Self Directed IRA\Solo401 for buying rental property?

18 Replies

Hello, I am new to this forum and also to real estate investing. I have been currently self employed for the last 12 years and have been contributing to a SEP-IRA yearly. I am planning to buy a Beach Condo which will be used mainly for rental (via a property management company), and also will be occasionally used by me. I wanted to use the funds in my SEP-IRA for buying this property.

Can anyone suggest what would be the best option to do this? Will moving part of the funds in my SEP-IRA to a SD IRA or Solo 401K be an option for buying the condo? Also can I still contribute to my SEP-IRA if I rollover part of my funds to an SD IRA\Solo401?

I appreciate any advice given.

I forget all the reasons why this is not usually considered a good idea. Tom Wheelright (rich dad advisor, cpa) has quite a bit to say about using 401k/IRA for real-estate investing.

A few issues I remember... First, thereis a tax disadvantage. Because the home is in your IRA, the mortgage interest isn't deductable. Second, lenders usually want you to have substantial reserves when investing in real estate. Can you afford a few months of no renter in place? Can you afford to fix the roof, the A/C, etc? So the lender will ask that you hold back quite a bit. This means you might only be able to use about 1/2 of the cash in your IRA. And that reserve you're holding in your IRA has to be cash, ie, not invested in other potentially risky investments.

@Sheldon A Baracho ,

Welcome to BiggerPockets and congratulations on your first forum post!

Since you are self-employed the best option for you would be truly self-directed Solo 401k plan. It is significantly better than SD IRA for the following reasons:

  • Custodian is not required = no custodian fees, no asset-based fees, no transaction fees
  • Checkbook control over your retirement funds
  • No tax on leveraged real estate
  • Ability to make large contributions: up to $61,000 annually
  • Ability to invest tax-free using Roth account 

The property owned by your 401k can't be used by you personally, has to be strictly investment. 

You can continue to contribute to your SEP IRA or to Solo 401k but not both. Since Solo 401k is way more advantageous than an IRA it would probably make more sense to transition to Solo 401k completely.

@Sheldon A Baracho

Your desire to have personal use of the property is a deal killer for any kind of IRA or Solo 401(k) based program. Such plans are purely a means to diversify your retirement savings and allow for investment opportunities beyond the stock market. You may not personally benefit from an IRA or 401(k) via use of plan held assets. To do so would violate IRS rules and result in severe tax penalties.

Originally posted by @George Pauley :

I forget all the reasons why this is not usually considered a good idea. Tom Wheelright (rich dad advisor, cpa) has quite a bit to say about using 401k/IRA for real-estate investing.

A few issues I remember... First, thereis a tax disadvantage. Because the home is in your IRA, the mortgage interest isn't deductable. Second, lenders usually want you to have substantial reserves when investing in real estate. Can you afford a few months of no renter in place? Can you afford to fix the roof, the A/C, etc? So the lender will ask that you hold back quite a bit. This means you might only be able to use about 1/2 of the cash in your IRA. And that reserve you're holding in your IRA has to be cash, ie, not invested in other potentially risky investments.

Those are all general observations with do not apply to everyone. Here is what you need to keep in mind:

  • Interest is not deductible - this is apples to oranges comparison. The interest is not deductible because there is no income to deduct it against. The income inside of the 401k is sheltered from taxes.
  • Lenders require substantial reserves. He wants to pay cash for the property, without using a lender, this would not be applicable.  
  • With the amount he has in his account and no mortgage he should be able to handle vacancies and repairs, this is a valid point, reserves are essential. 
  • If he was to use a loan, the lender will require reserves, however those funds can be invested, lender can't require you to keep them in cash. But it would be wise to have adequate amount of reserve in a liquid investment such as mutual fund.
Originally posted by @George Pauley :

George thank you for your response. I don't plan to get a loan for the property. This will also be an investment property. I have primary residence where I deduct the property tax,etc. What if I have 150K in SEP IRA of which I rollover to a SD IRA then use 100K to buy a condo, will that be acceptable to the lender? I am also a bit confused by who this lender will be if I am paying for the condo from the fund in the SD IRA and not taking a mortgage. Thanks.

Originally posted by @Brian Eastman :

@Sheldon A Baracho

Your desire to have personal use of the property is a deal killer for any kind of IRA or Solo 401(k) based program. Such plans are purely a means to diversify your retirement savings and allow for investment opportunities beyond the stock market. You may not personally benefit from an IRA or 401(k) via use of plan held assets. To do so would violate IRS rules and result in severe tax penalties.

