Prohibited Transaction?

[Randy Watson]

A plan holds real property as an investment. The sole participant in the plan improves the property with his own money. Assume that the participant does not benefit from the improvement in any way whatsover (other than from being a participant in the plan). Would the participant's improvement of the property be a prohibited transaction?

[QDROphile]

Could be a disguised contribution.

[mbozek]

Could be the furnishing or goods and services by a disqualified person to the plan. But even more important why would the individual make improvements to real property he does not own to increase his tax liability, e.g., using after tax funds to improve real property increases the basis and reduces cap gain on property he owns. In the Q plan he has now increased the value of the property which will be taxed as ordinary income when he receives a distribution. In effect he has converted after tax funds to taxable income.

[Randy Watson]

That's the one I was afraid of. But wouldn't you think that the purpose behind that prohibition is to prevent the disqualified person from receiving comp from the plan in exchange for his goods and services? Does it matter that the plan received a unilateral benefit?

This person was not aware of the PT rules when he improved the land and did not consult with anyone. There was no attempt to treat the improvement as a contribution/deduction. He merely made the improvements with the intention of distributing the property from plan upon retirement.

[QDROphile]

Regardless of intent or characterizations, he could have violated the contribution limits. Compare to contributing amounts at the contribution limit for the year and then using the contributions to pay for the improvements. Were the improvements more valuable than the amount of contribution could buy? If so, the effective contribution to the assets of the plan were beyond the contribution limit.

Now refine the calculation. In addition to the improvements, the plan used its actual contributions for the year for something else, so you don't really compare the theoretical contribution limt. You compare the theoretical limit minus the actual contribution. At least you don't also have an allocation problem in a one particpant plan.

Intent and knowledge of the rules don't really mean much when the rules are not followed. Start educating this person wfor the proposition that the plan assets are not his. If he does not get that point, then start preparing him for lots of remedial expenses and penalties over time.