Can a participant direct investments into undeveloped real estate?

[Guest]

I have a client with a daily valued 401(k) plan which allows individual brokerage accounts. The owner now wants to direct an investment into undeveloped real estate. It would be in his directed account and he would bear the risk. Does anyone have any good arguments I could use to talk him out of this, besides the usual annual appraisal requirement, taxes from plan assets, etc. Thanks.

[Guest lkshipman]

Additional arguments:

1. Is this a doctor, dentist or lawyer? If so, laugh for several minutes.

2. When it's time to roll over to an IRA, he may not be able to find an IRA custodian/trustee who will accept it.

3. When he reaches age 70-1/2 and still hasn't been able to liquidate that fabulous investment, how is he going to effect his MRDs?

4. Does he really want to use his other investments to pay for taxes, etc. on the property?

5. Is his account going to pay for liability insurance in case someone is injured on the property?

6. If this is such a great investment opportunity why is he putting it in his plan? The capital gain would be more effective as a taxable investment.

7. If the real answer is, he's investing via the plan because he doesn't have enough assets outside the plan to fund this investment, it just proves it's a bad idea.

[RCK]

You said that the plan has a brokerage window. Does that mean that the real estate would come in through the brokerage window? Or that it would be just a new investment option?

In either case, if you do it for the owner, you're going to have to make it available to all the employees, or at least enough to have nondiscriminitory benefits, rights and features.

[Bill Berke]

RCK asks the key question - is this purchase through a brokerage account of a type that is available to all participants and allows real estate? Or can each employee direct his/her assets in any way they choose? And purchasing real estate can be very tricky under IRC UBTI rules. Also you must deal with the valuation requirements. I don't want to be the fiduciary or trustee. I agree that this is generally not a good idea, but it is not forbidden provided document permits this. You also must plan for possible current income taxation and prohibited tax issues.

[AndyH]

I just read lkshipman's comments and I think they're terrific. Bravo!