Brian thank you for the response. If that's the case then I will only use it as a rental property.  Can the property ever be used? Like say at retirement?

@Sheldon A Baracho

If you ever wish to use a property personally, it must be distributed from the plan to yourself.  This is "possible", but generally not financially beneficial.

At the time of distribution, the property will need to be appraised.  That appraised value will be used to determine the taxable income amount of the distribution.  The 401(k) will not have sheltered the gain in value and you will likely end up in a very high tax bracket in the year of distribution.

The better strategy is to focus the 401(k) capital on the investment(s) that will produce the best results for the plan, not something you are personally interested in.

If the plan held a property that performed well for 5, 10 or 15 years to the point of your retirement, then have the plan sell that property.  That is a non-taxable event.  You could then use a portion but not necessarily all of the proceeds to take a distribution to yourself and use that as a down payment on a property you want personally in retirement - whether next door to or in a totally different market than the investment property.  The smaller distribution amount will result in a lower tax rate, and if the home interest deduction is still around, you'll benefit from that as you pay down the mortgage - possibly from smaller annual distributions from your plan.

@Sheldon A Baracho

Welcome to BP! The Solo 401k can be a great way to invest retirement funds into real estate. As others have mentioned, there are prohibited transaction rules that are important to understand. This would prevent any personal use of property owned by your Solo 401k. These rules also apply to IRAs.

A Solo 401k asset would need to be distributed to yourself in order for you to use it or benefit from it. After distribution, the asset is owned by you instead of your 401k. Distributions from pre-tax account generally add to your taxable income. Qualified distributions from Roth accounts do not add to your taxable income. The Solo 401k plan can be setup to allow for both pre-tax and Roth accounts under the same plan.

@Sheldon A Baracho

Some family members will be excluded because of the prohibited transaction rules. Your Solo 401k cannot rent properties to disqualified persons (you, your spouse, your parents, grandparents, children, and your grandchildren are examples).

This is true whether you manage the rental or a property management company takes care of the logistics.

Great post all. I have a follow up question based on the responses above. 

If I wanted to do this would be can I buy the property with 20% down  (pulled from a Solo 401K) then sell the property back to myself (while providing a gain to my solo 401K?

Or do something similar to a BRRR strategy but when I refinance it, it's actually a sale to myself with a portion of proceeds going back to my solo 401K for a "gain"

@Armin Nazarinia

Because of the prohibited transaction rules, you cannot transact with your Solo 401k. If the 401k owns a property, any sale would need to be with a non-disqualified person. This rules out you and certain family members.

More workable situations generally involve a clear separation between your activities and those of your Solo 401k plan.

@Armin Nazarinia

I see several flaws in your proposal:

  1. You said "then sell the property back to myself", which implies you sell the property to your 401k, is that correct? You can't do that. 401k can buy the property, but not from yourself or any other "disqualified person". 
  2. Your 401k can't sell the property it owns, but again not to disqualified person.
  3. If you wish to use leverage to acquire investment property in a retirement account you are not allowed to provide personal guarantee, therefore conventional loan with 20% down would not work. You must use non-recourse financing, typically those lenders will require 40% down. Here is a list of lender who specialize in this field:  https://www.biggerpockets.com/blogs/2810/50272-lis...

The bottom line is this: Solo 401k is powerful investment vehicle but you misunderstanding the use of it. It is intended to help you grow your retirement nest egg, not to provide you with the personal gains or benefits now. 

Originally posted by @Armin Nazarinia :

@Justin Windham - Thanks for the response. I figured as much; so even if I buy a rental property with it the rental income would also need to go back in to the solo 401K if I'm understanding correctly?

Armin, when 401k owns a property: 

  • All income from this investment belongs to the 401k
  • All related expenses must be paid from the 401k. 
Originally posted by @Armin Nazarinia :

@Justin Windham- Thanks for the response. I figured as much; so even if I buy a rental property with it the rental income would also need to go back in to the solo 401K if I'm understanding correctly?

 Yes, that's correct.

Free eBook from BiggerPockets!

Ultimate Beginner's Guide Book Cover

Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!

  • Actionable advice for getting started,
  • Discover the 10 Most Lucrative Real Estate Niches,
  • Learn how to get started with or without money,
  • Explore Real-Life Strategies for Building Wealth,
  • And a LOT more.

We hate spam just as much as you