Case Study: Using a Solo 401k to Purchase Tax Liens

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One of the most significant advantages to a solo 401k is the fact that you can have full control over the assets you invest in. This can be a variety of real estate assets, including rental properties, hard money loans, and even buying and selling land. But in this post I want to focus on using a solo 401k to purchase tax liens.

If done correctly, investing in tax liens can be very lucrative. When a homeowner is delinquent on paying property taxes, the tax assessor can place a lien against the property. Investors can acquire these liens and after a period of time (typically a few years), they can foreclose on the property.

As long as the purchase of tax liens is made with investment intent and not as a business activity, the solo 401k will not have any UBTI implications. UBTI is outside the scope of this post but you can find out more about it here.  Let’s take a look at what one investor did to supercharge his solo 401k.

So this client came to us with an interest in opening up a solo 401k. The account was established and funded with an employee tax deferral of $17,500 (the maximum employee deferral at the time). In addition, the client was able to make a 25% profit-sharing contribution, which was an additional $20,000. This combined $37,500 was put to use acquiring tax liens.

Tax lien auctions typically occur once a year by the county tax assessor. This investor was able to use these funds to buy approximately 43 tax liens. Each jurisdiction is different, but it usually takes upwards of three years to foreclose on a given tax lien. In the meantime, the current property taxes on the tax lien parcel are required to be paid.

So in the following tax year the client was able to contribute another $37,500 into the solo 401k. This money was used to not only buy additional tax liens, but to pay the property taxes on the liens that were acquired in the prior year.

Now let’s fast forward three years. Of the 43 tax liens originally acquired, two properties were foreclosed upon. These properties were acquired for a combined amount of approximately $4,000. When these properties were sold the client had earned $52,000. The remaining 41 properties were paid off with interest. The result was an overall profit of $74,000 on that original investment.

Now this is just one example. Investors could have better or worse results. But this illustrates how it is possible to use a solo 401k to buy tax liens. Also, make sure you consider portability.

Remember – there are certainly some considerations when buying and selling tax liens.  The most important of which is determining if it is a business activity or considered an investment.

But the point still remains, 401k solo plans with profit-sharing components are a truly excellent decision for many business owners. Not only do you have control of the investment itself, you are able to take a tax deduction when you put money into the plan. In the right situation, using a solo 401k to purchase tax liens can make a lot of sense.

Paul Sundin

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