I'm a little behind on my blog, so I'm going to answer all of Durga's questions at once. I hope you are reading this, Durga.

Q1: If I borrow from 401k to purchase my first home, would I owe tax to IRS when I sell the property with capital gain?

A1: There is no tax due from borrowing, whether from your 401(k) or from a bank. Plus, when you sell your primary residence, there is no tax so long as the gain is less than $250,000 if you are single, or $500,000 if you are married.

Q2: If I borrow from my 401k and buy a property for rental income, the income is taxed at favorable rate not ordinary rate? I do lose the tax benefits due to depreciation, don't I? How is the capital gain taxed if I plan to sell the property or do 1031 exchange? What is the plan of action needed in place if I plan to borrow from 401k to purchase my 1st investment property? I currenlty own one house. What are the disadvantages? Would you advise to go with the plan?

A2: As I mentioned in A1 above, there is no tax on borrowing from a 401(k). Since you are buying the property outside of the 401(k), you receive all of the tax benefits of ownership, including depreciation and the possibility of doing a 1031 exchange. I like this strategy for using funds from a 401(k) so long as you have the education necessary to make a good property investment.

What I don't like is buying rental real estate inside of an IRA. You are likely to lose leverage and some of your income from the real estate may actually be taxed to the IRA (due to using leverage inside of an IRA). In addition, you lose all of the tax benefits of owning real estate and when you withdraw the earnings, they are subject to ordinary income tax rates and a 1031 exchange doesn't do you any good.

Q3: How soon can one close any kind of entity if needed? Is there a time limitespecially if you are in CA that has minimum tax for LLC? Can you convert from one entity to another easily? If yes, how many times?

A3: You can close down an entity pretty much at any time. There may be tax consequences to doing so, so be sure to meet with your tax advisor ahead of time to discuss your strategy for closing down the entity. In California, I suggest you form your entity in Wyoming and register it to do business in California if you are planning to move to another state so you can take your entity with you and not have to continue paying the $800 minimum tax.

Converting from one entity to another is possible in most states. For example, most states now allow you to convert from a corporation to a limited liability company (LLC) by filing a simple form. Remember that you also have to make the proper tax elections, so be sure to work with your tax advisor on this.

Warmest regards,

Tom