Do you have an investment goal to purchase real estate? Maybe a small apartment building, a multi-plex, or a commercial property? There are several powerful ways you can do this. One that you may want to consider is using your retirement account to fund an LLC Partnership. This keeps you and a trusted partner in control of your investment (LLC Partnership). Another is investing your retirement funds in an LLC Partnership where you have little or limited control of the investments (private placement).
Understanding LLC Partnerships and Private Placements
Most Solo 401k owners want full control of their investment decisions. This is going to make the LLC Partnership more appealing to these investors compared to a private placement in someone else’s LLC Partnership.
LLC Partnership
There are a couple of ways you can accomplish this with relative ease. Which one works best for you will depend on your preferences and investing goals. One method is having an LLC with business partners but the business partners are excluded from participating in your Solo 401k plan. (For details, see Multi-Member LLC and the Solo 401k.) This is to set up your Solo 401k but not for the purpose of an LLC Partnership making joint investments in real estate.
To make joint investments in real estate with an LLC Partnership, you and another person need to jointly fund an LLC Partnership. This is the most frequently used for investing retirement funds in an LLC Partnership to purchase real estate. Your partner’s funds can be either in their own Solo 401k or come from another source. This works as long as all transactions are tied directly back to the sources of the funds. Purchases, maintenance, rents, etc. must be split according to the percentage allocated in the LLC Partner Agreement. The ownership can be split into any percentage that works best for you and your investment partner. The ownership split could be 50/50, 60/40, 75/25, or whatever is established in the agreement. This allows you to invest with certain family members but one thing to be cautious about in the is arrangement is Solo 401k Prohibited Transactions.
Steps to Invest in Partnership for Real Estate
These are the simple steps you take to invest your retirement funds in an LLC Partnership to purchase real estate:
- Setup your Solo 401k plan.
- Fund your Solo 401k plan.
- Choose the other LLC partner(s) and establish the LLC Partnership.
- Enter into a real estate purchase agreement.
- Fund your portion of the closing by transferring funds from your Solo 401k to the LLC Partnership per the LLC partnership allocation.
Follow this link for more information about forming an LLC, including a Partnership LLC.
Private Placements
These are more complicated because private placements can involve Security Exchange Commission (SEC) rules. Private placement involves investing in another entity (business) where you may or may not have any management control over how the other business operates. It’s complicated and less common but you could invest your retirement funds in an LLC Partnership as a private placement to purchase real estate.
Both the SEC and U.S. Courts have struggled for decades to clearly define exactly what a private placement is. The definition is important because private placements generally fall outside of the control of the SEC (but not entirely). Public offerings fall within the full control of the SEC and represent what most people associate with trading stocks/bonds on Wall Street and other stock exchanges. The history of clearly defining private placement goes back to the 1946 US Supreme Court precedent in SEC v. Howey Co., 328 U.S. 293.
However, there have been several refinements since then, with many favoring independent-minded investors such as Solo 401k owners. One of the primary refinements has been to define ‘sophisticated investors’ (aka ‘accredited investors’) that have sufficient investing knowledge or experience to evaluate the risks and rewards of a particular investment. One of the most current updates is summarized in the Significant Changes to SEC Accredited Investor Definition blog from the Nabers Group. For more information about private placement investing, you may also want to read our blog about Investing Spotlight: Private Placements.
Case Study of Jesse Purchasing Real Estate Using a Solo 401k with an LLC Partnership
Jesse has opened a Solo 401k account and funded it with a $100,000 rollover from a previous employer’s 401k account. She also found a 4-plex that she wants to invest in. Jesse has heard that it makes sense, liability and privacy wise, to invest in real estate using a Limited Liability Company (LLC).
Jesse establishes an LLC Partnership outside of the Solo 401k. One of the primary reasons is that owners and members of the LLC are not liable for the debts, obligations, and liabilities of the LLC. In most cases, your retirement is your most valuable asset. Protecting personal and retirement assets from attack by creditors is essential. By using an LLC, you shield all your 401k and other assets held outside the LLC from creditor attack.
Partnership Begins
Jesse and her partner, Joe, create a 50/50 partnership in the LLC. Jesse’s Solo 401k contributes $150,000 to the LLC. Joe also contributes $150,000 to the LLC (it doesn’t matter whether Joe’s money comes from a 401k or not). The combined all-cash $300,000 purchases the 4-plex.
Each year, the property generates $50,000 of rental income. Of that, Jesse’s Solo 401k receives $25,000 and Joe receives the other $25,000. Each partnership agrees to keep $5,000 available to cover maintenance and repairs of the rental property. Jesse keeps the $5,000 of reserve money in her Solo 401k. It earns interest in a money market account (tax-free) until it is needed for the maintenance of the rental property. By year five, Jesse’s investment has earned $120,000 ($25,000 X 5 years – $5,000 reserve) and paid out $2,300 for maintenance and repairs.
An Accident Occurs
Unfortunately, in year 6, a tenant’s guest has a slip and fall accident that insurance refuses to cover. The property management company failed to clear ice from the sidewalk in a timely manner. The guest files a lawsuit against the LLC. Because Jesse used an LLC to make the investment and did not directly invest with her Solo 401k Plan, the $120,000 of Solo 401k Plan assets held outside of the LLC is shielded from creditors due to the limited liability feature of the LLC.
The LLC Partnership owned by both Jesse and Joe will be liable for anything awarded from the lawsuit, but Jesse’s $120,000 retirement account is safe. The LLC partnership will pay any claim from the reserve fund and future income. Let’s say Jesse made the real estate investment directly using her Solo 401k Plan, and not using an LLC. Her entire Solo 401k retirement plan is liable and subject to the lawsuit.
In the meantime, Jesse has reinvested $120,000 of rental income (safe in her Solo 401k) into other investments. Her retirement account is now worth $138,000. Jesse diversified her Solo 401k into other investments that included: bitcoin, real estate notes, and property tax liens. Jesse is financially secure knowing that these investments will continue generating tax-free earnings to her Solo 401k. Income from the 4 plex streams back into the LLC once the liability issue resolves.
The Solo 401k is a Secret Weapon for Real Estate Investors to Retire Wealthy
The Solo 401k (aka ‘Individual 401k’ or ‘One Participant 401k’) can make real estate investments (and other alternative investments) where gains earned by the investment won’t be taxed until distributed during retirement. Or with a Roth Solo 401k, the gains connected with the investment are tax-free when distributed at retirement.
Investing Solo 401k funds in an LLC Partnership to purchase real estate is a powerful way to leverage into high-value properties, such as apartment buildings. But much in the same way that a Solo 401k creates countless investment options, there are other ways to leverage your investment funds. Instead of a partnership, another possibility with a Solo 401k is using a non recourse loan from a non-disqualified person, such as a bank. A loan not personally guaranteed by the borrower is a non recourse loan. Therefore, a Solo 401k account can use a non recourse loan to acquire real estate.
An important difference to know between a self-directed IRA non recourse loan and a Solo 401k nonrecourse loan is that the self-directed IRA may be subject to the Unrelated Business Taxable Income (UBTI) tax. A Solo 401k is not subject to UBTI. This is another of the many advantages that make the Solo 401k a secret weapon for real estate investors.
2 Responses
How should the ownership of the LLC partnership be shown? In the name of the trust, or is the name of the trustee adequate?
We definitely recommend titling assets owned by the 401k trust in the name of the 401k trust.