Real Estate Investing with your 401k
Real estate has long been one of the primary investment types, and it’s no surprise why.
Real estate has had consistent growth over the last century- even including the housing bubble - and investing in real estate offers diversification from the volatility of the stock market and inherent protection from the threat of inflation.
But why would I invest in real estate with a retirement account when I can do it with my own money directly?
If you purchase property using personal funds, the gains are subject to federal income tax and usually state tax as well.
However, with a Solo 401k, all gains from that real estate investment are tax-deferred, making any real estate investment more powerful as the gains can be reinvested without first being reduced by taxes.
It’s true that you can invest in real estate with some other retirement accounts (although most don’t allow it), but those that do allow it don’t offer the features and benefits of a Solo 401k.
A Solo 401k offers several great features that make investing in real estate easier and more hassle-free:
Unlike an IRA, You Don’t Need a Custodian: With an IRA account you need to go through a custodian to invest in real estate. And IRA custodians charge hefty fees for this service. Typically, an IRA custodian will charge you both a fee to purchase the property as well as annual percentage fee based on the value of the property for as long as you own it.
But with a Solo 401k a custodian isn’t required to purchase or hold real estate. This saves you a significant amount of money.
You Have Checkbook Control: If you purchase real estate with an IRA the custodian must issue all payments related to the property. Yes, even the bill from your gardener. And of course, they charge you for this, too. But With a Solo 401k you have checkbook control. This means you can issue payment for any services required to maintain or enhance your investment without the cost or delays of an intermediary.
Solo 401ks are exempt from UBIT/UDFI: if you purchase real estate with an IRA and use a mortgage to finance the transaction, the gains on the asset will be taxed under an obscure tax called Unrelated Debt Financed Income (UDFI). And the UDFI tax is a heavy tax at nearly 40%. So for example, if you paid 30% of the purchase price with IRA funds and used a mortgage for the other 70%, then 70% of the returns will be taxed at nearly 40%.
In stark contrast, a Solo 401k is not subject to UDIF taxes when investing in real estate using a mortgage.
- You can take advantage of non-recourse business loans: Non-recourse business loans are another big reason to invest in real estate with a Solo 401k. That’s because using a non-recourse business loan to purchase investment property with your Solo 401k protects your Solo 401k assets from being touched (we’ll talk more about how later).
All things considered, the Solo 401k is an ideal real estate investment vehicle in virtually every way, eliminating the hassle which typically applies to investing in real estate with a retirement account as well as affording advantages when compared to investing directly with personal funds.
How to invest in real estate with your Solo 401k
Investing in real estate with a Solo 401k is simple and straightforward, but it’s important to know the proper procedure for purchasing investment property with your Solo 401k plan.
There are basically 6 steps to purchasing real estate with your Solo 401k:
1. Open your Solo 401k account
It might seem obvious to first open your Solo 401k account, but it’s easy to bypass this step and assume you can begin the real estate purchase process and open the account later on down the line.
The reality is, because the purchase is technically being done by the Solo 401k and not you personally, you need the name of the Solo 401k plan for any purchase-related documents. If you don’t have it, you can’t complete any associated paperwork.
So, make sure to set up your account first.
2. Fund your Solo 401k bank account
Next, simply fund your new Solo 401k account. This can be done through a variety of methods, including:
- A contribution
- Rollover (via a Roth or pre-tax IRA)
- Or a transfer from another qualified plan such as a 401k
3. Decide how you’re going to purchase the property
There are three ways you can go about purchasing real estate investment property with a Solo 401k, each with their own unique benefits and conditions:
- Solo 401k cash purchase (basic): Transaction using all cash, no loan.
- Tenants-in-common (TIC) purchase: Transaction also using all cash, no loan, but with a portion being personal funds so that both you personally and your Solo 401k plan own a percentage of the property (we’ll talk about why this is advantageous in a minute).
Non-recourse business loan: Transaction using a non-recourse business loan to pay all or a portion of the purchase price of the property.
A Solo 401k cash purchase is simply an all-cash purchase using your Solo 401k bank account. Nothing more to it.
A tenants-in-common purchase allows you to split the purchase of real estate with both your personal funds and Solo 401k funds. In accordance with this, any investment income and expenses associated with the property with be shared based on said ownership percentage.
Why wouldn’t you just deposit into your Solo 401k to do a typical cash purchase? A tenants-in-common purchase offers the great benefit of being able to invest your Solo 401k with family such as your spouse, children, or siblings.
The one caveat is that a tenants-in-common purchase cannot use debt or a mortgage to finance a property.
Lastly, a non-recourse business loan allows you to take a loan out to help with the purchase of the investment property.
The great thing about this option is your assets are protected in case of a default or bankruptcy. If this were to happen, the lender is not allowed to touch said Solo 401k funds and can only take the Solo 401k-owned property to settle the debt.
4. Make your offer (with Solo 401k-listed documents)
Now, it’s time to make your offer.
Your Solo 401k is the buyer, so it’s important at this point to keep in mind that any and all paperwork filled out in connection with the purchase needs to list the Solo 401k plan itself as the buyer. For example: Jane Smith’s Solo 401k trust.
Listing your personal name on any Solo 401k real estate purchase-related documents is prohibited.
5. Make a deposit
This is as simple as it sounds: Because your Solo 401k plan is purchasing the property, the Solo 401k itself is required to pay the deposit.
So, make a deposit into the account (if it isn’t already funded with enough from earlier) to cover the real estate purchase deposit and any other necessary funds.
6. Complete the closing process
Lastly, as trustee of your Solo 401k plan, sign and submit all purchase-related documents to the escrow agent along with a check written from the Solo 401k bank account for the purchase amount.
Also, as trustee of your Solo 401k plan, it’s important to keep a copy of the below documents somewhere safe:
- Copy of the loan documents (if you purchased the property with a non-recourse business loan)
- Escrow instructions
- Purchase contract
- Settlement agreement
- Preliminary deed
A note on expenses
It’s important to keep in mind that both during the process of purchasing real estate investment property as well as while maintaining it, all expenses in connection with the Solo 401k investment must be paid for using funds from the Solo 401k bank account. Paying expenses with personal funds is prohibited.
However, the great thing is, with a Solo 401k it’s just as easy as if you were to pay these expenses with a personal account.
That’s because, by being able to bypass custodian approval, paying expenses with your Solo 401k is as easy as writing a check. In contrast, with other retirement accounts, you need to go through the hassle of paying custodian fees and waiting for custodian approval on each and every transaction, even small monthly bills and irregular expenses like upkeep and maintenance (yes, really).
Add the power and diversity of real estate to your portfolio with a Solo 401k
With the ability to bypass custodian approval, non-recourse business loans, and tax advantages a Solo 401k is the ideal vehicle for investing in real estate.
Opening a Solo 401k plan was once cumbersome and time-consuming, but now, with Maverick, your end of the setup process has been simplified and can even be completed entirely online (we take care of the rest).
So, if you’re ready to begin taking advantage of the benefits of investing in real estate with a Solo 401k, click here to set up an account.
And if you have any questions at all, contact us here and we’ll be more than happy to help.