One of the most popular questions clients often ask us is whether they can invest in real estate with a 401(k). While there are several real estate securities that can be purchased on an exchange, there is no true way to invest in real property without self-directing your retirement account. This guide will show you the steps required to rollover and invest in real estate using your 401(k).

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

Unfortunately, you can’t invest in real estate with a standard 401(k). Instead, you’ll need a retirement account that’s designated as “self-directed.”

With a self-directed retirement account, you can invest in real estate and other alternative assets, like raw land, mortgage notes, tax liens, and wholesaling. There are two primary ways to invest in real estate with 401(k) funds.

Option #1: Open a Self-Directed 401(k)

If you have a 401(k) through your employer, you can choose a self-directed 401(k) option if your employer offers it. This will enable you to invest in alternative assets not available to standard 401(k) accounts. Additionally, if you are self-employed or a business owner with no employees, you can open a self-directed solo 401(k).

Option #2: Rollover funds to a Self-Directed IRA

If your employer doesn’t offer a self-directed 401(k) option and you aren’t eligible for a solo 401(k), you can open a self-directed IRA (SDIRA). Once opened, you can roll over funds from an existing 401(k) or other eligible retirement plan and begin investing in real estate through the SDIRA.

Both self-directed 401(k)s and SDIRAs are set up through a custodian, like Horizon Trust. The custodian holds assets and plays an administrative role, but they are not responsible for choosing or otherwise guiding your investments.  With a self-directed retirement account, you decide when and how your funds are invested.

Pros and Cons of Investing in Real Estate with a Retirement Account

If you’re considering a real estate 401(k) or IRA, some benefits and drawbacks can determine if it’s fit for your retirement goals

Pros

Tax-deferred growth

Whether you’re planning to flip a piece of property or use it to establish rental income, your earnings, including capital gains, can grow tax-deferred in your account. This provides a level of long-term growth unmatched by other real estate investment methods.

Stability in volatile markets

When compared to other assets, such as stocks and bonds, real estate is a far less volatile asset and not as vulnerable to fluctuating markets. Property in your retirement account can act as a failsafe that weathers market upheaval.

Passive earnings

Property purchased to rent or lease can yield a passive income, as tenants make regular payments that are deposited directly into the retirement account. The passive earnings are tax-advantaged and allow for consistent growth with compound interest.

Maximize growth potential without exceeding contribution limits

The IRS limits the amount of contributions you can make to a 401(k), which can stifle your ability to scale your account to meet your goals. This is particularly true for SDIRAs, which have significantly lower contribution limits when compared to 401(k)s. However, earnings from real estate 401(k) or SDIRA assets are not considered contributions and are, therefore, not limited.

Cons

You can’t use the property for personal benefit

The IRS forbids disqualified persons from directly benefiting from assets held in a self-directed account.  In the context of real estate, that means you can’t live in or otherwise use a property held in the account.

For instance, if you invest in a vocational rental property, you can’t spend any time vacationing there. Likewise, if you invest in commercial space, you can’t have a storefront or office space in that building. This is also true for any disqualified person, including ascendents, descendants, and your fiduciary account.

No immediate access to cash flow

All earnings related to a 401(k) real estate holding must go back into the retirement account. That includes rent payments and any capital gains earned from a sale.  If you’re of retirement age, you can withdraw from the account, but you cannot take direct possession of the funds.

Funds can’t be accessed directly until retirement

When you invest in real estate with a 401(k) or SDIRA, all earnings, including rent or capital gains from a sale, must go back into the account.  If you’ve reached retirement age, you can withdraw them penalty-free. For traditional 401(k)s or SDIRAs, income taxes are deducted upon withdrawal.

How to Purchase Real Estate with a Self-Directed Account

When you purchase real estate with a self-directed retirement account, it’s the account — not you — purchasing the asset. As such, IRS law prohibits you from using your personal funds, such as those from a savings account, to complete the purchase.

Here are the most popular methods for investing in real estate with your self-directed account.

Direct purchase

If you have enough money in your retirement account, you can purchase the property outright. This is the ideal option, as the asset is fully owned by the retirement account, which can help you avoid certain types of taxes and increase liquidity should you wish to sell it.

Rollover funds from an existing account

If you have a standard 401 (k), you can roll those funds into a self-directed 401(k) or IRA to complete the purchase. Keep in mind that the accounts should be similarly structured so that funds from a traditional 401(k) are rolled into a traditional solo 401(k) or SDIRA.  Accounts with a Roth designation should be rolled into the equivalent solo 401(k) or SDIRA.

Partner with another self-directed retirement account holder

If you know another investor with the same type of self-directed account as you, you can partner with them to purchase a real estate property. Earnings would be split based on ownership. For instance, if your accounts each own 50% of the property, you’d each receive 50% of the earnings.

Get a non-recourse loan

If you don’t have enough funds to purchase a property and can’t or are unwilling to partner with another investor, you can finance the property via a loan. To finance a real estate 401(k) purchase, you must apply for a non-recourse loan.

A non-recourse real estate loan is secured only by the property for which it is used. If you default on the loan, the lender can take possession of the property but not the other assets held in your retirement or personal accounts.

If you purchase a property with a non-recourse loan, income from the property is considered unrelated debt-financed income (UDFI) and subject to unrelated business income tax (UBIT).  To avoid or limit this tax obligation, it’s best to pay off the non-recourse loan as quickly as possible.

Using Leverage to Invest in Real Estate

Larger investment properties can yield higher returns and set you up to make more lucrative investments down the road, but what if you don’t have the funds available? Using leverage to invest in real estate refers to the practice of borrowing money to make those larger purchases.

As discussed above, you can do this via a non-recourse loan that allows you to purchase beyond your account balance. The concept hinges on the notion that your real estate investment will appreciate over time via increased property value or ongoing rental income (or both).

Despite its benefits, using leverage is not without risk. If your property decreases in value, you may find you owe more than it’s worth. As with any real estate venture, always complete due diligence before moving forward with a purchase, whether using leverage or otherwise.

Streamlining Investments with Checkbook Control

One of the most attractive aspects of a self-directed retirement account is that you are in the driver’s seat, deciding when and how you invest your money. But even a self-directed account requires you to process investments through the account custodian. Fortunately, you can take even more control of your self-directed retirement account through checkbook control.

Checkbook control is established when you open a self-directed retirement account in the name of a limited liability company (LLC). In a checkbook-controlled account, you act as the account manager and gain the ability to write checks directly from the LLC’s bank account to make investments. In doing so, you can bypass your self-directed account custodian, making purchases and managing deposits as needed.

For real estate 401(k)s and SDIRAs, checkbook control makes it easy to purchase property quickly and efficiently.  It also makes it easier to manage properties, as you can easily access account funds to pay for property-specific expenses like property management, repairs, or renovations.

FAQs

What types of real estate investments can be made within a 401(k)?

You can use 401(k) funds to invest in multiple types of real estate, including:

• Residential property, including single and multi-family properties.
• Commercial buildings, such as office space and retail buildings.
• Industrial properties, like warehouses and manufacturing facilities.
• Raw or undeveloped land.
• Real estate investment trusts (REITs)
• Mortgage notes and deeds of trust.

Are there tax implications for investing in real estate within a 401(k)?

Yes, there may be tax implications for investing in real estate with a solo 401(k), especially if you use a non-recourse loan to finance part of the purchase.  Earnings from a financed real estate property held in your 401(k) are considered unrelated debt-financed income (UDFI) and subject to unrelated business income tax (UBIT).