Mortgage as profit sharing investment

[ombskid]

Business owner wants to use part of his profit sharing segregated account to make a mortgage loan to an unrelated individual. Proper documentation and an attachment or lien will be filed. Any problem with this type of loan?

[shERPA]

A few concerns - if he later wants to terminate the plan, assuming he wants to roll over, he has to find an independent IRA custodian who will accept the loan as an asset.  They exist, but for a fee.

Unrelated individual - so not a disqualified person with respect to the plan.  Also need to advise client that he is not deriving any other personal benefit by making this loan with plan assets to avoid a PT. 

Plan assets are supposed to be carried at fair market value, but you say it is a segregated account, so if the valuation is off somewhat, no harm no foul.  Fiduciary aspect - is it a good investment, appropriate terms for the risk involved and will the plan still be adequately diversified?  Again, segregated account negates most of this as a practical matter, since it is the owner/plan fiduciary investing his own account.  

If there are other plan participants, presumably they also have the option of making similar investments with their plan accounts?  Fiduciary aspects may be a concern here if a R&F participant actually wants to do this.  In practice it almost never happens. 

[ESOP Guy]

Can this be legal? Sure

Search the term real estate on this board for possible practical problems. 

Things like what if he needs part of this assets value to pay an RMD becasue there isn't enough cash in the plan to pay an RMD.  How do you pay a part of a mortgage? 

You can find plenty of people who work with plans that came to regret these kinds of odd and illiquid investments.  

[CuseFan]

As these knowledgeable practitioners know very well, there is often a wide chasm of warnings between "can" and "should".

[Belgarath]

As Sherpa alluded to earlier, will the rank & file have this option? The BRF testing must pass both current and effective availability. Current availability is a mathematical test, which might pass. I'm dubious that in a typical plan with rank & file employees that the "effective availability," which is a facts and circumstances test,  will pass.

If no rank & file participants, then scratch my comment. 

[ombskid]

Thanks for the valuable input

[Luke Bailey]

On ‎8‎/‎20‎/‎2019 at 1:16 PM, Belgarath said:

As Sherpa alluded to earlier, will the rank & file have this option? The BRF testing must pass both current and effective availability. Current availability is a mathematical test, which might pass. I'm dubious that in a typical plan with rank & file employees that the "effective availability," which is a facts and circumstances test,  will pass.

If no rank & file participants, then scratch my comment. 

I concur with all the other comments that these sorts of investments can create myriad practical difficulties. Re BRF testing, it is my view that if the plan terms and communications tell the participants they can invest in anything, including private assets, that they can find and meet minimum for, and that doesn't risk prohibited transaction, or maybe UBIT, that satisfies BRF. The fact that the the rank and file will not have as great an investment selection, e.g. will not meet Reg D accredited requirements, is not, I think, a 401(a)(4) problem. Maybe others will differ or have experience of IRS raising issue in exam. I have not seen a problem.

[Lou S.]

And don't forget this will not be a "qualified plan asset" you won't be able to file Form 5500-SF and you have additional requirements to avoid the small plan audit requirements is that's a concern.