Prohibited Transaction - how to correct?

[Blinky the 3-eyed Fish]

A client in a self-directed 401(k) plan owns land within the plan. He is now in the process of building a house on that land funded with personal money. He of course plans to use this house as a vacation home.

I can't figure out a way for him to correct this situation to allow him to use the house. He can't use the house on the land owned by the plan = PT. He can't buy the land from the plan = PT. Unless there is some exception that I am not seeing.

If an exception doesn't exist, anyone know the process to apply for one?

One other fact: he can't distribute the land from the plan. The money consist of sources ineligible for distribution pre-59 1/2.

[Kevin C]

The DOL's Voluntary Fiduciary Correction Program may help. Is there any chance the property would be considered an illiquid investment? They have information on their website.

http://www.dol.gov/ebsa/compliance_assistance.html#section8

How can I find out more about the Program?

Interested parties may contact the appropriate EBSA regional office. Regional coordinators assigned to the Program will assist you with your questions. Information about the VFCP can also be obtained by calling EBSA's Toll-Free Hotline number at 1.866.444.EBSA (3272) and ask for the VFCP Coordinator.

Even if VFCP won't help, they can help with corrections outside of the existing programs.

[12AX7]

How about a non-related third party purchase of the home, and then your client purchases the land from that party? Substance over form perhaps?

[Blinky the 3-eyed Fish]

How about a non-related third party purchase of the home, and then your client purchases the land from that party? Substance over form perhaps?

That's explictly not kosher.

[jpod]

From the facts it's not clear to me whether a PT has occurred YET. If not, consider the DOL's EXPRO exemption program. You may be able to get a quick PT exemption to permit him to buy the property from the plan (for "adequate consideration," substantiated by a non-bogus independent appraisal).

[movedon]

I don't understand why he would expect an exception - isn't this pretty much the exact situation the rules are designed to prevent?

If he gets the exception, please post the details. I'd love to buy my neighbor's house in my solo-k and tear it down and put in a fishing pond where it was.

[Kevin C]

The DOL can work outside the box if they decide it is in the plan's best interest. We recently finished two cases with them that were handled outside of existing programs. We presented proposed corrections in both cases and the DOL approved. They were surprisingly reasonable and helpful.

But, this situation might fit in VFCP. From the 4/19/06 VFCP Notice:

(f) Holding of an Illiquid Asset Previously Purchased by a Plan

(1) Description of Transaction. A plan is holding an asset

previously purchased from (i) a party in interest with respect to the

plan in an acquisition for which relief was available under a statutory

or administrative prohibited transaction exemption, (ii) a party in

interest with respect to the plan at no greater than FMV at that time

in an acquisition to which no prohibited transaction exemption applied,

(iii) a person who was not a party in interest with respect to the plan

in an acquisition in which a plan fiduciary failed to appropriately

discharge his or her fiduciary duties, or (iv) a person who was not a

party in interest with respect to the plan in an acquisition in which a

plan fiduciary appropriately discharged his or her fiduciary duties.

Currently, a plan fiduciary determines that such asset is an illiquid

asset because: (A) The asset failed to appreciate, failed to provide a

reasonable rate of return, or caused a loss to the plan; (B) the sale

of the asset is in the best interest of the plan; and © following

reasonable efforts to sell the asset to a person who is not a party in

interest with respect to the plan, the asset cannot immediately be sold

for its original purchase price, or its current FMV, if greater.

Examples of assets that may meet this definition include, but are not

limited to, restricted and thinly traded stock, limited partnership

interests, real estate and collectibles. (2) Correction of Transaction. (i) The transaction may be corrected

by the sale of the asset to a party in interest, provided the plan

receives the higher of (A) the FMV of the asset at the time of resale,

without a reduction for the costs of sale; or (B) the Principal Amount,

plus Lost Earnings as described in section 5(b). The Plan Official may

cause the plan to sell the asset to a party in interest. This

correction provides relief for both the original purchase of the asset,

if required, and the sale of the illiquid asset by the plan to a party

in interest; relief from the prohibited transaction excise tax also is

provided if the Plan Official satisfies the applicable conditions of

the VFC Program class exemption.

(ii) For this transaction, the Principal Amount is the plan's

original purchase price.

(iii) The principles of paragraph (f)(2) of this section are

illustrated in the following examples:

Example 1. A plan purchases undeveloped real property from a

party in interest with respect to the plan for $60,000 in June 1999.

In April 2004, Plan Officials determine that the property is an

illiquid asset. A qualified, independent appraiser appraises the

property at a current FMV of $20,000. The plan sponsor pays the plan

the Principal Amount of $60,000 plus Lost Earnings as described in

section 5(b), and Plan Officials transfer the property from the plan

to the plan sponsor. The Plan Officials also comply with the

applicable terms of the related exemption.

Example 2. A plan purchases a limited partnership interest for

$60,000 in June 1999 from an unrelated party after plan fiduciaries

properly fulfill their fiduciary duties with respect to the

purchase. In April 2004, Plan Officials determine that the interest

is an illiquid asset because the interest has failed to generate a

reasonable rate of return. A qualified, independent appraiser

appraises the interest at a current FMV of $80,000. The plan sponsor

pays the plan the FMV of $80,000 without a reduction for the costs

of the sale, which is greater than the Principal Amount plus Lost

Earnings, and Plan Officials transfer the interest from the plan to

the plan sponsor. The Plan Officials also comply with the applicable

terms of the related exemption.