Real Estate Investing with Solo 401k
Many mistakenly believe that their retirement accounts must only be invested in stocks or mutual funds. Not so!
The IRS has always permitted real estate to be held inside retirement accounts. The IRS rules allow you to engage in almost any type of real estate investment, except those involving a disqualified person. Investing with the Solo 401k in real estate is fully permissible under the Employee Retirement Income Security Act of 1974 (ERISA).
Real estate investment types
- Single family rental property
- Commercial property
- Apartments
- Townhomes and condos
- Mobile homes
- Real estate purchase options
- Mortgage notes
- Tax deeds & tax liens
Benefits of using a Solo 401k to purchase real estate
All income or gains generated by investing with a Solo 401k are tax-deferred or tax-free for Roth. Tax-deferred means that taxes are paid at a future date, instead of the year that investment income is realized. The Solo 401k allows you to invest tax-free and, in most cases, defer paying taxes, which allows your retirement funds to grow tax-free.
Investing in real estate is quick and simple
Investing with the Solo 401k in real estate is a similar process to buying real estate personally
- Set-up a self-directed Solo 401k with Sense Financial
- Identify your investment and conduct due diligence on the property to ensure it fits your criteria
- Purchase investment property with the Solo 401k as the trustee of the plan – no need for custodian approval
- Title all investment property and transaction documents in the name of the Solo 401k
- Sign the property investment documents as trustee of the Solo 401k
- Pay all expenses of the investment property from the Solo 401k
- Deposit all rental income directly into the Solo 401k bank account, not into your personal accounts
- All income or gains from the investment flow into your Solo 401k tax-free!
Organizing the transaction
There are several ways you can organize the transaction when using your Solo 401k:
- Use your Solo 401k funds to make 100% of the investment
You can make the purchase outright in your Solo 401k if you have sufficient funds to cover the entire real estate purchase, closing costs, taxes, fees, and insurance. All ongoing expenses related to the real estate investment must be paid out of your Solo 401k bank account. In addition, all income or gains related to your real estate investment must be returned to the Solo 401k bank account.
- Partner with family, friends, or colleagues
Your Solo 401k can also purchase an interest in the property along with a non-disqualified person, such as certain family members, friends, or colleagues. This option can be used if you don’t have sufficient funds in your Solo 401k to make the investment outright.
For example, your Solo 401k could partner to purchase a piece of property that is $100,000. Your Solo 401k could purchase a 50% interest in the property for $50,000, and your family member, friend, or colleague could purchase the remaining 50% for $50,000.
All income or gain from the property would be allocated to the parties in relation to their percentage of ownership, e.g. 50-50 in the above example. Likewise, all property expenses must be paid in relation to the parties’ percentage of ownership in the property. Based on the above example, for a $1,000 property tax bill, the Solo 401k would be responsible for 50% of the bill ($500), and the family member, friend, or colleague would be responsible for the remaining 50% ($500).
- Borrow money for your Solo 401k
You may obtain non-recourse financing for a real estate purchase using a Solo 401k, if financing is needed.
A prohibited transaction is a transaction that directly or indirectly involves the loan of money or other extension of credit between a plan and a disqualified person. Normally, when an individual purchases real estate with a mortgage, the traditional loan provides for recourse against the borrower (i.e., personal liability for the mortgage).
However, if a Solo 401k purchases real estate and secures a mortgage for the purchase, the loan must be non-recourse. A non-recourse loan only uses the property for collateral. In the event of default, the lender can collect only the property and cannot go after the Solo 401k itself.
Unlike a self-directed IRA LLC (or Checkbook IRA), a Solo 401k would not be subject to Unrelated Business Income Tax (UBTI) when using non-recourse leverage as part of a real estate transaction. This is pursuant to Internal Revenue Code Section 514(c)(9). UBTI imposes a tax in the range of 35% on all income and gains relating to the debt-financed portion of the investment.
Rick Bartosik
May 10, 2017 @ 7:54 am
Good morning. My wife and I are interested in purchasing real estate through our solo 401k plan. Our goal is to buy land that could be used as a retirement home in the future or a safe haven investment. We do not have plans on creating a rental position strictly ownership for future use. Could we use our plan for this purpose or does the property need to generate revenue back into the plan as a rental, etc? Thanks.
Dmitriy Fomichenko
May 11, 2017 @ 12:21 pm
Rick, you can buy a land in your Solo 401k plan that can be used in the future to build a retirement home on. I don’t see how you can rent out just a land without a house so just holding on to it as an investment is fine. However, before you can start using property personally you would have to distribute it out of your 401k as “in-kind distribution”.