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Wallstreet Esq.
Wallstreet Esq., Tax Attorney
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Experience:  10 years experience
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I own properties which produce a positive income showing

Customer Question

hello. i own properties which produce a positive income showing rental profit after interest, depreciation, expenses, etc. Is there a way to use that income to fund a solo / one participant 401k ? I have an LLC that can be used to act as a management company which i would own. or is there any other way? thx
Submitted: 7 months ago.
Category: Tax
Expert:  Jason M. Tyra, CPA replied 7 months ago.

Hi There:

You can use rental property income to fund an individual 401(k) if you meet both the active and material participation rules to qualify as a real estate professional.

Rental income is usually considered passive, which means it is not subject to self-employment taxes (among other things). Since your net income from self-employment determines how much you can contribute to an individual 401(k), the amount would be $0 each year unless the income was considered non-passive. Whether you operate as an LLC does not, in itself, change the character of rental property income (i.e. make passive income into non-passive income), though it would help with establishing the plan from an administrative standpoint.

Customer: replied 7 months ago.
I was referring to the LLC from the administrative point and I was wondering if it had to be an S corporation not just an LLC. It can be considered active management because I don't pay a management company to take care of them so the properties don't take care of themselves. I do a lot of the work involved and I do the management myself. However I do have another cleaning business that I own butt that one has a few employees and I'd rather use the rental property income to fund a 401k. Would I have to pay self-employment tax in order to use it in a 401K plan?
Expert:  Jason M. Tyra, CPA replied 7 months ago.

You would need to meet both the active participation rules and material participation rules in order for the income to be considered non-passive. Merely being involved with management would satisfy the active participation rules, but not the material participation rules.

Here are the material participation rules:

1.____ Does taxpayer and/or spouse work more than 500 hours a year in the business?

2.____ Does taxpayer do most of the work? Even if taxpayer does not meet 500 hour test, but his participation is the only activity in the business, he materially participates. Example: sole proprietor with no employees.

3.____ Does taxpayer work more than l00 hours and no one (including non-owners or employees) works more hours? Example: If owner puts in l75 hours a year and an employee works 190 hours a year, taxpayer would not meet material participation test.

4.____ Does taxpayer have several passive activities in which he participates between 100-500 hours each, and the total time is more than 500 hours? The following activities should not be included in the above test: rental activities: activities involving portfolio or investment income, and activities in which the taxpayer does most of the work.

5.____ Did taxpayer materially participate in activity for any 5 out of l0 preceding years (need not be consecutive)? Example: taxpayer who retired and his children now run business, but he stills owns part of partnership.

6.____ Did taxpayer materially participate in a personal service activity for any 3 prior years (need not be consecutive)? Personal service activity includes fields of health, law, engineering, architecture, accounting, actuarial science, performing arts and consulting.

7.____ Do the facts and circumstances indicate taxpayer is materially participating? Test does not apply unless taxpayer worked more than 100 hours a year. Furthermore, it does not apply if:

  1. any person, other than the taxpayer, received compensation for managing the activity; or,
  2. if any person spent more hours than taxpayer managing the activity.
Expert:  Jason M. Tyra, CPA replied 7 months ago.

If you meet both of those sets of rules, then the income could be considered non-passive. Non-passive income would qualify for contributions to an individual 401(k), but it would also be subject to self-employment taxes.

Expert:  Jason M. Tyra, CPA replied 7 months ago.

Your company need not be an S Corp to qualify. An LLC treated as a sole proprietorship would work fine.

Expert:  Jason M. Tyra, CPA replied 7 months ago.

By the way, you only need to meet one of the material participation criteria, not all of them.

Customer: replied 7 months ago.
Hello, i tried to rate you but i cannot do it. i don't remember if i rated you.

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