DB pension investments

[Gary]

A one-participant/owner plan is purchasing an apartment complex. The plan intends to use plan assets 1) for a down payment, 2) to pay mortgage, 3) to receive rent payments, and 4) ultimately to collect and recognize the capital gain (proceeds) from the sale (or loss for that matter).

Questions.

1. In the scenario above, does anyone believe it is a PT?

2. Could the receipt of the rent payments and payment of the mortgage payments be done outside of the plan (say by the owner) and still not be a PT? And the investment would just be treated as an asset with a recognized gain/loss at time of sale?

3. I'm not even sure that the plan can recieve the rental payments and make mortgage payments. I finf it hard to believe it can make mortgage payments and not sure if the receipt of rental payments wouldn't be deemed plan contributions?

4. Does the real estate need to be appraised annually for the 5500 or can it be just valued at cost basis until it is sold?

Curious to hear comments.

Thanks.

[WDIK]

Whether or not it is a prohibited transaction depends on any relationship that exists between the plan and its fiduciaries and those involved in the sale of the property.

Debt-financed property can be allowed in retirement plans, but can result in unrelated business taxable income. Mortgage payments are made from plan assets.

The real estate must be valued at fair market.

[mwyatt]

One other point is what do you do when the plan winds down? I'm assuming that we're talking someone reasonably close to retirement here, since this is a 1-man DB plan. The exit strategy is dubious at termination of the plan, especially since any transaction between the plan and the sponsor to take the property off the plan's hands would be a PT. Has this gone forward or still in the planning stages?

Your client may be viewing this from his personal tax viewpoint. Unfortunately, things that might make sense from an after-tax investment are absent within a qualified plan, namely the ability to write off expenses against income, depreciation, and capital gains v. ordinary income.

[AndyH]

Excellent comments.

[SoCalActuary]

Additionally, will the participant live in the apartment building? Rent-free?

Will the participant receive fees for property maintenance, rent collection, etc?

Each of these would suggest a PT.

If the building is purchased at a good price with upside appreciation potential, then this could be a good pension investment. But I caution that the owner needs to be reasonably informed on the duties of the trustee before closing escrow.

[could be me maybe not]

The plan sponsor better never have a common law employee become eligible; then he'd have a big problem.

[Gary]

A couple of questions or desire for further clarification based on the above responses.

1. If the plan purchases the property and then sells it to distribute assets as a result of a plan termination, I don't necessarily see why that is a PT? Assuming that it is only a transaction between the plan and an unrelated party. Of course a sale may occur sooner than that too.

2. The participant will not be living in the apartment complex. The plan would receive all rent collection and make all mortgage payments, maintenance payments, etc.

3. If the plan is receiving rent collection, making mortgage payments etc. how is it handled? Are they simply forms of income and expenses? And not considered pension funding contributions?

Thanks.

[mwyatt]

Rent is just income to the Plan and not construed in any way as an employer contribution. Expenses just get taken out of plan assets (and BTW, you lose the ability to deduct these things in contrast if he held the apartment building as an after-tax investment). He should really run the numbers because you lose a number of items (mortgage interest, operating expenses, repairs, etc.) that contribute on the outside to making this an economically viable investment. We won't even mention ordinary income v. capital gains taxation.

[Gary]

Thanks for all the input.

Clearly, it appears that if done properly this can be an allowable investment and not a PT. However, albeit, it may not be the wisest investment based on all the tax ramifications.

GAry