Can a self-directed 401k accept a non-recourse loan with the purpose or using the money to fund a loan the 401k will give to a rehabber?

QUESTION: Can a self-directed 401k accept a non-recourse loan with the purpose or using the money to fund a loan the 401k will give to a rehabber? 

ANSWER: It is our understanding that non-recourse loan funds may only be incorporated in conjunction with the planned self-directed 401k owned property—that is, the debt financing proceeds must be used to purchase the property not for rehabbing the property. Of course, the non-used self-directed 401k funds may be utilized to improve or develop the property.

QUESTION CONTINUED: As an example, non-disqualified lender makes 5% non-recourse loan to my 401K. My 401K loans money to rehabber at 12% (rehabber is also a non-disqualified individual). Rehabber pays 12% interest and principle back to 401K. 401K pays back lender at 5%. 

In a sense my 401K earns 7% interest on the deal with none of its own money invested. 

ANSWER CONTINUED:  Our understanding is that the self-directed 401k cannot obtain a loan for the purpose of reinvesting the borrowed funds in a promissory note (e.g., the 401k loans the borrowed funds to a rehabber and charges an interest rate of return).  The only circumstance where funds maybe loan to a solo 401k other than for the purpose of investing in real estate directly (non-recourse loan) is if the 401k runs into liquidity problems.  Click on ProhibitedTransaction Exemption 80-26 (PTE 80-26) to read our blog surrounding this topic.

Regards,

Christine in Florida