ScaredyCatGuide to the 401(k) - Part 11: Using Your 401(k) to Invest in Real Estate

USING YOUR 401(K) TO INVEST IN REAL ESTATE

Let’s be straight right off the bat. If you are in an employer sponsored 401(k) plan and it is the only 401(k) account you hold then most likely you will not be able to invest directly in real estate.

Please note the word “directly.”

There are some wonderful things the IRS lets us do with retirement investments and as long as you follow all the rules, you can continue to enjoy those tax deferred benefits.

Borrow from yourself with a 401(k) loan

Yes, you can indeed loan money to yourself for the purchase of real estate.

First thing to check is if your employer allows 401(k) loans. If so you are allowed to borrow up to half of your account balance or $50,000, whichever is less.
(*At the time of this writing those limits are temporarily raised as part of the CARES act)

The money can be used as a down payment on an investment property of to buy it outright. Since it is a loan you will need to pay interest to your 401(k) account and the loan must be paid back in five years.

If you have not invested in real estate it may not seem worth it, being the loan has to be paid back in five years. However, experienced real estate investors leverage this option often as it provides them working capital to acquire rental properties.

The five year duration is of no concern to a real estate investor because they will have either sold the home by then or refinanced into a new mortgage, freeing up the funds to pay back the 401(k) loan.

If you would like to learn how invest in real estate the Investing in Rental Properties book in the ScaredyCatGuide series is a great place to start.

USING YOUR OLD 401(K)

Do you have a 401(k) from a previous employer? If so you can open yourself up to a plethora of investment options by rolling it over into a self directed IRA. In chapter 4 we covered the different types of IRA accounts and when it made sense to leverage them.

When holding an old 401(k) you are no longer receiving the benefits of employer matching, being that you are no longer contributing to it yourself. With that lost benefit, why pay fees for a 401(k) plan that also limits your investment options.

By rolling it into a self directed IRA you will can reduce your costs and directly invest in many other assets, including real estate.

Here is a list of approved assets for investment within a self directed IRA:

• Single Family Homes • Commercial Buildings • Mortgage Notes • Raw Land • Tax Lien Certificates • Precious Metals • Privately Held Companies

As you can see from the list there are several real estate related assets accessible for invested with a self directed IRA.

Between saving on fees and having more investment options you can see why it makes sense to rollover old 401(k) accounts. Here is where it gets really exciting though. You are now able to invest in real estate on a tax deferred basis.

For example, if you use the money in a self directed IRA to purchase a rental property a couple of tax benefits are at work.

You do not have to pay tax on the rental income collected
If you sell the property you do not have to pay capital gains

You won’t pay any tax on any of that income or gains until you begin withdrawals on your IRA, and that will be taxed at your ordinary income rate which is often less than capital gains.

But wait, there’s more! (I’ve always wanted to say that). If you do this with a Roth IRA then you never pay taxes on any of that income or capital gains!

Remember, traditional IRAs give you the tax benefit at the time you contribute and then you pay taxes when taking distributions. The Roth contributions are not tax deductible, but you do not have to pay tax on the distributions.

Follow the rules

The most important part is to follow the rules because a misstep will nullify you tax deferred status.

When it comes buying real estate in a self directed IRA it needs to be purely for investment purposes. Meaning there cannot be personal use of the property. You also cannot buy a property with your IRA that you or a relative already own.

The property and expenses must be paid for directly from the IRA. If the roof needs to be replaced for example, the check needs to come from the IRA account.

Any rental income needs to be paid directly to the IRA, not you.

As you can see the rules are not overly complicated, but one harmless mistake could lose you a lot of money in tax benefits so make sure you are aware of them all.

There are fiduciaries and investment advisors that specialize in 401(k) account rollovers and using IRAs to invest directly in assets like real estate. I highly suggest leveraging their services and rolling the account over to their firm as they can ensure all rules are met so you may enjoy those tax benefits.

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