Solo or Independent 401K

The True Path to Total Financial Freedom              

Power Chapter

An Open Letter to Accountants and a Thank You to The Good Ones!

More than once, I have heard accountants make surprisingly uninformed statements about solo 401Ks.  Since the law is now over 15 years old, I would fully expect a professional whose business is mitigating taxes for clients to be fully informed on this.  Yet the level of familiarity is surprisingly low.  So what follows are some arguments accountants have made as to why 1.) A client shouldn't invest in real estate in a retirement plan, and 2.) Why these plans won't work.

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Capital Gains Become Ordinary Income


Why would you want to invest in real estate in an 401K instead of mutual funds?  If you hold real estate for more than a year, you get taxed at Capital Gain Rates instead of Ordinary Income!  If you buy houses in your IRA or 401K, when you take a distribution, you'll be taxed at a much higher rate.

Wait!  When I invest in stock and hold it over a long period of time, doesn't it get taxed at capital gain rates?  Are a good share of my mutual funds growing from capital gains?  Sure, they pay dividends too, but unless I'm in a fund designed for income, a good share of my Mutuals grow from appreciation.  So why would converting capital gains in mutual funds be preferable to converting cap gains on a house?

Capital Gains!  Who Cares?


The second, unanswered part of that objection is:  Why would you sacrifice return?  As stated elsewhere, a client of mine started with $300,000 in his TA 401K.  He has done three fix and flips a year at $30K to $35K per flip.  So his retirement has grown to $600,000 in three years. 

If he had averaged 12% per year in mutual funds (an unusually high return), his retirement account would total around $473,000 for the same period of time.  So even though he's going to pay ordinary income on that money, where is he better off?

$600,000 or $473,000?  You decide.

Another aspect of the fallacy of this argument is that fix and flips develop short term capital gains.  My client would have paid ordinary income tax on this money anyway.  His $100,000 per year would have been reduced to $72,000 in a 28% tax bracket.  He would have lost $84,000 in three years that he's using now in his 401K for more deals

You Lose Your Depreciation


Yes, there's no way to claim depreciation on your property if you hold it for over a year in your 401K.  Depreciation is a deduction that a property owner can use to reduce income tax.  Since there is no tax charged in a TA 401K, you don't get to deduct the depreciation.

Let's think that through.  If I collect $18,000 in rent, in my own holdings, and my depreciation is $9,000, I only pay tax on $9,000.

If I own that same home in my TA 401K, I collect $18,000 and I pay NO TAX.  None, Zero, Zip. Zilch.  But wait, I've lost my depreciation, because THERE IS NO TAX to write off!

So would you rather pay tax on $9,000 or would you rather pay no tax (and lose your depreciation in the process)?