Real estate in owner only plan

[SSRRS]

Hi,

Thank you all as always. A owner only DB Plan (husband and wife), has about 4,500,000 in assets. Part of the assets is a condo worth 1.5 million (they rent it out). They would like to invest further in real estate and have the plan purchase another condo, worth aprox 2 million, however the seller is willing to agree to sell it for 1.8. Is it advisable to purchase another RE Investment? It is in the same area as the first condo, so that might play a role in lack of diversification? Thank you

[Paul I]

Whether it is advisable depends upon the owners' overall financial situation.

It is permissible in this case because the participants, plan sponsor, and plan administrator (i.e., the owners who fill all of these fiduciary roles) can decide this is a sound investment for themselves.  They certainly could diversify if they wish, but are not required to diversify.

[SSRRS]

Thank you Paul I! I appreciate it. Just trying to understand the point about that it depends on the  financial situation of the owner. If they are using plan assets to purchase this investment, why does his financial situation play a role? Thank you.

[Paul I]

Part of your question was is it advisable to purchase another RE investment.  If their financial portfolio outside the plan is made up of a variety of other investments, they may well be quite diversified and the investment in RE inside the plan could be a fraction of their total financial situation.  Considering solely the assets inside the plan may be myopic.

[Bill Presson]

I would think having a potentially volatile asset in a DB plan might not be advisable. 

[Paul I]

One would think so, but consider that Peter Thiel turned a $2,000 balance in a Roth IRA into $5,000,000,000 (yes, billion) and it's not taxable when distributed.

[C. B. Zeller]

...which would be a significant problem in a DB plan, as opposed to an IRA or DC plan. Based on the 2025 limits, the 415 maximum lump sum is about $3.5 million. If the husband and wife are the only participants and the assets grew to $5 billion, then they would be stuck with $4.993 billion that could not be distributed, but would be a taxable reversion to the employer, plus subject to $2.5 billion in excise tax.

[SSRRS]

3 hours ago, Bill Presson said:

I would think having a potentially volatile asset in a DB plan might not be advisable. 

Thank you. 1.Does this mean that you frown on a  DB plan in general, investing in RE? 2. The main Focus of the original post, was as to the legality of a second large plan investment in RE. The sponsor would like to, but is hesitant if there are any IRS issues? Thank you in advance.

 

[Lou S.]

I think there are a number or threads on real estate in small qualified plans in general and small DB plans in specific you might find in a search of this this website.

This is not advice, an endorsement of real estate or to suggest that you should not do it but there are several items to consider -

An annual independent appraisal to get the fair market value for both funding and 5500 reporting, though you might use actuarial value of assets instead of FMV for funding your still going to need a good value FMV to work with.

The potential for prohibited transactions is greater with real estate than other investment. Not that it can't be avoided, it just has the potential to look out for.

The asset is not liquid which can cause problems with distributions, especially at termination or if RMDs come into play.

If 415 limit is a consideration, not having an accurate FMV can cause the plan to exceed the 415 limit when you do get a value at payout or sell it and find it was worth more than the appraisals. Not the worst problem but one to consider as folks tend to not like being hit with a surprise excise tax.

You tend to lose many of the tax benefits of investing in real estate by holding it inside a plan.

I'm sure there are others but that's just a short list of things to keep in mind when a small DB plan invests in real estate.

 

[Gina Alsdorf]

I remember many years ago (like 20?) the DOL had a project and basically targeted plans with Real Estate.   Owner only would not be ERISA, but I think that sums up the likelihood of something going wrong with a real estate investment as far as a PT, or some other issue. 

[Bill Presson]

First, I'm not an advisor so we are technically investment agnostic. The only advice we give is how the investment would likely impact the plan and actuarial calculations. Lou S. did a good job of laying many of the concerns.