Each and every day we discuss retirement strategies with real estate professionals. These real estate professionals come to us from a variety of backgrounds, including real estate agents, appraisers, flippers etc.
When a real estate flipper comes to us and asks for retirement advice the first question we ask is whether or not they are “dealers” or “investors”. An extensive discussion of dealer status is outside the scope of this post. But let’s discuss it briefly.
Determining dealer status can be challenging. If you buy and sell properties on a continual basis the IRS will typically take the position that this is your business activity. In this situation, the profits are classified as ordinary income and it would allow the owner to contribute to a retirement account.
Let’s talk about one couple who were real estate flippers and met the “dealer” distinction. They were a husband and wife team in their early 50s who had been in the real estate business for approximately 20 years. They had minimal retirement assets and were getting to that point in life where they needed to put away as much money as possible.
For many clients, I will often start them out with a solo 401k and then possibly include a cash balance pension plan depending on their income and retirement goals. For these folks I recommended a solo 401k with a profit-sharing component that would allow both the husband and wife to contribute to the plan.
Their taxable profit for the year was expected to be around $200,000 and they had an S-Corporation structure. This being the case, they paid themselves what they deemed a reasonable wage (on a W-2) of $50,000 each.
So let’s take a look at the amount they were able to contribute to the solo 401k:
- First, since each of them were on payroll they were able to get $18,000 in each as an employee deferral.
- Second, since they both were over the age of 50, they were allowed to contribute another $6,000 each under the employee “catch-up” provision.
- Lastly, they were allowed to make a 25% employer profit sharing contribution on their combined W-2 income of $100,000. This was an additional $25,000.
So when you combine all those amounts, they were able to contribute $73,000 into the plan and take a full tax deduction. Based on their combined state and federal marginal tax rate, they were able to save approximately $24,000 in income tax.
In addition, since they were the trustee of the solo 401k plan they were able to use these funds to invest in other real estate activities. Specifically, they were able to use the money to make loans (essentially hard money loans) to other real estate investors at a high rate of return.
So the solo 401k plan worked out great for these clients. They were able to save a large amount of money, reduce their overall tax liability, and still have control of their assets so they can use them for real estate activities.
Each and every client who comes to us has different goals and needs. Our job is to understand those goals and tailor a retirement plan to the client. This was a great structure for these clients and they are on their way to saving for a wonderful retirement.