non-owner participant wants to purchase real estate

[TPAnnie]

A terminated non-owner participant wants to purchase real estate in his self-directed 401(k)/PSP. The trustee is fine with this, as he himself has real estate as one of his investments, but wants to know if all the same rules regarding real estate investments apply to a non-fiduciary.

Also, does the participant's real estate investment need to be offered to all plan participants - or is the option of finding their own enough?

Are there any other special things to consider?

TIA!!

[ERISAnut]

The plan's investment policy will typically answer all these. The investments allowed for the plan's participants must be made available on a non-discriminatory basis. Therefore, you allow Real Estate for one (especially an HCE), you are better served allowing it for all.

In all instance, you have to remain aware that the real estate purchased will be an asset of the trust. Trust assets must be valued at least annually. Everything legal is not practical.

[TPAnnie]

The investments allowed for the plan's participants must be made available on a non-discriminatory basis. Therefore, you allow Real Estate for one (especially an HCE), you are better served allowing it for all.

The trust allows for all participants to self-direct all funds. It also allows real estate as an investment option. When the trustee/owner invested in his real estate investment, he gave all employees the option to choose that specific property investment as an election.

But, does each future property investment have to be given as an election to each employee, or is the option to purchase real estate enough of an option? For instance, if Joe NonHCE finds a piece of Texas property he wants to invest in as part of his self-directed account, do the trustees need to let every plan participant choose whether they want to invest in that same Texas property too? And, would your answer change if it was Susie HCE purchasing the Texas property?

Thanks!

[Guest Sieve]

Open architecture re: plan investments does not require all participants be given the option to bid on each investment opportunity.

Make sure the individual learns about real estate held by a qualified plan before diving in head first--as pointed out by ERISAnut, there can be valuation issues, real estate tax issues, use by family & friends issues, liquidity issues, UBTI issues, sweat equity issues, etc., etc (even though these assets will not be shared by everyone). Remember, too, that distributions from the plan are taxed as ordinary income, and the real estate therefore will not be subject to capital gains tax (whichever direction that may go).

[J Simmons]

It would be interesting to learn how enthused the TEE will be about plan investments in real estate after all the issues Sieve pointed out have been vetted, both to what extent they need to be by the former EE from his/her end and by the TEE from his/her end, and then the TEE coordinates the annual valuation, etc. for a year or two.

ERISAnut succinctly said it in 5 words: "Everything legal is not practical." This might be especially so for the TEE when having to deal with all these issues for a real estate investment for a former EE.

[Kevin C]

Isn't there also a requirement that the purchase price not be more than fair market value?

The DOL's VFC program lists correction methods for 1) purchase of an asset from a person who is not a party in interest with respect to the plan at a price more than fair market value, and 2) sale of an asset to a person who is not a party in interest with respect to the plan at a price less than fair market value.

[Peter Gulia]

Have the plan’s fiduciaries considered whether they need to require that some portion of the participant’s plan account be invested in assets that can be sold quickly to raise money to pay taxes, insurance premiums, and other expenses?

Have the plan’s fiduciaries considered that ownership of real property can result in a liability (especially an environmental liability) that exceeds the property’s value?

Even if a plan otherwise meets all ERISA § 404© requirements, a fiduciary doesn’t get relief and instead is stuck with responsibility if he, she, or it follows a participant’s instruction that “[c]ould result in a loss in excess of a participant’s or beneficiary’s account balance[.]” 29 C.F.R. § 2550.404c-1(d)(2)(ii)(D).

If the plan trust pays such a liability, do the plan’s fiduciaries know what allocation method they would use to apportion that expense among the plan’s participants, beneficiaries, and alternate payees (including those who had no interest in the real property)?

Does each fiduciary who also is a participant understand that his or her plan account can be offset to pay his or her fiduciary liabilities to the plan (with that amount allocated among non-breaching participants)? See ERISA § 206(d)(4)(A)(ii).

[TPAnnie]

I want to thank you all for the very detailed replies. I will go over these issues with the trustee and I'm going to guess they'll decide this is much too involved. (Hopefully!)

Thank you again!!

Annie

[J Simmons]

Have the plan's fiduciaries considered whether they need to require that some portion of the participant's plan account be invested in assets that can be sold quickly to raise money to pay taxes, insurance premiums, and other expenses?

Have the plan's fiduciaries considered that ownership of real property can result in a liability (especially an environmental liability) that exceeds the property's value?

Even if a plan otherwise meets all ERISA § 404© requirements, a fiduciary doesn't get relief and instead is stuck with responsibility if he, she, or it follows a participant's instruction that "[c]ould result in a loss in excess of a participant's or beneficiary's account balance[.]" 29 C.F.R. § 2550.404c-1(d)(2)(ii)(D).

If the plan trust pays such a liability, do the plan's fiduciaries know what allocation method they would use to apportion that expense among the plan's participants, beneficiaries, and alternate payees (including those who had no interest in the real property)?

Does each fiduciary who also is a participant understand that his or her plan account can be offset to pay his or her fiduciary liabilities to the plan (with that amount allocated among non-breaching participants)? See ERISA § 206(d)(4)(A)(ii).

Peter,

I've come across situations where a plan sets up a second plan trust and transfers enough assets to it to purchase the R/E, names the employee as an additional Co-TEE of just the second trust, to segregate the R/E and attendant potential liability from the main plan trust holding non-R/E assets. I've not been the attorney setting up such a trust, but have wondered about the efficacy? What do you think?

[Peter Gulia]

J Simmons, I have some thoughts about the idea you describe and stronger ways of implementing it. But those thoughts would be out of place on this public bulletin board. Please feel free to call me.