[Originally published at JeffNabers.com.]
There’s something that most “successful” Self-Directed Solo 401(k) investors do that can spin them out of control and get them into trouble. I say “successful” in quotation marks because I’m talking about the particular kind of Self-Directed Solo 401(k) success that is sexy enough to be frequently written about. What is this dirty deed that leads to massive profits and the potential implosion the very same Self-Directed Solo 401(k) that got those profits? Entrepreneurship.
Yep. Entrepreneurship is so powerful that it seems to be the source of all aggressive wealth creation. So where’s the danger? Let me explain. Some of the most [initially] profitable Self-Directed Solo 401(k) stories sounds something like this… Joe, a Self-Directed Solo 401(k) investor, knows how to work real estate deals into profits. So he buys and sells real estate in his Self-Directed Solo 401(k).
Sometimes he involves bank financing. Sometimes he involves private financing and partnering. But one thing is for sure: Once Joe purchases a property, the work has just begun. He has a system. He only buys properties that meet a certain criteria. After the closing, he usually has repairs and/or remodeling work done. And his system works. He’ll put $30k or $40k of his Self-Directed Solo 401(k) money into a deal and get $80k to $100k out, often less than a year or two later.
First, applaud Joe for being a successful entrepreneur. Did you catch that? Joe is being an entrepreneur rather than an investor. This is because his deals have his active involvement rather than the passive placement of his money.
The Pinless Grenade
Unbeknownst to Joe, he’s no longer in control of his financial outcome. His choice to try to sneak business activity inside his Solo 401(k) gives the IRS an open invitation to tax the hell out of him. How much? Well, the IRS can declare Joe’s Solo 401(k) deals to be a “trade or business” in which they’ll apply the UBTI tax. Also known as the most aggressive tax schedule in the United States. It ramps up to 35% federal tax after only $10,000 of profit. Will the IRS make this move? When? That’s unknown, and Joe is no longer in control of his financial outcome.
All kinds of strategies fit into this same category. I have a friend who has done over 100 deals inside his Self-Directed Solo 401(k), producing a return-on-investment of over 9,000%. And he’s hiding under a rock. He won’t returns the calls of the newspaper and magazine reporters who want him to share his strategies with the world. He rarely teaches investing seminars, and when he does he only invites people who he has personally met and known for at least 6 months. He essentially lives a life of fear because he knows the day his Self-Directed Solo 401(k) gets audited may be the day he gives up at least $1,200,000 plus late penalties and interest to the IRS.
Enjoyable, Controlled Success
Do you know how to do deals that turn pennies into thousands? Thousands into millions? Fantastic. Don’t ever consider not pursuing massive profits, and don’t ever lock away your talents and skills to be unused. Just take a few minutes to educate yourself about the best way to structure your deals to keep you in control. More info coming in Part Two of this post soon 🙂