair or maintenance activities. These would be considered Non-Cash Contributions to the plan, and they are restricted.

Remember: white collar activity is fine; blue collar activity is prohibited.