If you create a self-directed individual retirement account by establishing a solo 401(k) or Roth Solo 401(k), you can use it to invest in real estate. This particular self-directed 401(k) was created by the IRS for those individuals who are self-employed, small business owners with no employees outside of themselves and a spouse, or for people who consistently generate a part of their income through self-employment. This 401(k) does not refer to the traditional, employment-sponsored 401(k) as that cannot be directly used to invest in real estate.
If this applies to you, read ahead to learn how you can make a solo 401(k) work for you.
How to invest in real estate with a Solo 401(k):
Begin by opening a solo 401(k) account. Your account name will be the one associated with all purchase-related documents and not your personal name. Then you can transfer funds through rollovers, a pre-tax deposit, or transfers from qualified accounts that you already have.
After that, you have a few options for buying properties. You can purchase real estate from there by using funds solely from your Solo 401(k). If you want to utilize personal funds along with funds from your Solo 401(k), this can happen through a tenants-in-common (TIC) purchase. This allows for partnering up with individuals with other retirement accounts that are considered “disqualified persons.” Or you can utilize a non-recourse loan to help fund your real estate investment.
Once you make an offer, you must make certain that your solo 401(k) is the sole buyer of the property, and once closed, you must submit all purchase documents to your escrow agent.
Pros:
There are lots of advantages to investing with a self-directed solo 401(k) that make it easier and relatively hassle-free in comparison to other options.
One of the main differences between purchasing real estate with a solo 401(k) versus an IRA is that the UBTI tax that may apply to profits made on IRA-financed properties isn't applicable to solo 401(k) loans. If eligible, this can be a substantial tax benefit.
A solo 401(k) is a flexible option. Unlike borrowing from a bank, obtaining a loan from your solo 401(k) does not necessitate a credit check. You can borrow half your balance or up to $50,000. This amount is tax and penalty-free and can be used for whatever purpose, whether business or personal. And since you’re the trustee of the plan, investing can be as straightforward as making a wire transfer or writing a check.
Your profits are tax-deferred, and this can help you grow your savings more quickly. When you use your solo 401(k) to invest, the tax-deferred profits offer larger funds that you can utilize in future investments.
Since the solo 401(k) plan itself can take ownership of purchased property, you do not necessarily need an LLC to buy real estate with your solo 401(k) plan. However, being the manager of an LLC that owns the property under a solo 401(k) plan can offer some additional asset protection and give you more control over your real estate investments. This can be particularly helpful if the property you purchase is out of state. In that case, be certain to take a look at the key state laws.
Cons:
The most important thing is to make sure that you remain IRS-compliant with your solo 401(k) plan. Here are some tips:
- Keep exact records of income and expenses. It can help to segregate your funds to keep your books looking more transparent.
- All expenses used in deposit, purchase, and expenses need to go through your 401(k) account. Keep an adequate amount of money in your account as needed, as you should not use personal funds from a disqualified person. If additional funds are needed, you should borrow from the retirement account or a non-disqualified person.
- If you’re not careful to be compliant, you could be fined by the IRS, so be sure to commit due diligence on your transactions and carefully research which parties you utilize to fund your investments.
Utilizing retirement funds to invest in real estate provides numerous benefits. It offers protection against inflation, investment diversification, and helps you generate tax-free and tax-deferred income and gains. While the self-directed solo 401(k) may not be a feasible option for every investor or business owner, it can be a versatile retirement account for anyone looking to utilize an IRA to invest in real estate.
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