Using a 401(k) to Invest in Real Estate

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Using a 401(k) to invest in real estate is allowed as long as the plan document is written to allow that asset. Using a Solo 401(k) to invest in real estate is a powerful combination because 401(k) plans are typically exempt from UBIT incurred by UDFI.

What is a Solo 401(k)?

A Solo 401(k), also known as a Solo 401(k), operates essentially in the same way that a 401(k) offered by a large employer does. The official IRS designation for this type of account is a One-Participant 401(k) plan. A Solo 401(k) differs from major employer plans in that it’s specifically for companies whose only employee is the owner (although spouses may be eligible).

A Solo 401(k) boasts many features that are not offered by other IRA structures. This blog will give you a better sense of the advantages of using a 401(k) to invest in real estate, and how these advantages can benefit you and your real estate investing goals.
Large Contribution Limits

A Solo 401(k) provides investors with the opportunity to defer substantially more income annually than a Traditional or Roth IRA. In 2016, the contribution limits for a Traditional and Roth IRA are $6,500 (if you are under 50 years old). In comparison, the contribution limits for a Solo 401(k) are up to $53,000 ($59,000 if you’re over 50).
This contrast in contribution limits can make a difference in a retirement investor’s real estate investment options. Larger contributions annually mean access to larger properties or multiple properties that will potentially provide higher returns.
Tax-Deferred or Tax-Free Growth

One advantage of utilizing retirement account funds for real estate is receiving the benefit of tax-deferred growth. As cash is invested into a 401(k), it grows without taxes. When paying the full purchase price for real estate using 401(k) cash, investors don’t have to worry about depreciation or investment expenses, because there are no taxes on growth.
Additionally, when the plan sells the investment property at a later date, investors don’t have to concern themselves about capital gains or the need for a 1031 exchange. The tax advantages enjoyed by 401(k) owners can create a dramatic snowball effect of growth over time.
Special Tax Treatment on UDFI (Unrelated Debt Financed Income)

All retirement plans can seek out a non-recourse mortgage to increase the purchase power of the plan assets. Lenders will usually look for down payments between 30-40%.

Normally with an IRA, profits generated from debt-leveraged financing are subject to unrelated business income tax (UBIT). This special tax is the IRS’s way of leveling the playing field for tax-advantaged entities utilizing leverage and investing in ongoing business activities. However, UBIT associated with UDFI does not apply to Solo 401(k)s. Self-employed real estate investors can benefit from additional tax savings under the Solo 401(k) structure when leveraging retirement dollars.

It’s important to note that the 401(k) structure is not exempt from UBIT when it comes to unrelated business taxable income (UBTI), which is derived from an operating business. Continuous fix-and-flips may constitute an operating business, and may therefore be subject to UBIT as a result. At this time, there are no IRS rulings that clarify whether a second, third or twentieth flip constitutes an operating business. It’s best that you consult an experienced ERISA attorney for advice.
Fewer Investment Restrictions

Many brokerage houses offer Solo 401(k) plans for little to no cost. The pitfall of owning retirement plans with a traditional provider is the asset options are typically restricted to traditional publicly-traded securities. This means being unable to invest a Solo 401(k) in real estate. Make sure to adopt plan documents that are written to give you the flexibility to invest in alternative assets.

To invest in real estate with your Solo 401(k), choose a provider that has experience with real estate and a long track record of successful on-time closings. If you’ve already created a Solo 401(k), check with your provider to learn about any investment limitations. You can always perform a restatement of plan documents, which means replacing your existing Solo 401(k) plan documents with new documents that allow you to invest in anything allowable by law.
Using a 401(k) to invest in real estate offers account holders many unique benefits. Feel free to contact New Direction IRA to learn more and to start investing for retirement with tax-advantaged savings!

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