A 401(k) can bring financial security to your later years, but how much wealth you can accumulate often depends on the assets you hold in your portfolio. While some assets, like stocks, can serve as a foundation, they aren’t always enough to expedite growth.

Real estate can often yield higher earnings at a faster pace, but can you hold real estate in your 401(k)? We’ll help you understand 401k real estate investment, including when and how you can add property to your 401(k) and the pros and cons of doing so.

Can You Invest in Real Estate with a 401(k)?

You can invest in real estate with a 401(k), but only if the account is designated a self-directed 401(k).  The IRS sets specific rules regarding what assets can be held in a 401(k). Standard 401(k)s, frequently offered by employers, limit your investment options to common assets, such as stocks, bonds, and mutual funds.

A self-directed 401(k) allows you to invest in real estate, including residential and commercial properties as well as raw land.  You can also use this type of 401(k) to take advantage of other alternative investments, such as mortgage notes, private equity, cryptocurrency, and precious metals.

How to Invest in Real Estate with a 401(k)

Investing in real estate with a 401(k) is easy if you follow these steps:

1. Open a self-directed 401(k)

To add real estate to your retirement portfolio, you must first open a self-directed 401(k), also known as a Solo 401(k), One-participant 401(k) or Individual 401(k). To open this type of account, you must be self-employed or a business owner with no employees.

You can typically open a self-directed 401(k) at a financial institution or with a custodian like Horizon Trust.

2. Choose Your Investment Strategy

There are many ways you can invest in real estate using your 401(k). The investment path you choose should reflect your short and long-term financial goals, industry knowledge, risk tolerance, and preferred level of participation. Common options include:

Rentals and Leases

Purchasing properties to rent or lease can create a long-term, passive income stream for your 401(k). Self-directed 401(k)s can help both residential and commercial properties, allowing you to choose the type of investment and property management scenario that best fits your goals and account balance.

Flipping

Flipping properties is a common investment strategy among self-directed 401(k) and IRA owners. This strategy allows you to purchase a property, make renovations or improvements that increase the property’s value, and then sell that property for a profit. This can be a lucrative, short-term investment strategy.

Wholesaling

Wholesaling is a short-term investment strategy by which an investor finds a property to put under contract, often at a lower-than-market price, and then sells that contract to another buyer.  Wholesaling investors typically look for deeply discounted properties or those owned by individuals who want to or must sell a property quickly.

Syndication

Real estate syndication allows you to invest in larger real estate assets, such as commercial spaces or apartment buildings, by pooling your funds together with other investors. This method typically includes a syndicator who manages the investment and a group of passive investors who only contribute capital.

This is a popular option among investors who don’t have the funds necessary to invest in large properties or prefer to be a passive investor not responsible for property management.

Using Leverage for Transactions

You can use the funds in your Solo 401(k) to purchase many types of property, but what if your account balance doesn’t cover the cost? As is the case with personal real estate purchases, you can use a loan to finance a portion of the property.

Leverage for real estate transactions typically comes as a non-recourse loan. When you take out a non-recourse, the property becomes the collateral. If you cannot repay the loan, the lender can seize the property, but your personal assets and those remaining in your 401(k) remain shielded.

UBIT and Tax Considerations

Financed properties can generate what’s known as unrelated debt debt-financed income (UDFI). When that financed property is held in a self-directed IRA, its earnings can trigger unrelated business income tax (UBIT). However, 401(k)s are excluded from this tax law, making them ideal for investing in real estate with a non-recourse loan.

Pros and Cons of Real Estate in a 401(k)

Like any type of investment asset, there are benefits and drawbacks to holding real estate in your 401(k).

Pros

• Tax benefits: Income generated by real estate in your 401(k) grows tax-free while in your account.
• Potential for high earnings. Compared to other assets like stocks and bonds, real estate can yield higher returns, including short-term returns netted from flipping or wholesaling.
• Passive income. If you plan to lease or rent a property held in your 401(k), you can gain a stream of passive income as long as the property is in your portfolio and occupied.
• Potential to increase buying power. When you sell property in your account, you can gain an influx of capital that increases your buying power, making it easier to invest in more lucrative or advantageous investment opportunities, often within a shorter period when compared to earnings from common assets.
• Diversification. Real estate allows you to diversify your portfolio with an asset that isn’t dependent on market performance.

Cons

• Difficult to liquidate. While assets like bonds, stocks, precious metals, and cryptocurrency are easy to liquidate, real estate generally doesn’t provide the same level of flexibility.
• Real estate market fluctuations. The real estate market isn’t as volatile as the stock market, but there is always a risk that fluctuations can lead to property depreciation.  This can be particularly troublesome if you’ve financed property.
• Rental/leasing issues. If you plan on renting or leasing property held in your 401(k), you may be vulnerable to issues commonly faced by landlords, including tenant issues, repairs, and long-term vacancies.
• Strict IRS rules and requirements.  The IRS sets very specific rules about property held in a 401(k), and failing to follow these rules can result in penalties. For instance, the account holder or any other disqualified person (e.g., spouses, ascedants, descendants, account fiduciaries) cannot directly benefit from the property. This means you can’t live in or maintain office space in a 401(k) property. The same is true for other disqualified persons.

Real estate investing with a 401(k) is easy and straightforward. To learn more about self-directing your retirement plan, schedule an appointment with a concierge team member at Horizon Trust.

FAQs

How does a self-directed 401(k) differ from a standard 401(k)?

The primary difference between self-directed 401(k)s and standard 401(k)s is the type of assets you can hold in the account. Standard 401(k) assets are limited to those sold on the open market, such as stocks, bonds, and mutual funds. Self-directed 401(k)s can hold a variety of alternative assets, including real estate.

Additionally, self-directed 401(k)s are only available to individuals who are self-employed or business owners with no employees.

What types of investments can I hold in a self-directed 401(k)?

You can hold a wide range of assets in a self-directed 401(k), including:

• Real estate
• Precious metals
• Private Equity
• Mortgages notes and deeds of trust.
• Tax liens.
• Cryptocurrency
• Commodities

What are the contribution limits for self-directed 401(k) plans?

Self-directed 401(k) contribution limits are $69,000 as of 2024. If you’re 50 or older, you can make an additional $7,500 catch-up contribution.

Solo 401(k) account holders can contribute as both an employer and employee. The combined contribution limit of $69,000 is comprised of the following:

• Elective deferral: 100% of compensation/earned income up to $23,000.
• Employer nonelective contributions: 25% of employees’ compensation.

Note that self-employed individuals must use a separate formula to determine their contribution limit. If this applies to you, refer to Chapter 5 of IRS Publication 560, Retirement Plans for Small Business.