As an entrepreneur, I’ve appreciated the ability to save for retirement and invest in real estate with a Solo 401(k). Traditional employer retirement plans have a contribution limit of $20,500 (as of 2022). However, with a Solo 401(k) I can contribute up to $61,000 (as of 2022) towards retirement.
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Then, I can turn around and invest that money into a hotel deal, multifamily syndication, or any other real estate opportunity. Plus did I mention I get to deduct my Solo 401(k) contributions from my taxable business revenue? Now that’s what I call a win-win.
Last year, I lowered my tax bill by 25% by contributing to my Solo 401(k). I also used the funds in my account to invest in a multifamily syndication deal with 354 units. Below is a great article by a guest contributor, Rick Pendykoski. He shares a similar appreciation for a Solo 401(k) and how to leverage it to invest in real estate. If you want to learn more grab a free copy of this book I used to learn more about the benefits of investing with a Solo 401(k).
Steps to Investing In Real Estate with a Solo 401(k)
Investors who mean to diversify their portfolios always look into investing in real estate. Yet a lot of investors are not aware that they can use a retirement account for their investment!
Why Invest in Real Estate?
The real estate industry is enjoying its position as one of the most popular investment options among retirement holders. The IRS has permitted solo 401(k) account holders to make real estate investments, and most retirement investors are attracted to the real estate industry.
Real estate provides a stable income and is one of the most popular ways to expand your retirement portfolio. Apart from this, during the inflation period, the value of real estate often tends to increase. That can be counted as an additional advantage of a real estate investment.
The inflation period is nothing to be scared of; however, it can harm your retirement portfolio. Hence, investing in real estate is known to be far more protective against inflation damage.
If you use your solo 401(k) retirement account to invest in real estate, you get the added tax benefits unavailable to people using personal funds. Through this retirement account, you are deferring tax until you turn about 70 ½. Hence, the beauty of investing with a retirement account remains unmatchable.
What is a Solo 401(k)?
Business owners that do not have employees can open a solo 401(k) retirement account. Compared to other retirement plans, the solo plan has additional benefits like higher contribution limits and self-direct funds for investment.
There are two solo 401(k) plans a business owner can consider:
Traditional Solo 401(k)
Individual retirement plans allow you to invest money with a tax break. When you reach the retirement age, you can start withdrawing the money with a tax deduction based on your income at the time.
The biggest disadvantage here is that you will eliminate all the tax advantages you had during the previous years. However, if you think you will have a lower income tax bracket during your retirement than in your working years, a traditional solo 401(k) is worth thinking about.
Roth Solo 401(k)
With a Roth solo 401k, tax is already deducted from the contributions before hitting your retirement account. Since the funds are taxed, you can withdraw money tax-free after retirement. The withdrawal funds will include contributions and returns received in the account.
How to Invest in Real Estate with a Solo 401(k)
A solo 401(k) plan is a self-directed account that you can use to invest directly in real estate. Investors prefer a self-directed IRA for investing in real estate because gains or incomes from the investment are tax-free.
401k Real Estate Investment Rules
Several rules need to be followed before investing in real estate with a solo 401(k) plan. Here is a list of a few:
- IRA will not permit you to purchase a property you plan to live in. It includes a vacation home as well.
- The property you are investing in should meet the rigid definition of investment property. You or your family member cannot occupy it. It should be strictly an income-generating property.
- You cannot disapprove of the IRA-owned property even if it takes a loss. Plus, if the investment is in a loss, you lose tax breaks.
- People above 70 ½ who want to take required minimum distributions from their IRA need to secure enough cash in their IRA to aid this requirement.
- You cannot work at the property yourself. Even if you are a contractor, it will be considered self-dealing.
- A fair market value of the property should be given to the IRS every year. You must pay expenses from the IRA, and income should be paid to the IRA.
Methods to Invest in Real Estate from 401(k)
There are four methods by which you can make a real estate investment with your solo 401(k) account.
- Cash: With cash, you own the property without owing anyone money. However, if you are going all cash, the property title should be in your plan’s name.
- Debt: A debt financing or non-recourse loan can be used to take funds from your 401(k) plan. In this method, you can have multiple properties and larger gains.
- LLC: You can even use a single-member LLC with one member in the 401(k) plan and the other is the director of LLC investments.
- Tenants-in-Common (TIC): In this method, other investors, along with the solo 401(k) plan owner, can invest in the same real estate.
Conclusion
Remember, the property funded through your solo 401(k) plan is not for your personal use. The money that goes on the property should be through your retirement account only.