When we say you can “invest your 401(k) in real estate,” it does not refer to the traditional, employee-sponsored 401(k). You can invest your 401(k) in real estate only when you establish a Self-Directed 401(k)/Solo 401(k) or a Roth Solo 401(k).
The IRS created Self-Directed 401(k), also known as the Solo 401(k) to aid the following group of people:
However, if you use your 401(k) to invest in real estate, you cannot:
Let’s understand this with an example. Let’s assume that you bought a small property for $120,000 using your Solo 401(k) plan, and that property is rented out for $2,000 for a month ($24,000 a year)
Although you are getting a great return on your investment, you cannot legally use this money for your own benefit. This income has to be returned to your 401(k) plan. Whatever property expenses you incur, such as maintenance, repairs, etc., also has to be paid with the funds in your 401(k).
With a Solo 401(k), you have a wide array of real estate options that you can select from – raw land, residential property, commercial property, private mortgages, and tax liens. You can also choose to buy a home in a place where you’d like to live post-retirement. If the price of the property you wish to buy is more than the money you have in your Self-Directed 401(k) account, you can choose to borrow the balance required through a non-recourse loan.
When investing a Solo 401(k) plan in real estate, you need to follow a set of sequential steps depending on the real estate method you use:
Since your Self-Directed 401(k) is going to purchase the property, there are certain rules you need to comply with. You have to use the funds from your Solo 401(k) to pay ALL fees, including the escrow deposit.
There are various ways to fund the solo 401k plan: annual contributions, transferring funds from other qualified plans, and direct rollovers from retirement plans, such as traditional IRAs, SIMPLE IRAs, and SEP IRAs.
There are typically four methods of investing a Solo 401(k) plan in real estate. They are as follows:
However, each method of investment has its own set of rules. To learn more about each of these four real estate investment methods using Solo 401(k) funds, read this.
When you are putting together a purchase offer, ensure that you list the Solo 401(k) as the buyer. Always keep in mind that your Solo 401(k) is a separate entity/investor, and your Solo 401(k) is the buyer, not you. In all the property purchase documents, the Solo 401(k) must be listed.
The earnest deposit must be made using the Solo 401(k) funds and not your personal funds. Remember, it’s not you nor your business that is investing in the property; it’s the Solo 401(k), and the IRS wants the earnest deposit to be made using the funds in the Solo 401(k).
During the closing, you, being the trustee of the Solo 401(k), will sign and approve the property purchase documents and then submit them to the closing agent enclosing a check or wire for final funding from the Solo 401(k) bank account.Once the property purchase is closed, you being the trustee of Solo 401(k) has the following responsibilities:
The IRS provides a list of approved investments for Solo 401(k) plans, but the Employee Retirement Income Security Act of 1974 (ERISA) contains certain rules that apply to sol0 401(k) investments.