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What is the Plan Asset Rule? April 25, 2008

Posted by Jeff Nabers in : Self Directed IRA Solo 401k , 9comments

The plan asset rule, among other things, is used to determine whether or not a retirement plan is involved in a prohibited transaction.

A PT happens when a plan enters into a transaction with a disqualified person. In our previous post, we covered how to make a list of disqualified persons for a specific plan. This included determining whether a partnership, LLC, corporation (or other entity) is a DQP itself because of significant ownership by other DQPs.

A prohibited transaction occurs when all three factors are present: a DQP, a plan, and a transaction between the two. So, from the previous post we know how to determine if an entity is considered to be a DQP itself. But how do we know if an entity is considered to be a plan?

Plan asset look-through

…is the term DOL uses (The U.S. Department of Labor, DOL, is the government entity that solely has the authority and responsibility to interpret prohibited transactions code). If a situation does have plan asset look-through it means that you look through an entity to the plan and consider the assets of the entity to be the assets of the plan itself. This also means that when you do have plan asset look-through, that entity is treated as if it is the plan itself for PT purposes. That would mean that that entity could not transact with a disqualified person.

When is there plan asset look-through?

The first hard and fast rule is that when an entity is owned 100% by a plan, there is plan asset look-through. So if your Solo 401(k) was 100% owner of an LLC (or any other type of entity) then that LLC would be seen as if it were the plan itself for purposes of PT determination.

The second rule is that when a plan owns 25% or more of an entity, there is plan asset look-through. I know you have a scrunched up face right now because the second rule seemingly makes the first rule unnecessary. This second rule isn’t hard and fast like the first rule. This rule does not apply if you have an “operating company”.

What is an operating company?

This is where the fun starts.

An operating company is one that primarily makes or sells a product or service other than the investment of money.

A real estate operating company is one where at least 50% of its assets (valued at cost) are invested into managed real estate or real estate development, provided that the entity is directly engaged in the management or development activities.

So, back to plan asset look-through… If you have an operating company, the there is only look through if a plan owns 100% of the operating company. If you don’t have an operating company, there is look through if the plan owns 25% or more of the company.

At first glance you may think “wow, there are some major benefits to investing in an operating company”. I partially disagree. Firstly, your plan is intended (more…)