Solo 401k Plan Prohibited Transaction Examples Continued: Investments in qualifying employer real property

The leasing of real property by the Solo 401k  to a disqualified (e.g., trustee, father, son, mother, sister) person would generally be considered a prohibited transaction. However, ERISA 407 prescribes rules that permit certain investments by the Solo 401k plan in qualifying employer real property. In addition, ERISA 408(e) exempts from the prohibited transaction rules, the sale or acquisition or lease by the Solo 401k plan of qualifying employer real property that satisfies the requirements of 407. IRC 4975(d)(13) exempts from the excise tax provisions of 4975 any transaction which is exempt because of ERISA 408(e). ERISA 408(e) requires that the transaction relate to qualifying employer real property. The percentage of assets held in qualifying employer real property is limited by ERISA 407. See ERISA 408(e)(3). To be an exempt transaction, the sale must be:

1.    For adequate consideration and

2.    no commission may be charged with respect to the transaction.

Definition of qualifying employer real property. To be qualifying employer real property:

1.    The property must be leased from the Solo 401k plan to the employer (or to an affiliate of the employer).

2.    The parcels of employer real property must be geographically dispersed, and

3.    Any improvements on the real property must be suitable for more than one use.

The primary purpose of the geographical dispersement and multi-use requirements is to minimize the investment risk to the Solo 401k plan participant. Investments in qualifying employer real property are exempt from the diversification requirements under ERISA 404.

Confusion exists. A lot of confusion exists with respect to the exception for qualifying employer real property. Many solo 401k plan trustees have made the mistake that any parcel of land owned by the employer may be acquired by the Solo 401k plan and leased back under this exception. This is simply not correct.

Geographical dispersement. The geographical dispersement requirement implies that there must be more than one parcel of land. In Zabolotny v. Commissioner, 7 F.3d 774 (8th Cir. 1993), a corporation unsuccessfully argued that its single parcel of farmland could satisfy the definition of qualifying employer real property. The court held that a single parcel does not satisfy the geographical dispersement requirement. Similarly, in Rutland v. Commissioner, 89 T.C. 1137 (1987), an office building failed to meet the definition of qualifying employer real property because it constituted the only parcel of land being leased to the employer. In Lambos v. Commissioner, 88 T.C. 80 (1987), the geographical dispersement requirement was failed, even though there were three parcels of land, because they were all located in the same county. Also see TAM 8753001, where the parcels were located in the same city and the IRS ruled the parcels did not satisfy the geographical dispersement requirement.

Limitations on the percentage of assets invested in qualifying real property. ERISA 407 limits the percentage of Solo 401k plan assets that can be invested in qualifying employer real property without engaging in a prohibited transaction.

10% is general limit. If a Solo 401k plan acquires qualifying employer real property, the aggregate fair market value of such property held by the plan may not exceed 10% of the fair market value of the Solo 401k plan assets, determined immediately after the acquisition. See ERISA 407(a)(2).

Adequate consideration requirement. The acquisition, sale or lease involving qualifying employer real property is not exempt from the prohibited transaction rules unless it is for adequate consideration. See ERISA 408(e)(1). DOL Reg. 2550.408e(d) provides rules for determining adequate consideration. For a marketable obligation, adequate consideration is determined under ERISA 407(e)(1), which determines the appropriate price based on whether the obligation is acquired on the market, from an underwriter, or directly from the issuer. In all other cases, adequate consideration means a price not less favorable to the Solo 401k plan than the price determined under ERISA 3(18), which is either the price on a generally recognized market, or is the fair market value determined in good faith by the trustee or named fiduciary.

Exemption not available unless no commission is charged on transaction. The prohibited transaction exemption for acquisitions of qualifying real property is not available unless there is no commission charged with respect to the transaction. See ERISA 408(e)(2). A commission includes any fee, commission or similar charge paid in connection with a transaction, except a charge incurred for the purpose of enabling the Solo 401k plan fiduciaries to evaluate the desirability of entering into the transaction (e.g., appraisal or investment advisory fee). See DOL Reg. 2550.408e(e).