Rental property owned by plan

[doombuggy]

OK, this 401(k) Profit Sharing plan purchased some land in 2004, built a house and started renting it out in September of last year. The rental payments go into the plan's account, i have no problem with that part. Since it is real estate, it doesn't get assessed every year. Does the plan sponsor need to have the property appraised at the end of every plan year? I see that the plan sponsor w/d the taxes for the property ffrom the plan's account. I am ok with that part.

The client's advisors sent me a copy of the lease and what looks like info from the county property appraiser's books (which you can get online, something I learned last year when I tried to buy a home). Is the county appraiser's value ok to use? I think the answer is no?

Thanks for your help!

[jpod]

It is a qualification rule that a plan's assets be valued every year. Naturally, you need a value for 5500 purposes too.

Is the investment a self-directed investment for a single participant? If so, in my estimation it is not necessary to secure an appraisal by a qualified appraiser.

However, if it is not a self-directed investment, how often are plan valuations required (by the terms of the plan) for purposes of making distributions to participants? Hopefully, it is only once a year, in which case it would be most prudent to secure an appraisal every year (which can be paid for with plan assets).

[Kirk Maldonado]

While this is off the subject, are there any UBTI or UDFI issues implicated in that arrangement?

[namealreadyinuse]

Is it a ERSOP or does the plan own the rental directly? Why doesn't UBIT kill this plan?

[jpod]

Namealready:

1. Why would UBTI "kill" any plan?

2. What is an ERSOP and why would the plan's status as such be relevant to the valuation issue raised by the original post?

[Guest Gompers]

As to UBTI my understanding is that rents from real estate (not personal property) are generally not UBTI. UDFI comes into play if the property is leveraged. Here, my recollection is, that the rules for IRAs and qualified plans differ greatly. A qualified plan, with certain enumerated exceptions, can borrow money to purchase real estate and not have this count as "acquisition indebtedness." If there is no acquistion indebtedness then there would be no UDFI from rents or from the sale of the property. The last time I looked at this I recall seeing a very coherent explanation of the rules in Tripoldi's Outline.

Interested in why jpod doesn't think that you need an appraiser if it is self-directed. It would seem that arriving at FMV would be possible. I thought you were obligated to provide "current value" which is

The term “current value” means fair market value where available and otherwise the fair value as determined in good faith by a trustee or a named fiduciary (as defined in section 1102 (a)(2) of this title) pursuant to the terms of the plan and in accordance with regulations of the Secretary, assuming an orderly liquidation at the time of such determination.

Who are they leasing the house to? I hope it is to someone who has no connection with the plan or plan sponsor.

[jpod]

Gompers:

If the rental property is a self-directed investment, there is only one person who really cares what the value is at any point in time; i.e., using an artificially low or high value would not hurt or favor another participant who is entitled to a distribution from the plan.

[John Feldt ERPA CPC QPA]

A couple of ERSOP links, I am neither claiming agreement nor disagreement to these type of arrangements at this time:

http://www.businessweek.com/smallbiz/conte..._0799_sb006.htm

http://www.rainwatercpa.com/links/ersop.pdf

[Guest mjb]

In order for an ERSOP to be valid it must:

1. be subject to ERISA i.e., have common law employees

2. not pay more than adequate consideration for the stock of the corp. ERISA 408(e)(1). If the corp is a shell corp with no assets the value will be close to 0.

UBIT would not kill the deal but will reduce/eliminate the gain because of the35% tax on profits in excess of 10k when the property is sold.

[Guest Gompers]

jpod--agree with you reasoning but not sure it comports with the plan's reporting requirements with regard to the 5500.

mjb--Why do you think there would be ubti in this instance? Rents generally are not UBTI. Even if leveraged you could presumbably meet the requirements of 514©(9) and woould have no acquisition indebtedness to trigger udfi.

Here is a brief discussion:

http://www.americanreal.com/publications/article6.shtml

http://www.akingump.com/docs/publication/378.html

[Guest mjb]

where did I say there was ubit- I was responding to the Q of whether UBIT would kill the deal, i.e., make it a pt, not whether UBIT applies.

[Guest Gompers]

O.k. I misunderstood. I thought that when you said UBTI would not kill the deal but only reduce the gain that meant you thought the deal had UBTI.

