Retirement-plan borrowing

I am considering the purchase of some apartments in my town to hold as rental property. While I can get financing elsewhere, I would prefer to borrow from my corporate retirement plan, so that I will be paying interest to myself. My accountant disagrees. What do you think?

Charles Blair, DDS

John McGill, MBA, CPA, JD

I am considering the purchase of some apartments in my town to hold as rental property. While I can get financing elsewhere, I would prefer to borrow from my corporate retirement plan, so that I will be paying interest to myself. My accountant disagrees. What do you think?

We agree with your accountant. Borrowing from any type of corporate retirement plan should be the last, rather than the first, resort. While it is true that you are paying interest to yourself, you are overlooking the fact that the funds loaned out will not be available for investment. In recent years, doctors who have invested well have achieved a much higher rate of return than the interest that would be charged on the loan to you. As a result, your retirement-plan balance would grow less rapidly if you were to enter into the proposed loan arrangement.

Tax considerations also dictate against retirement-plan borrowing. Interest paid by a plan that is owned by a key employee is not deductible. Furthermore, the loan must generally be repaid over five years, a term that is shorter than what would be required from a commercial lending institution. More importantly, if the loan is not repaid exactly as agreed, you can be hit with tremendous tax penalties.

In a similar situation, a doctor borrowed $340,000 from his corporate retirement plan and used the proceeds to purchase an apartment building. The loan was initially unsecured by any mortgage, although the doctor later agreed to use the proceeds from the future sale of one of the buildings to assure that the loan would be repaid. The IRS audited the plan and hit the doctor with $290,000 of taxable income, in addition to numerous penalties. As a result of these factors, we strongly recommend against retirement-plan borrowing.

I remarried several years ago and moved into my new wife`s home, which we decided to keep titled in her name. This year, we plan to sell this house and build another. I have heard that we will not be able to exclude up to $500,000 of gain on this sale because the house was titled only in my wife`s name. Is this correct?

Assuming that you file a joint tax return, you are eligible to exclude up to $500,000 of the gain, since you both used the home as your principal residence for at least two out of the five years ending on the sale date. Since your wife owned the house for two years or more, it does not matter that the property was not titled jointly.

I own stock in a company that offered me the choice of taking a dividend in cash or in additional shares of stock. I understand that if I take the stock, instead of cash, that I will not have any taxable income. Is this correct?

No. Since you had a choice as to whether to receive cash or the stock dividend, you must pay tax on the shares that you received, based upon their fair-market value at the time of distribution. However, upon a later sale or disposition of these shares, your tax basis (cost) also is equal to the fair-market value of the share at the date of distribution.

If you had not been offered this choice, the stock dividend would have been received tax-free. In that case, however, your tax basis for future sale would not have changed as a result of receiving the stock dividend.

The information provided in this column is based upon the current Internal Revenue Code, regulations, IRS rulings, and court cases as of the date of publication. This column is not to be construed as legal or tax advice with respect to any particular situation. Contact your tax attorney or other adviser before undertaking any tax-related transaction.

Dr. Blair is a nationally known consultant and lecturer. McGill is a tax attorney and MBA. They are the editors of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($155 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217 or call (704) 424-9780.

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