Can RENTAL PROPERTY OWNERS Use A Self-Directed 401(k)? | SDITalk.com/315

Have rental properties and want to set up a company and an associated self-directed 401(k)? Good idea… but the IRS might stand in your way. I’m Bryan Ellis. I’ll tell you all about it RIGHT NOW in Episode #315 of Self-Directed Investor Talk

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Hello, Self-Directed Investors, all across the fruited plane. Welcome to another action-packed, edge-of-your-seat thrill ride into the fantastic world of tax-free alternative asset investing. This is Self-Directed Investor Talk, the SHOW OF RECORD for savvy self-directed investors like you, and today we have an excellent show for you

This is Episode #315, so to get the transcript and other resources for today’s show, visit SDITalk.com/315, that’s SDITalk.com/315 for all of those resources, provided to you with our compliments.

So…

I regularly hear from rental property investors who want to use a self-directed 401(k). The idea is that they want to form a company connected to their rental properties since one must have a business in order to establish a self-directed 401(k). On the face of it, this isn’t a bad idea.

My regular listeners will, of course, know that I am a huge proponent of self-directed 401(k)’s as being the absolute crème-de-la-crème of self-directed retirement accounts versus any type of IRA in Every Single Way…

…Except one.

“Well Bryan, what is that one exception?” I can practically hear you asking right now? It is this:

Far fewer people actually QUALIFY to set up a self-directed 401(k) in the first place. The qualifications aren’t complicated – really, all you have to have is a business that you own which has no full time employees other than you and maybe also your spouse, and your business has to have earned income. That’s really about the size of it.

But therein, there’s a pretty big GOTCHYA for rental property owners who want a self-directed 401(k). What is it? Well, it’s that caveat of having EARNED INCOME.

Earned income, as you may know, is the type of income that results whenever an employer gives you a paycheck or, if we’re talking about a business rather than a person, it’s the type of income that results whenever a business is paid for the purchase of a product or a service. It’s income that’s earned on the basis of active effort.

You’ll note that that definition doesn’t directly apply to rental income. Rental income is, under the tax code, what’s known as UNEARNED income. Not unearned in the sense that you’re unworthy of receiving the income, but unearned in the sense that rent is payment for the use of an asset rather than for the purchase of a product or service. From a tax perspective, there’s no active effort involved in receiving rental income.

So that’s a problem. If the only income you are receiving comes from rental income, then all you’re receiving is UNEARNED income rather than EARNED income. And it really doesn’t matter whether those rents are being paid to you personally or to a company you form to own the properties. Either way, the nature of the income itself is still UNEARNED.

And if that’s the only kind of income you’re receiving, that’s not sufficient basis to establish a self-directed 401(k), I am sorry to say.

But NEVER FEAR, my friends. As always, I have a solution, which Self-Directed Investor Society clients have been using quite productively for years now, and it is this:

While RENTAL INCOME won’t qualify you to set up a self-directed 401(k), what COULD qualify you to do so is to establish a PROPERTY MANAGEMENT company which serves your rental properties. In other words, let’s imagine you have one or ten