Investing In Real Estate?

[austin3515]

Does anyone have a good article on what you need to be wary of when investing in real estate in a 401(k) plan? Property taxes, increased audit risk due to 5500 disclosures, nondiscrimination issues, etc.

I have a trustee that wants to do this in his self-directed 401k, but I want to make sure I've at least told him why this is not a good idea (at least from a compliance perspective).

[My 2 cents]

Just guessing here, but wouldn't there be at least the following:

1. Liquidity issues, in the event that minimum distributions became necessary or if it ever became necessary or desirable to terminate the plan

2. Valuation issues - how often would professional assessments of value be needed? This would perhaps fall under 5500 issues

And that is assuming that the real estate in question is not going to be used in any way by the participant, which could represent an entirely different can of worms.

[Bill Presson]

We've had a few people do this and we recommend they use someone that knows what they are doing.

We've had some success with the local office of these guys:

http://www.theentrustgroup.com/

[JRN]

Reasons not to use Plan assets:

a. Debt-financed income rules – A portion of the income earned will likely be taxable as “deft-financed income”. But, see IRC § 514©(9) exception.

b. Deductions such as interest, depreciation, operating expenses, etc. can’t be used by individuals. Can be used by Plan to reduce otherwise taxable income (but depreciation is limited to straight line only).

c. Ownership by Plan may complicate financing – because participant may be asked by lender to personally guarantee the debt – which he/she can’t do.

e. At some point, you will likely want to get the Property out of the Plan. Distribute fractional interests – taxable income. Gain is taxed as ordinary income (compare if owned individually, gain would be taxed at more favorable capital gains rates). Participant can’t purchase the Property from the Plan – that’d be a PT.

f. Are there any other participants in the 401(k) Plan? If so, they arguably must also be given the right to self-direct.

g. Will likely need annual valuation of Property for the Form 5500 filing.