Solo 401k Eligibility Requirements vs. the ROBS 401k Financing Requirements

BACKGROUND: Mike here.  We spoke and you told me about some restrictions on Real Estate investing 401’s. It truly seems like what I’m looking for is a ROBS, but will just tell you what I need to do:

To be a real estate “investor” means that I will start out wholesaling (finding, placing under contract, then assigning the contract to a buyer, or doing a “double-close”) properties.  This will result in an assignment fee as a profit.  I presume this could go back into the solo k as profit.

To invest though, I want to be a corporation, and my price to incorporate is $1995.  May I start a ROBS, or solo k as a sole proprietor? and then use funds from say the ROBS to start the incorporation process?  (There’s so much to it!!!)

ANSWER: First, it is important to take a step back and understand the solo 401k eligibility or qualification requirements. As outlined in IRS Publication 560–the publication dealing with retirement plans for the self-employed including a self-employed plan such as a solo 401k plan– you can adopt a solo 401k plan if you have net earnings (compensation) from self-employment in the trade or business for which the plan was set up. Your net earnings must be from your personal services, not from your investments. The key part of this sentence is “not from your investments.” Essentially, this means that you cannot open a solo 401k if your business only generates passive income, meaning that you are not actually doing work.
What’s more, if you meet the solo 401k opening rules and thus proceed to open a solo 401k, you may not personally benefit from any of the solo 401k investments. For example, you may not receive a commission or other type of fee resulting from the sale of a solo 401k asset (e.g., a real estate holding). Reason being, as the solo 401k owner you are considered a disqualified party and therefore may not personally benefit from the assets of the solo 401k plan.  Lastly, you may not use the solo 401k assets towards qualifying for self-employment activity in order to setup a solo 401k
QUESTION: I will eventually do some rehabs, which means contractors, etc.  May I fund them through a ROBS?  Can I roll the ROBS into an RE solo k?

ANSWER: Unlike the solo 401k which is used for investing passively in assets such as real estate, for example, the ROBS 401k plan may be used to fund one’s own business, provided the business qualifies as an operating company (by offering goods and/or services) or real estate operating company (see requirements discussed below). Further, the ROBS 401k funded company will allow you to take a salary as a W-2 employee. The ROBS transaction requires the use of a C-Corporation because the 401k buys stock shares in the C-Corporation. An S-Corporation may not be used because the S-Corporation rules do not allow Trusts as shareholders and all 401k plans fall under the trust category.

As such, if you wish to invest your ROBS 401k retirement funds in a company that will invest in real estate, the business must qualify as a real estate operating company which will require satisfying the following two conditions:

a. At least 50 percent of the assets of the corporation, valued at cost, must be invested in real estate which is managed or developed and with respect to which such entity has the right to substantially participate directly in the management or development activities.

b. Such entity in the ordinary course of its business must be engaged directly in real estate management or development activities.

To read more about the ROBS arrangement visit 401k business funding FAQs.

Compare the Self-Directed 401k vs the Solo 401k

Thanks, Mike in Virginia

About Mark Nolan

Each day I speak with energetic entrepreneurs looking to take the plunge into a new venture and small business owners eager to take control of their retirement savings. I am passionate about helping others find their financial independence. Having worked for over 20 years with some of the top retirement account custodian and insurance companies I have a deep and extensive knowledge of the complexities of self-directed 401ks and IRAs as well as retirement plan regulations. Learn more about Mark Nolan and My Solo 401k Financial >>


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