Real Estate Buyer Tip: How To Use Your IRA & 401(k) With Tax Benefits

It’s easier than you think to use a self-directed IRA or 401(k) to invest in real estate.

When you have a self-directed 401(k) (SD 401(k)), particularly a Solo 401(k) for self-employed individuals, you can take advantage of the tax-advantaged retirement savings accounts to buy and sell real estate.

Before we delve into the details and explain how to utilize an IRA and 401(k) for purchasing real estate, please note that we do not provide financial advice.

The following content is informational only, and we recommend seeking professional advice from a registered accountant or financial advisor.

IRA and 401(k)

With either an IRA or 401(k), you’re holding assets until you reach 59½. These plans aim to save for retirement, and employers can contribute by matching your contributions.

A 401(k) is an employer-sponsored super plan. If you’re self-employed, you can set up a self-directed or solo 401(k) plan.

There are contribution limits – currently, it’s up to $23,500 annually. However, if you’re over 50 years of age, you can receive $7,500 or up to $34,750 if you’re aged between 60 and 63.

An IRA is an individual retirement account, and you set this plan up with a licensed provider, such as a bank or credit union, or indirectly through a brokerage.

There are no employer contributions to an IRA unless the plan is a SEP or Simple IRA.

Self-Directed IRA

With a self-directed IRA, there are specific rules you need to follow when you are buying real estate.

Rules you need to follow

• The real estate owned using your IRA must be a purely investment property. You or your family members cannot use it for personal reasons whatsoever. For example, you can’t invest in a vacation rental home and use it when it’s unoccupied.
• You cannot pay for the property expenses through your account; they must be paid through the IRA.
• You cannot use your personal belongings/possessions in the property.
• Income generated by the real estate must be paid to the self-directed IRA and not to you.
• You cannot use your self-directed IRA funds to buy property from yourself or a family member.

401(k)

If you have an employer-sponsored 401(k), participants can not invest in properties or participate in crowdfunded real estate investments.

If you have an active 401(k), your options for investing in real estate using it are limited because you are still working for the sponsoring employer.

Old 401(k)

However, if you have an old 401(k), your options for investing in real estate are much better.

You can roll over your former employer’s 401(k) account into a self-directed IRA and use the funds to invest in real estate.

If you’re self-employed, you have yet another option.

Self-employed professionals have several other retirement plan options, including SEP-IRAs and SIMPLE IRAs.

Solo 401(k)

A solo 401(k), owned by a self-employed individual, can be rolled over into a self-directed solo 401(k) plan. These plans are offered by the same custodians that provide self-directed IRAs.

The rules and procedures for investing in real estate using a self-directed 401(k) are the same as with an IRA. However, there is one big difference: the IRS provides a specific exemption for 401(k)s – the UBTI tax that applies to profits generated by IRA-financed real estate does not apply to solo 401(k) loans. This is a significant tax benefit. So, if you are eligible for self-directed 401(k), use it to buy real estate.

Steps to Invest in Real Estate Using Your IRA and 401(k)

1. Eligibility

Verify if your 401(k) and IRA are eligible for real estate investment and learn the steps required to utilize your funds for property purchase.  If not, set up the accounts.

2. Open Account

Most IRA custodians do not allow real estate investments; if that’s the case, open your own self-directed IRA at a financial services firm that permits such investments.

3. Rollover

Employer-sponsored 401(k) doesn’t allow you to invest directly in real estate. Consider rolling over your 401(k)  into a self-directed IRA and then using the funds to invest in real estate.

4. Buy an investment property

Take your time to find a suitable investment.  Consider commercial, residential, or even land notes.  The asset must be bought through the IRA or 401(k).

5. Follow the rules

Your family or friends can not use the property.  The asset must be kept at an arm’s length.

6. Property Management

All transactions and accounting of income and expenses, including maintenance, management, tax, and insurance, must be in the plan’s name and bank account.

Hire a property manager to manage and provide accounting records on your behalf.  Use an online accounting program to track cash flow and profitability.  If you sell your real estate assets, the funds remain in the IRA or 401(k) until you reach retirement age.

Final Words,

Using your 401(k) or IRA to invest in real estate has tax advantages.  You need either a self-directed 401(k) or a self-directed IRA.  Like all things related to finances, there are complexities and compliance requirements.  Engage a professional advisor or accountant before taking action.