Background:
When a solo 401k invests in a promissory note, the note can be structured as secured or unsecured. If secured, the solo 401k promissory note investment is generally secured by some form of physical real estate such as vacant land, vacant lot or physical property.
By investing in a secured promissory note, the solo 401k can take over the property securing the note investment in the event of default.
QUESTION:
I invested my solo 401k in a promissory note secured by a vacant lot and the borrower defaulted on the loan, resulting in my solo 401k plan now owning the vacant lot. The land has entitlements to be developed into 16 units. Can I sell the solo 401k owned land to an unrelated developer, and the solo 401k plan receive the proceeds from the sale of the units?
ANSWER:
When the now solo 401k owned land is sold to an unrelated party (in this case a developer), the proceeds from the sell flow back to the solo 401k plan and continue to grow under the tax sheltered umbrella.
On the other hand, if the solo 40k trustee decides to have the solo 401k owned land developed, the following solo 401k rules apply:
A Solo 401k cannot run a business out of the 401k such as a real estate development company.
Running a business could be challenged as a prohibited transaction or the income your Solo 401k receives could be subject to Unrelated Business Income Tax (typically 40% tax rate)
If the Solo 401k were to partner with a developer in the form of an LLC, the following would apply:
The Solo 401k would contribute the land, which is owned free and clear to the LLC for units.
The Solo 401k would need to a minority owner of the LLC (own less than 50% of the LLC).
The Solo 401k cannot be a General Partner; Any other partner/investor must be an unrelated person (e.g. cannot be the solo 401k participant personally).
The Solo 401k would need to be strictly a passive investor only and you could not work on the development.
Any construction loan or debt would need to be obtained by the developer and there could be no recourse to the solo 401k or the solo 401k participant personally.
The solo 401k participant cannot personally guarantee any loans to the LLC.
Another is to Sell the Property to a developer and the Solo 401k maintaining a portion of the equity. The solo 401k owned property can be sold to a developer for both cash and equity in the development. The 401k would retain the equity and any additional returns from the sale of the development would-be deposited to the Solo 401k. However, it would be prohibited fro the solo 401k participant to acquire any equity ownership personally.
