Real Estate in a Custodial Account under a Profit Sharing Plan

[Guest San Diego Benefits Guy]

This is a good one. A client recently sold his business, but has a two-year employment agreement with the new owners. The client has $2,000,000 in the company's profit sharing plan. As the client still has 12 months to go under his employment agreement, he is not entitled to receive a distribution from the profit sharing plan.

The profit sharing plan does allow participants to self-direct their investments. Additionally, the profit sharing plan allows participants to set up investment accounts at other providers for investment purposes. The client wants to pay cash for a $1.6 million dollar home. The home will be rented so we dont need to worrry about prohibited transations.

Clearly, this would be permitted under a self-drected IRA or a qualified plan in which the individual was the only participant. In the past, I've only considered this issue with self-directed IRAs. Does anyone know of any contacts that would permit a account to hold real estate for a participant in this situation.

Thanks in advance.

Ed

[K2retire]

If I were advising the trustee of this plan, I would want to find a way to make this NOT happen.

First, the rental income will likely be UBTI to the plan. Accounting for that will increase the plan's expenses.

Second, with the current state of the real estate market there is some question in my mind about whether a "prudent man" would agree to such an arrangement. (By the way, many estimates that I've seen indicate that the better time to buy real estate will be along about the time when this participant will be eligible for a distribution anyway.)

Third, does the plan trustee really want to be responsible for answering late night calls from the tenant who has a plumbing leak or some such emergency? Does the participant's account have sufficient liquidity to cover such expenses? Is the plan prepared to handle such accounts payable?

[QDROphile]

Although the arrangement has aspects that may not have been adequately considered, and perhaps the participant should not be indulged, why would the rental income be UBTI if the property were purchased entirely for cash?

[K2retire]

I'm not all that familiar with UBTI rules, but why would direct rental income be treated differently than rental income from a limited partnership?

[Guest mjb]

I'm not all that familiar with UBTI rules, but why would direct rental income be treated differently than rental income from a limited partnership?

Under IRC 512(b)(3) rents from ownership of real property are exempt from UBIT if there is no leverage becausae it is passive income.