Using Solo 401k To Buy Real Estate
If you are a small business owner, you can open a Solo 401(k), and use it to invest in your preferred investment options. A Solo 401(k) comes with lots of perks, some of which may not be available in a company-sponsored 401(k) plan. As a self-directed retirement plan, you can decide to invest your retirement savings in different types of investments such as real estate, precious metals, bonds, stocks, mutual funds, tax deeds, etc.
using solo 401k to buy real estate
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Generally, you can purchase real estate using Solo 401(k) funds. You can purchase different types of real estate properties such as apartments, residential properties, commercial properties, condos, and mobile homes. All expenses related to the purchase of real estate property must come from the Solo 401(k) account, and any funds used from your personal finances will be considered to be an early distribution with tax implications. Most investors use a Solo 401(k) as a tax strategy since any gains or incomes from the real estate investment are tax-deferred until you make a withdrawal, or tax-free if you are using a Roth Solo 401(k).
You must first open a Solo 401(k) account that will be used to purchase the real estate property. The IRS requires that all fees associated with the real estate purchase must be made using funds from the Solo 401(k) account. You should not use your personal name on any purchase-related documents.
You can use debt financing to fund purchase of real estate property. You can obtain a non-recourse loan from a bank or other lending institution. The IRS prohibits investors from borrowing from relatives such as a spouse, natural and adoptive parents, or any business owned by the Solo 401(k) owner or family members. Also, the Solo 401(k) must have sufficient funds to meet the non-recourse loan payments.
Although real estate purchases can be made directly using the Solo 401(k) account, some investors may opt to create an LLC for the purchase of making the purchase. You can obtain an EIN for the LLC, which will be required to open the LLC bank account. Once the bank account becomes active, you can fund the account using Solo 401(k) money.
This method allows investors to purchase real estate property using a mix of Solo 401(k) funds and personal funds. You can partner with another investor or certain family members to purchase the property; the ownership of the property will be split based on the agreement. Any expenses and incomes from the property will also be shared based on the agreed percentage between the owners.
A Solo 401(k) owner cannot live in a home or other real estate property purchased using a Solo 401(k). The owner-employee of a Solo 401(k) is considered a disqualified person by law, and hence, cannot use the property. Other disqualified persons include your spouse, your natural parents, natural grandparents, spousal lineal descendants, and ancestors. Persons who are considered qualified to live in the property include sisters, brothers, aunts, uncles, and cousins, who can live in the property and pay rent directly to the Solo 401(k).
Another key advantage of using your Solo 401K to invest in real estate is avoiding the Unrelated Debt-Financed Income (UDFI) tax. For a real estate investor, you do not have to pay the 40% UDFI tax on income or gains on your investment paid for by your Solo 401K.
Scenario 1: Bob uses a Solo 401k and invests $100,000 of Solo 401k funds to acquire a real estate property. Bob also secures a nonrecourse loan from a bank for $100,000 and purchases the property for $200,000.
Assume the property generated $10,000 of net income in a year after calculating all eligible deductions. The UBTI tax would not apply to any of the income or gains generated by the real estate investment!
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Just like all the gains and expenses would flow through the solo 401k bank account when investing in real estate directly through the solo 401k, the same is true for real estate investments placed under the solo 401k owned LLC.
The Solo 401k plan is allowed by the IRS to invest in real estate. While some plan providers may restrict the options to certain investment products they offer, most plan owners can eliminate such restrictions by switching to a truly self-directed plan.With a self-directed Solo 401k, the investment choices are virtually limitless. Real estate investors can use the funds to purchase a property, such as single family or multi-family homes, commercial buildings, even raw land.While investing in real estate with a Solo 401k plan is not a complicated process, there are certain rules that plan owners need to follow.The plan owner only acts on behalf of the plan. This means all income and expenses related to the property must go in and out from the plan itself. For example, the plan owner cannot use the Solo 401k funds to purchase the property and then use his personal money for repair and maintenance.
Aside from directly purchasing a property, the Solo 401k plan can act as a bank or a private lender that can extend financing to other investors. Among the investment options are private placements, mortgage notes, and trust deeds.In real estate, the loan can be secured with a property. The plan participant then will not be involved in the rehab process or the leasing of the property. The plan will lend out its money and passively collect the principal and interest payments.Because of this passive nature, private lending is a great option for the Solo 401k plan. The plan participant only needs to make sure that they lend to a non-disqualified person and perform due diligence on the lending venture.Private lending in a tax-deferred or tax-free environment allows accelerating the growth of your wealth much faster comparing to lending with personal funds.
Each of these real estate investment opportunities can provide you with stable returns as long as you make smart investments. There are many benefits that come with investing money in real estate. These benefits are compounded when you invest in commercial real estate properties. The main reason that you should think about investing in real estate is that these properties generally appreciate in value over time, which allows them to increase in value with inflation. The average appreciation amount per year since 1968 is right around six percent.
*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.
Many self-directed investors have the option of choosing between a self-directed IRA or a self-directed solo 401k. Both accounts can be self-directed so that you can invest in any investment allowed by law such as real estate, LLCs, precious metals, or private company stock. However, depending on your situation, you may choose one account type over the other. What are the differences? When should you choose one over the other?
Another major consideration in deciding between a solo 401(k) and a self-directed IRA is whether there will be debt on real estate investments. If there is debt and if the account owner is self-employed, they are much better off choosing a solo 401(k) over an IRA as solo 401(k)s are exempt from UDFI tax on leveraged real estate.
Mat has been at the forefront of the self-directed IRA industry since 2006. He is the CEO of Directed IRA & Directed Trust Company where they handle all types of self-directed accounts (IRAs, Roth IRAs, HSAs, Coverdell ESA, Solo Ks, and Custodial Accounts) which are typically invested into real estate, private company/private equity, IRA/LLCs, notes, precious metals, and cryptocurrency. Mat is also a partner at KKOS Lawyers and serves clients nationwide from its Phoenix, AZ office.
The 2001 Economic Growth & Tax Reconciliation Act (EGTRA), greatly increased the popularity of the Solo 401(k) Plan. The Solo 401(k) Plan has become a popular retirement vehicle for real estate agents across the country. As a real estate agent, there are many features of the Solo 401(k) plan that make it so appealing and popular among self employed business owners. The following chart will illustrate the advantages for a self-employed attorney of using a Solo 401(k) Plan:
Beth who is a real estate agent earns a $100,000 a year. Beth is 43 years old and the sole shareholder of an S Corporation called ABC, Inc. Beth is the sole owner and employee of the corporation. Beth wishes to make the maximum amount of tax-deductible contributions allowed by law. If Beth used a Traditional IRA, she would be able to make a tax-deductible contribution of just $6,000. Whereas, if she had used a SEP IRA as the retirement vehicle, Beth could make a tax-deductible contribution equal to $25,000 (25% of $100,000). However, if Beth establishes a Solo 401(k) Plan, she can make a tax-deductible contribution of $43,000 ($19,000 as an employee and a corporation profit sharing contribution equal to 25% of her compensation).
Over 5 years ago I went on the hunt for the best solo 401k providers, did my research, and learned a whole lot. I've shared in the past the best options for saving for retirement with a side income, and I've leveraged a SEP IRA in the past. 041b061a72