How I Used My 401(k) To Buy Real Estate

Dated: 11/15/2017

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One of the many reasons why I like to invest in real estate is the ability to use non-conventional financing to acquire property. A strategy I deployed at the beginning of this year was to use my 401k to buy real estate. By using this strategy I was able to purchase a duplex property that met my investment criteria, located in another state, from a turnkey rental provider.

I should clarify up front, this strategy did not involve taking a loan or an early distribution from a standard 401(k) plan. Both of these actions can have significant tax consequences that to me, would not be worth the penalty. The strategy I used was available to me through the use of a Solo 401k plan, in which the IRS specifically allows the use of funds to purchase real estate investments.

Before I made a career change to become a full-time real estate broker & investor, I spent nearly two decades in a corporate career across a variety of technology related roles. I worked for two different companies during the span of my career. Both companies offered their employees an option to invest in an employer sponsored 401(k) plan. I made full use of both offerings.

With employer sponsored 401(k) plans, your investment options are typically limited to a set of funds or stocks selected by your employer. This means unless one of the pre-selected investment options includes a REIT, investing in real estate through these plans is usually not option for employees. That said, most employers typically offer a matching program in which they match an employee’s contribution up to a certain percentage. Maxing out the employee contribution limit and employer-matching limit is a great way to accelerate growth in the employer sponsored 401(k).

After I left my corporate career I had two options for the funds that I accumulated in my employer 401(k) over the years. I could leave the funds invested in my last employer’s plan until retirement age (59 ½), or I could roll the funds over to another qualified plan. One such qualified plan that’s available to people who are self-employed is called a Solo 401k plan. At a high level, the eligibility qualifications for a Solo 401k are:

  1. The presence of self employment activity
  2. The absence of full-time employees

As a full time real estate broker (real estate brokers are typically self-employed individuals who are hired as independent contractors by employing brokers), I currently meet both requirements so I opted to roll my funds over to a Solo 401k plan. Creating the actual plan according to the rules and regulations defined by the IRS is beyond my area of expertise, so I hired a company who specializes in this service called Sense Financial. The Sense Financial team created all the required plan documents and other administrative items that allowed me to open a trust account to hold my 401(k) funds and assets.

One of the major advantages of using a Solo 401k trust account created by their team is that you gain ‘checkbook control’ over your funds. This means you can make investments by simply writing a check or making a wire transfer yourself, without having to go through a custodian. Even though this provides you with direct access to the funds in the account, there are still many guidelines, rules & regulations that you’re required to follow with regard to how the funds are spent or invested. Any violation of these rules & regulations can land you in serious hot water with the IRS, resulting in hefty fines and penalties. That’s another reason why I hired a professional service to help advise me on my strategy and to make sure I operate according to the policies defined by the IRS. Using the funds to invest in real estate however is an allowable transaction (with certain exceptions).

Creating this trust account is what enabled me to use my 401k to buy real estate. The title for the property purchased through this strategy is held in the name of the 401k trust account. All expenses related to the property (utilities, property management, insurance, property taxes, etc.) must be payed through the trust account as well. You cannot use any personal funds towards any of the transactions related to the investment. Any co-mingling of personal funds with investments made through the Solo 401k would be another violation of the IRS rules, again landing you in hot water. The same is true with any rent proceeds that are generated from the property. The proceeds must go directly back in to the trust account. You cannot personally benefit from or use any of the proceeds until you start drawing from your fund at retirement age.

The last piece to mention regarding this strategy for using a 401k to buy real estate is financing. Unless you’re purchasing and holding the property with an all cash investment, you’ll need to use a specific type of lender called a non-recourse lender. A non-recourse loan is a loan that is not personally guaranteed by the individual. The loan can only be secured by the property itself. This is in line with keeping the trust and individual completely separate.

Using funds in a Solo 401k combined with leverage through non-recourse loans can be a clever strategy to build up an investment property portfolio that you will benefit from at retirement age. Each lender has slightly different requirements but on average, I’ve seen lenders typically able provide loans with a 65%-75% LTV (loan to value) ratio. Depending on the amount of funds available in your 401k plan, and the price point of your rental properties, you can use the funds from your Solo 401k as the down payments for more than one property while funding the remaining portion through non-recourse loans. The beauty of this process is that if managed correctly, you will have tenants paying off the loans to the properties over the years that the loans are amortized. This can be a powerful method to grow the value of a retirement fund. Collecting monthly rents into the plan, building equity through debt pay-down and possible appreciation of the properties owned by the plan. Once enough cash has been acquired through collecting rents or enough equity has been generated through paying down the loan and appreciation, the process can be repeated to acquire additional properties.

So although I won’t personally benefit from any gains through collected rents or appreciation of this property until retirement age, this strategy provided me with another creative option to continue expanding my investment property portfolio today. I’ve also used more conventional strategies to invest in real estate which I’ll cover in upcoming articles.

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Timothy Smith

Colorado Springs was home for most of my childhood and teenage years before venturing out to live in other areas of Colorado, the US and eventually Asia. After many years of living abroad, I was ultim....

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