Invest in Real Estate with Your 401(k)

Many people want to invest in real estate “if I could only find the cash for the down payment on a property or two.” But for many would be investors – the answer to getting started in direct real estate investment is right under their nose: You can use a self-directed 401(k) to invest in real estate.

Techniques

For Employees

If you don’t own your own company (so you can become the sponsor of your own 401(k) plan, you have a couple of options:

Borrow. If your plan allows, you may be able to borrow up to $50,000 or 50% of your account value (whichever is less) to invest in real estate in a taxable account. If you go this route, understand you only have five years to repay the loan. Otherwise it’s considered a taxable distribution and if you are under age 59½, may generate penalties to boot.

Execute a Rollover. If it’s a 401(k) from an old employer, or if your plan allows in-service rollovers, you may consider rolling over some or all of your 401(k) balance to your own IRA. There you have a couple of options: You can pay income taxes on the rollover and start a Roth IRA (thereby gaining the advantage of tax-free growth forever in exchange for a near-term tax hit), or continue with the tax-deferred approach.

In this case, in a traditional IRA, your real estate investment will (hopefully) grow tax-deferred. Rental income is also tax-deferred – just reinvest it within your IRA until you are ready to take distributions. Required minimum distributions, of course, still apply starting April 1^st of the year after the year in which you turn 70 ½. Distributions are taxable as ordinary income. Any gains attributable to money borrowed from outside the IRA may also be taxed under unrelated debt-financed income tax rules.

In the case of a Roth IRA, since you already paid income taxes on the money, growth and rental income are tax-free, as long as the money remains in the Roth at least five years. There are no RMDs to worry about either.

If you own a business

If you own your own business, setting up your own self-directed solo 401(k) for the purposes of owning investment property may be a compelling option for several reasons:

• Unlike IRAs, 401(k)s have no income qualification requirements. You can make a contribution to your own solo 401(k), regardless of how high your income is. And if you have no other qualifying employees other than yourself and a spouse, there are no top-hat or discrimination rules to worry about, either. The solo 401(k) can be optimized for your benefit, to maximize the allowable contribution.
• You can still set up the account to allow for borrowing.
• Assets in a solo 401(k) enjoy substantial creditor protection
• You may be able to avoid unrelated debt-financed income tax by holding real estate within a 401(k) rather than an IRA. Speak with your tax advisor for more information.
• You can contribute much more to a solo 401(k) plan than you can to an IRA. While the IRA limits you to $5,500 in new contributions each year ($6,500 for those over 50), employees can contribute up to $18,000 in elective deferrals in a 401(k). Meanwhile, the company can kick in between 20 and 25 percent of total compensation (up to a $265,000 compensation cap) on contributions. All told, you may be able to contribute up to $53,000 per year, tax-deferred, or tax-free if you choose to use a Roth option and contribute with after-tax money. ($59,000 if you are over 50, thanks to the effect of ‘catch-up contributions).

For more information, visit us online at www.americanira.com, or call us for a free consultation at 866-7500-IRA(472).