Real estate investment

[Guest Quacka]

Sole proprietor and spouse participate in 401(k) (no other participants) and wants to use plan assets to finance daughter's primary residence, which will be used as collateral.

Permitted? PT issues, limit on loan amount, loss of interest deduction for daughter, and/or ERISA fiduciary issues? (or anything else?)

Thanks in advance.

[QDROphile]

You could describe the proposed transaction in some detail but it will almost certainly come out to be a prohibited transaction.

[Guest Quacka]

That's about the limit of my knowledge, but I think you can assume the loan will exceed the IRS limit (lesser of $50k or 1/2 balance), that the property will not be used in plan administration, and that the daughter not will not provide any services to the plan.

[WDIK]

I think we can surmise that the daughter is a lineal descendant of a party-in-interest.

[Below Ground]

I think this was a DC-3 Exam example of how a self-directed account can't be used to finance a real estate for a relative. As I recall, this type of transaction was being used to explain that while self-direction does not make a participant a fiduciary, it does make them a party-in-interest for such prohibited transaction.

[Guest Sieve]

You can't use these assets as suggested while they are in the plan (obvious PT). But, as an alternative, why can't the participant(s) take out the maximum loan possible and use the assets to make the down payment on a house in their name (to be used by daughter), then just pay back the plan loan within the 5-year maximum period? This means, of course, that there is a mortgage on the house after all is said and done, but at least a significant down-stroke has been made.

[BG5150]

Why would the house have to be in their name? As long as the loan is being repaid w/in 5 years, it doesn't matter what they use the money for. If it's for more than 5 years, then, of course, it would have to be for their PRINCIPAL residence. That would be a tough one to get around.

[Guest Sieve]

Could be in the daughter's name. I just thought that buying it in the daughter's name might raise the issue of "indirect" PT, and parents buying in their own name might give the transaction an extra layer of protection. (Note wording of IRC Section 4975©(1) & ERISA Section 406(a)(1): " . . . any direct or indirect . . . use by or for the benefit of a disqualifed person of the income or assets of a plan [or] act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest . . ." (Emphasis added.))

[BG5150]

Could be in the daughter's name. I just thought that buying it in the daughter's name might raise the issue of "indirect" PT, and parents buying in their own name might give the transaction an extra layer of protection. (Note wording of IRC Section 4975©(1) & ERISA Section 406(a)(1): " . . . any direct or indirect . . . use by or for the benefit of a disqualifed person of the income or assets of a plan [or] act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest . . ." (Emphasis added.))

If putting the house in the daughter's name raise the issue of an "indirect" PT, wouldn't putting the house in their name raise the issue of a "direct" PT?

[QDROphile]

Nice point.

[Guest Sieve]

No it wouldn't, because the owners, as participants and fiduciaries, are protected from a PT under statutory exemptions for "receipt . . . of any benefit to which [the participant] may be entitled . . ." (IRC Section 4975(d)(9) & ERISA Section 408©(1)) and for "any loan made by the plan to a . . . participant . . . " if the loan meets normal plan loan requirements (IRC Section 4975(d)(1) & ERISA Section 408(b)(1)).

[BG5150]

So if the loan is not a PT, then what happens to the money wouldn't be either, I would think.

[Guest Sieve]

You're probably right, BG--as I said earlier, my approach (home in name of participants) was intended as a suggested extra layer of protection. That's because (a) I generally take a conservative position so that I can start the client from a safe position while he/she negotiates with himself/herself with regard to a potentially questionable transaction, which keeps the client more on track, and (b) I'm very leery of the DOL/IRS when it comes to PT issues for a number of reasons, and I feel that this is one area where they give no quarter whatsoever.

On the other hand . . . I'm not convinced that a "good" loan means you can always do anything you want with the $$ without it being a PT. For example, you probably can't take a loan and then turn around and loan it to the employer, especially if you're an NHCE--I think that's an example in some reg. somewhere.

I can support your position without hesitation in this particualr circumstance--after all, there's really no difference between taking a loan to buy all your children Christmas gifts (obviously no PT) and using the loan as a down payment to buy one of them a house. Given the choice however, I might opt for a bit more conservative approach.