solo 401k - pay cash or finance real estate

Private Lending & Conventional Mortgage Advice

solo 401k - pay cash or finance real estate

Investor · Torrance, CA · Member since 2016 · 52 posts · 24 votes

BP, I'm in the process of setting up a solo 401k. Does it make sense to pay cash for small 6 unit MF rental, or should I get a commercial loan? After speaking with some lenders, most commercial loosens are max of 60% LTV, because they must be non-recourse loans. Since the property will be in a solo 401k, I don't have any benefit of using mortgage interest or depreciation for that matter, on my taxes. Should I pay cash for a property, thus maximising the account growth, because most of the rental income will grow the account faster? no loan to pay back. if I finance the purchase I could buy two or three properties, but lower cash flow, since I'll have loans to pay... I'm stuck. can't decide one way or the other. I feel the analysis paralysis closing in on me... JC

0 Reply

24 views

Most Popular Reply

Brian EastmanPro Member

Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes

@JC Conchas

The use of leverage in a Solo 401(k) can, if well deployed, be a path to building wealth faster. As with all things investing, however, it is a matter of risk vs reward.

With an all cash purchase, there is less risk, as there is no mortgage to pay each month.

With a mortgage, the Solo 401(k) has the obligation to pay the mortgage whether there is a tenant paying rent or not. As such, you should retain a reasonable amount of 401(k) capital in reserves in some form of cash or semi-liquid investment.

The use of mortgage financing, however, should allow for a higher cash-on-cash return. You may not see it directly in immediate cash flow, but the income will be purchasing additional equity in the properties as you pay down principal on the note(s).

Here is a basic Investopedia article on the topic of leverage:

https://www.investopedia.com/articles/mortgages-re...

While your statement is correct that the 401(k) will not have the benefits of deductions like depreciation, that is because the rental income is not being taxed in the first place since it is fully tax-deferred within the plan. No taxes = no need for write-offs.

3 Reply

See this reply in the discussion

12 Replies

Jump to latestLatest

Sort by

Jimmy MurrayBusiness Member
Investor · Warwick, RI · Member since 2013 · 220 posts · 119 votes
8y
@JC Conchas One other factor to think about are taxes.
You may need a savvy accountant to complete your tax return if you go the financing route. I'm not incredibly well versed in this area but I know the taxable basis for the loan portion becomes a bit tricky when leveraging self directed assets for multi-family investment.
[email protected]401-829-1533
Lyon Property Group4.5638 Reviews
Website View Page
0 Reply
Brian EastmanPro Member
Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
8y
@JC Conchas
The use of leverage in a Solo 401(k) can, if well deployed, be a path to building wealth faster. As with all things investing, however, it is a matter of risk vs reward.
With an all cash purchase, there is less risk, as there is no mortgage to pay each month.
With a mortgage, the Solo 401(k) has the obligation to pay the mortgage whether there is a tenant paying rent or not. As such, you should retain a reasonable amount of 401(k) capital in reserves in some form of cash or semi-liquid investment.
The use of mortgage financing, however, should allow for a higher cash-on-cash return. You may not see it directly in immediate cash flow, but the income will be purchasing additional equity in the properties as you pay down principal on the note(s).
Here is a basic Investopedia article on the topic of leverage:
https://www.investopedia.com/articles/mortgages-re...
While your statement is correct that the 401(k) will not have the benefits of deductions like depreciation, that is because the rental income is not being taxed in the first place since it is fully tax-deferred within the plan. No taxes = no need for write-offs.
3 Reply
Tom Keating
Lender · Chicago, IL · Member since 2017 · 42 posts · 26 votes
8y
@JC Conchas - What would be the purchase price of the property? If the property would require a loan of $1mm or more, I am confident you can attract 75%-80% LTV non-recourse loan. Feel free to PM me with any other questions.
0 Reply
Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
8y
@JC Conchas, I think @Brian Eastman hits the nail on the head. You need to keep in mind that you can still use the rest of the funds on other investments if you use leverage for the first one. Think of it this way - if you borrow at 6% and can make 12% on what you do with those fund that is a pretty good return.
One other things we look at is the equity build up rates. If you pay 100K cash and you are in a market that has appreciation of 2% you are only making 2K (2%) in addition to your cash-flow each month. If you put 40K down on the same place you would knock down cash 2K-3K per year with the interest payments, put you are gaining about 4K-5K with loan pay-down and appreciation, and you are doing it with a 40K investment. So if you figure you are netting an extra 2K on a 40K investment, that is an additional 5% return.
I hope that makes sense.
Dan Dietz
[email protected]608-524-4899
1 Reply
JC Conchas
OP
Investor · Torrance, CA · Member since 2016 · 52 posts · 24 votes
8y
@Jim Murray I don't believe taxes the loan portion is an issue with solo 401k, I think that applies to SDIRA's. I'll check with CPA. @Brian Eastman the purchase price would be under $250k. plus if all cash maybe get a better deal if all cash. I have just over $400 to invest and am doubtful I could get two loans at 60% LTV. so was trying to figure out use $250k pay cash, then NOI goes into solo account, before too long I could repeat with property to purchase. @Tom Keating the purchase price would be well under $300k. @Daniel Dietz the area would probably be a 1% appreciation, but cash flow really well. I'm most concerned about qualifying for the loans, and the loans themselves. I have other units that are 4-plexs, with regular 30 year loans, so commercial loans, kind of worry me. The idea of having to refinance every 5 to 7 years, would drive me nuts.
2 Reply
Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
8y
@JC
@JC Conchasundefined, just as an FYI, we were able to lock in a 20 year note for our non-recourse loans (we did 2 at the same time) at 6% interest and 40% down. The paperwork process took a LOT longer than the Commercial Blanket Loans we were doing at the same time. We used Jason Zook at NASB. I think @Dmitriy Fomichenko has a list compiled of most of the major non-recourse lenders if you are interested in going that route.
Dan Dietz

[email protected]608-524-4899
1 Reply
Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
8y
Daniel, here is the list that you referenced:
https://www.biggerpockets.com/blogs/2810/50272-lis...
1 Reply
Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
8y
@JC Conchas
It's true SDIRAs generally owe UDFI tax on debt leveraged real estate, but this does not apply to the Solo 401k.
0 Reply
JC Conchas
OP
Investor · Torrance, CA · Member since 2016 · 52 posts · 24 votes
8y
@Daniel Dietz that was one company I did not contact. I sent them an email to look into it further. Thanks for your help JC
0 Reply
George Blower
Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes
8y
@JC Conchas
That is good that you are doing some planning before proceeding. You certainly will need to plan as there are only a few ways to get funds into a solo 401k plan. So you if your plan runs out of funds to cover expenses in connection with the property you won't be able to simply contribute additional funds to the solo 401k plan unless it falls under a qualified event such as the following:
1. If you generate net self-employment income through the business that sponsors the solo 401k plan, you can make an annual solo 401k contribution up to the allowed limits.
2. You transfer other IRAs or former employer plans to the solo 401k plan.
3. As a last resort, by selling other assets of the solo 401k plan in order to have liquid funds.
1 Reply
George Blower
Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes
8y
Another bank that will loan funds to a solo 401k on a non-recourse basis is Titan Bank.
0 Reply
JC Conchas
OP
Investor · Torrance, CA · Member since 2016 · 52 posts · 24 votes
8y
Thank you to everyone for the input.
I've started the process with NASB, so far so good.
JC
0 Reply

Join the conversationCreate a free account to reply, vote on answers and follow this thread.