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I own multiple rental properties and a property management LLC.

I would like to start paying a 10% management fee (industry standard rate) on all my rentals to my property management LLC.

My understanding is that this would reclassify the 10% management fee from passive rental income to active property management income. Is this accurate? If so, once it's active income I should be able to use it for solo 401k contributions.

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  • Do you have a full-time job and some rentals on the side, or is the bulk of your time spent in real estate? – Hart CO Dec 10 '19 at 23:30
  • I have a full time job with rentals on the side. – newUserNameHere Dec 11 '19 at 1:39
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My understanding is that this would reclassify the 10% management fee from passive rental income to active property management income. Is this accurate? If so, once it's active income I should be able to use it for solo 401k contributions.

I've been hesitant to answer because I don't know a great deal about Solo 401k requirements and I haven't found concrete evidence to support my feeling that the IRS would view the 2nd company as a sham.

You definitely need earned income rather than passive to contribute to a Solo 401k, so the idea that you'd have to convert some of your passive rental income holds up. Normally you wouldn't want to convert passive to active because that triggers self-employment tax. Solo 401k contributions do not decrease self-employment tax.

In other schemes where the 2nd business serves no purpose other than some sort of tax advantage the IRS can and does challenge the setup. This feels very much like that sort of situation to me, but I see people claiming it is proper and haven't heard of anyone being challenged on it (that doesn't mean they're not).

If the management company was an S-Corp you might be able to avoid some self-employment tax, but you'd definitely be paying some, which you aren't currently paying on the passive rental income. Since you aren't a real estate professional the S-Corp shouldn't hold your properties, you'd run afoul of passive income restrictions.

This is complex enough that I suggest consulting a professional about your specific circumstances, and perhaps even getting a second opinion after that. Focus on net benefit after setup/on-going costs.

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I would only trust a tax accountant's answer on that one. It seems like it could go either way and may even change from year to year. LLCs organized as a sole proprietorship would be tricky in this case.

If, however, your LLC was organized as a S-Corp this would be an unnecessary step. You would simply hire yourself and pay yourself occasionally. Part of that payroll could be directed to your solo 401K. No revenue is necessary. In order to save on payroll fees you may choose to pay yourself only annually or quarterly.

However, in order to have a match, you will need profit. But that is a different discussion.

What I would do, in your case, is re-organize your current LLC into an S-Corp or start a new one. Then make your contributions that way.

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  • S-Corps have passive income limits, an S-Corp election on the LLC would most likely be a bad idea. – Hart CO Dec 12 '19 at 19:34

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