Plan & ER own same Realty in PSP

[Guest Ddalk]

A 401k PS plan, which permits self-directed investments, purchased (40% interest) and co-owns commercial real property with the employer (the plan's trustee) (60% interest).

Is this transaction a Prohibited Act under ERISA §406 and §4975?

The language of ERISA §406 covers the Sale, exchange, or lease of any property between the plan and a party in interest...not the initial purchase.

I can see possible problems when minimum distributions are required.

This co-ownership seems to have the appearance of impropriety. Without the plan's 40% contribution of purchase price. the ER would not be enjoying the benefits the real estate investment.

Thanks for helping me out.

[Belgarath]

My inclination is the same as yours, and I always advise our clients to seek competent ERISA counsel for a question like this. Going beyond my gut feeling, there was a PWBA opinion letter 2000-10A which dealt with IRA's, and it said there was NOT a PT where the IRA owner was a general partner and family members had limited partnership interests, and the IRA invested in the limited partnership. Whether this same type of logic would/could be used in your non-IRA situation, I wouldn't care to guess without a lot of thought! I'm always inclined to be very conservative on any of these issues anyway, but if the client's legal counsel opines that it is ok, then all I ask for is a letter from the client so advising me.

[RTK]

You mention that the plan is self directed. Does this mean that the plan's interest was purchased pursuant to a participant's direction? Also, is the plan a 404© plan?

[mbozek]

Doesn't IRC 4975 forbid a fiduciary from investing plans assets for the benefit of his own account. And doesnt this rule apply when an individual invests the funds in a self directed account, Flahertys Arden Bowl, Inc. v. Comm. 115 TC 269, even though the participant is not a fiduciary under ERISA 406?

[Guest Ddalk]

Belgarath, RTK and mbozek, Thanks for your questions, comments and suggestions.

Belgarath: I too am conservative when it comes to these investment issues. I did find 29 CFR 2509.94-3, an Interpretive bulletin issued by the DOL stating that an in-kind contribution to a plan that reduces an

obligation of a plan sponsor or employer to make a contribution measured in terms of cash amounts would constitute a prohibited transaction under section 406(a)(1)(A) of ERISA (and section 4975©(1)(A) of the Code). This broadens the meaning of 'sale' and 'exchange' in self-dealings in both ERISA & the Code to include the purchase and contribution of real property. However, the plan's ER contributions are discretionary not obligatory, and therefore n/a.

RTK: The Plan's 40% interest was purchased as a 'prudent investment' and the remaining 60% was purchased by the ER as a self-directed investment. The Plan is 404c qualified, but I'm not sure that is relevant here because the property has been very successful as a Plan asset and 404c is not really a defense to a prohibited transaction.

mbozek: I agree with your assessment. The funny thing is, is that I felt that 4975©(1)(E) prohibited this particular transaction. I was told that I was incorrect by an attorney from a very large law firm--a partner, mind you & he graduated first in his class from the U of Chicago, so I tried another tact--4975©(1)(A)--prohibited sale or exchange. The attorney thinks that the self-directed investment provision in the Plan permits this type of co-ownership/purchase. I think that any way you read 4975 c)1)E), 'act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interests or for his own account', this transaction is prohibited.

The use of Plan assets for the benefit of a plan fiduciary's account (retirement or otherwise) is prohibited.

[mbozek]

I am not sure who owns the investment. Was the plans 40% purchase by the trustee for all participants or for one particpant? Was the employer's 60% purchased as a plan asset or as an investment for the employer's general account?

[Guest Ddalk]

The Plan's 40% interest in the property is a Plan asset for benefit of all Plan participants. The ER's 60% interest in the property is a self-directed investment that's of benefit only to himself.

[RTK]

I asked about 404©, because there is language in the 404© regulations that provides prohibited transaction relief for ERISA purposes. The relief may be available even if the particpant is otherwise a fiduciary. See DOL advisory opinion letter 75-24. Although 404© does not provide relief from IRC prohibited transaction, it does remove ERISA from the equation.

I still am not sure how the ER's investment is held. Is the ER's 60% interest held as a self-directed investment under the plan? If so, does that mean that only the ER may self-direct?

In any case, regarding fiduciary and prohibited transaction issues, the case that comes to mind is Leigh v Engle I (727 F2d 113), where the Circuit Court found violations of 404, 406(a)(1)(D), and 406(b)(1) where plan assets were used to as part of the fiduciary's investment and acquisition program.

[Guest Ddalk]

Thanks for following this up RTK. The ER holds the 60% property interest as a self-directed investment under the Plan. Self-directed investments are available to all Plan participants. Thanks so much for the citation--I look forward to reading it, it sounds like the case is right on point.