[jpod]

mjb: Thanks for the free education about ubti. You're probably the only one out there who knew that a plan would have to pay federal income tax on ubti. However, I only wanted to know why the person who said ubti would kill the deal felt that way.

[doombuggy]

The plan is a 401(k) Profit Sharing Plan.

Yesterday we obtained more info on what some of the credits & debits were (the plan has assets in 2 accts with Blue Vase and 1 at SunTrust). The turstee used funds in this plan to purchase the lot, build a house, and last September, started renting it to a family, none of who are employed at the company (or rather PPA, it's a doc's office). It looks like a nice plan, and for $550/mo, I'd rent it, if it was around here.

The plan is valued annually. It is trustee directed. We have had a great deal of difficulty getting this info. We have had to ask the client (actually, the broker) for info several times, and it trickles in. I am actually in the process of amending the 2004 5500, as that is when they started this whole mess and we just found out ("oh, you have 2 accts with Blue Vase? Please send us the statements for that one too") If we had an emoticon of "head bashing brick wall" I would insert it here................

I also found out yesterday that when they purchased the lot that started this thread, they also purchased another lot in the same town, probably had a home built on that one too, but sold it for a profit in December 2004. We were just trying to get some additional info off of the county appraiser's web site, but they are not as savvy in that state as they are around here in Central FL. We are just going to have to run with what we have. As my old boss used to say, "We aren't the Pension Police!"

We have told the broker that we felt the property that they are renting out (which is held as an asset of the plan, not to one specific person) needs to be appraised each year by an independent appraiser.

Thanks for your input guys & gals! If anything else in this crazy story comes up, you'll hear about it......

[Kirk Maldonado]

jpod:

I was surprised, to say the very least, to see your remark:

Thanks for the free education about ubti. You're probably the only one out there who knew that a plan would have to pay federal income tax on ubti.

when I was the person that initially raised the question. I guess you didn't read the prior posts in this message thread.

Gompers:

Are you saying that a plan would not have UBTI even if it built the property? Isn't there a concern about it engaging in a trade or business? I'm not sure that constructing one dwelling would necessarily cause a problem, but if the plan built five or ten, I think you have a UBTI problem.

[jpod]

Kirk: I guess my sarcasm (in my response to mjb) didn't come through in print. I certainly read all the posts; sorry for the confusion.

[Guest Gompers]

Kirk,

Good point. I focused on the buying renting and selling but not the building. I believe you can be "active" rather than passive with regard to real estate and still not have the rents or appreciation on sale be considered UBTI. I also know that a number of large pension funds have developed their own real estate projects. But, they may have done this believing it to be a solid investment even if they had to pay tax on some UBTI.

I still think they would be o.k., but I haven't gone back and looked at all nuances of 514. I would hope that a fiduicary would pin this down before they start buiding houses with plan money.

[namealreadyinuse]

I didn't ask why UBIT wouldn't kill the deal. I asked why it wouldn't "kill" the deal. UBIT would decrease the return and cause heartburn from a prudence standpoint for any investment, imo.

[jpod]

namealready: Understood! However, in this case the original poster told us that the plan already owned the real estate; she wasn't asking whether we thought it was a good idea to invest in real estate. I thought you were suggesting that the existence of UBTI (and there may not be any if there is no leveraging) somehow presented a problem beyond a UBTI tax liability.

[Kirk Maldonado]

I once worked on a transaction that was going to generate UBTI. Despite that fact, some of the largest pension funds in the country were investors (there were a lot of dollars at stake). The investors that were pension plans demanded (and got) the promotor to take care of all of the administrative complications resulting from the UBTI (other than actually paying the taxes). There was even a group trust set up in connection with the deal.

[Guest Gompers]

Choice of entity for the investment can make a big difference as well. A plan might reasonably forego the favorable tax treatment of 514©(9)'s exclusion of income from leveraged property from UBTI in order to avoid being directly liable for the losses that might exceed the cost of the investment. If another entity is formed (and is properly operated and structured) any loss would be limited to the assets of the entiy.

Then, if you are in the area of commercial real estate you could have issues like income from parking, provision of cleaing services provided to tennats etc that could raise UBTI conserns.