Investor · Cohutta, GA · Member since 2015 · 8 posts · 2 votes
Hey I m looking into taking a loan out from my self directed 401k to purchase some rental properties, I am trying to be as carful as possible by planning for the worst case scenario. I was curious if those who have used this technique for purchasing rentals have came across any situations where some one has done this and things went wrong with renters not paying or something happening to the property, just anything that might go wrong, and how I can protect myself from anything that might put my $401k in jeopardy?
The only thing from a 401k perspective that can "go wrong" is that you fail to make payments in the required fashion and the amount of the loan is treated as a taxable distribution, with an additional 10% penalty for early distribution if you are under age 59 1/2.
As such, you want to be very sure that you will have the ability to repay the loan, and structure your real estate deal accordingly, with plenty of reserve capital in the event you have an extended vacancy or significant repair expense.
You also want to keep in mind that you put that money into the plan tax-deferred, and will be replacing it with after-tax money, so the income you receive personally needs to be a significant return on investment to offset the negative ROI equal to your tax rate that the plan is experiencing.
An alternative would be to use the plan itself to make the investment in property. Of course in that case the income from the property accrues to the plan and is not usable for you personally.
if you decide to use this strategy be sure to have adequate reserves. Like Brian mentioned above it is your ability to repay the loan that matters. The property itself has not connection to the loan that you take from your 401k. But if you are relying only on rent payments to repay the loan without having a cushion - then this would not be a good idea and you should think twice before implementing it.