Prohibited Transaction

[Guest padmin]

Client is a sole proprietor with no employees maintaining a profit sharing plan. One of the assets is a rental property that is owned as follws:

participant personal ownership 4/6

profit sharing plan 1/6

nephew of participant 1/6

Client would like profit sharing plan to buy out remaining 1/6 from newphew.

Does anyone see any issues with either the existing ownership structure of this property or proposed in relation to the ps plan.

Thanks

[QDROphile]

Absolutely a problem. Any time personal investing is mixed with plan investing (essentially joint venturing) you have an issue and almost always you have a prohibited transaction. The fiduciary is using plan assets for personal benefit. If the fiduciary does not have sufficient person assets to buy the property, the fiduciary cannot look to the plan to make up the difference. And I never believe the line that the fiduciary out of goodness just decided to cut the plan in on a really great deal that the fiduciary could have had all to itself or that the fiduciary covered the part of the investment personally that the plan could not afford in full.

[goldtpa]

I agree with QDROphile. You have a prohibited transaction. One additional point. Since your plan does not have any NHCEs it is not subject to ERISAs prohibited transaction rules. However it is still subject to the prohibited transaction rules under the IRC.

[Kirk Maldonado]

I am in agreement with what was posted before.

But isn't there an issue about the potential violation of the exclusive benefit rule?

I believe that there may be an issue, even if the person being benefitted is the participant, if the benefit to him occurs in his individual capacity (rather than in his capacity as a plan participant).

[TCWalker]

Agreed. And padmin when you say "owned" are you saying there is no debt financing involved with this rental property? If there is, then there may be a UBTI issue for the PSP as well. See IRC Secs. 512 & 514

[Guest P A Weick]

Devil's advocate time. The nephew is not a relative under ERISA Section 3(15) and therefore is not a party in interest under Section 3(14). Therefore, there does not appear to be a purchase by the plan from a party in interest, and therefore no PT. Please explain how this would be treated any differently than if Joe Shmoe owned the nephew's interest.

Or are you saying that any joint purchase is a PT? Or are you saying that having an initial joint venture, the plan cannot purchase other investor's interests later?

The reason I ask is that we received a major law firm's opinion on a similar sale that concluded there was no prohibited transaction. There appeared to be some logic to their position.

[WDIK]

Or are you saying that any joint purchase is a PT?

This is how I interpreted the other posters' comments.

[QDROphile]

I don't think anyone was commenting directly on the nephew and your observations are correct about who is a party in interest. However, given the personal connection with the nephew, the circumstances could be such that the fiduciary is getting some personal benefit because of the transaction involving the nephew, whether tangible or intangible. That would make the transaction prohibited. The circumstances could be such that the nephew transaction is OK, but it is better not to get into quations about facts and circumstances in the first place. Family members always raise questions, even when they are outside of the defintion.

[david rigby]

Or put another way, even if the nephew portion/transaction is not a problem, the other 5/6 was a problem from the very beginning.

[Mike Preston]

Well, I'm on the other side on this one. I've been through a couple of DOL audits in the last few months with these types of transactions, and the DOL has not raised the issue. Of course, in each case I've been involved with the plan and the fiduciary could each have purchased 100% of the investment quite a few times over without straining. That is, there was no issue that the plan was helping the fiduciary "afford" the investment and there was no issue that the fiduciary was helping the plan "afford" the investment. In fact, the existence of multiple investments of this kind, leading to diversification of risk, is probably a contributing factor to the non-exitence of a PT.

It all depends on the facts.

[KJohnson]

I am with Mike on this one. I always advise against doing this, but I don't see a PT on the face of it (assuming that the Plan did not first acquire its 1/6 from a party in interest) Section 406(b)(1) really does have a very subjective nature to it.

That said, I think that when you engage in such a transaction you are just asking for trouble even if there is no problem with the initial purchase. Handling repairs on the property, the collection and allocation of rent, preparing leases etc. All of this is going to be involving allocations of moneys between the plan and a party in interest--presumably a fiduciary in this case. Maybe you could have the owner do repairs, rent collection and the like and bill the Plan for its share and try and get away with it under 408(b)(2), but I would have serious doubts about whether jall of this would "services" and there is also the ongoing battle about whether 408(b)(2) covers transactions with fiduciaries. Otherwise, you would obviously try and divide all costs based on ownership. However, are you really cutting a separate check from the Plan for every expense?

[Kirk Maldonado]

The DOL has taken inconsistent positions (at different times) regarding whether "co-investing" is per se prohibited or per se permissible.

[KJohnson]

Kirk,

Are you talking formally or informally. I know in advisory opinions they always say that the 406(b)(1)/4975©(1)(E) issues are inherently factual and they won't issue an opinion.

From the Code side (where DOL still has jurisdiciton for PTs) they have said in instances where IRA assets have been lent to a corporation in which the IRA owner was a shareholder (but did not hold sufficient shares to make the corporation a party in interest/disqualified person) that 4975©(1)(E) was an issue but because of the factual nature would not issue an opinon on the issue.