Investor · Des Moines, IA · Member since 2013 · 137 posts · 49 votes
My wife and I are beginning to pool funds to begin a real estate investing venture. I have a 401k from a former employer that I would like to leverage to our new business. I have been researching "Checkbook Control" Solo 401(k)s here and on the web... I like the idea of being able to cut a check from my 401(k) to use in my business! It's easy to find info on WHAT they are, however it isn't exactly clear HOW I can use those funds in real estate endeavors.
I would like to hear how you have used these funds in your RE investing. As always, the more creative the better! Conversely, are there any prohibited transactions I should watch out for?
Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
11y
In a way, pretend that it's someone else's money. You cannot use it in such a way that the money will go into your own pocket, it has to go back to the plan.
For example, if you were to take a portion of the money and put it in your own personal bank account, then you'd have to pay taxes (and penalties) for taking that money.
If you use the money to buy a property, you cannot self-manage that property or do any work on that property yourself. Pretend it was someone else's money -- would you work for free? Of course not, you'd get compensated. The rental income and expenses would go back into the retirement account.
Now keep in mind that you CAN generally take a personal loan from the Solo 401(k) plan, and pay it back with interest. That limit is 50% or $50,000 whichever is less. So in that one sense you could personally benefit from the Solo 401(k) plan however you are paying the plan back with interest.
You could also loan out other money as an investment out of your Solo 401(k) to other real estate investors, and get a return. (Example: they are doing a flip.)
There are many ways to use your Solo 401(k) for real estate investing. I've given some broad sweeping examples and generalizations and so you'd need to check with your own financial situation and Solo 401(k) plan administrator (and financial adviser, and maybe CPA) to make sure what is right for you.
A self directed IRA or Solo 401k can be a great tool for diversifying your retirement investing into real estate.
These tools are not, however, a way that you can access capital for your own personal real estate business. This is tax-sheltered money intended for your future use in retirement. If you attempt to use the money for personal benefit other than by taking distributions and paying taxes, you will have engaged in a prohibited transaction that comes with some very serious tax consequences.
So, approach this as "you are a fund manager for your retirement plan, and choose to invest in real estate", and you will be on the right path.
Dimitriy is correct that there is a lot of good information here on BP (also some inaccurate stuff, as with any web forum). Educate yourself a bit online, but the real step forward in your education will be to speak with a few professionals in the field.
Investor · Des Moines, IA · Member since 2013 · 137 posts · 49 votes
11y
Thanks for all the great advice-I appreciate it. And I will seek professional advice when I do it.
...But it doesn't really get at what I was asking for... Brian's comment clarified that it couldn't be used for "my" RE projects (i.e. my LLC's), but I could add RE to my 401(k) as an investment. So in what ways have people invested in RE with their Solo 401k?
There just isn't a lot of info out there about this and it's challenging to search for. I assume SFR's are a simple, bread and butter way but I'd be interested in hearing other ways people have used this in RE deals. Have people bought properties and rehabbed/flipped them?
Again, just trying to get a sense for HOW they're used and what types of transactions people are doing with them.
A self directed IRA or 401k may invest in real estate in many ways, so long as the transaction is completed at arm's length.
Clients of ours have held rental properties, flipped properties, engaged in joint ventures with other investors to hold or develop property, invested in tax liens, and operated as private lenders to other investors.
There is a distinction, however, between passive income such as interest on a note or tax certificate, or rents from real property, and "engaging in a trade or business" such as being a wholesaler, developer or re-developer (flipper) of property.
Income from passive activities is fully tax sheltered under the umbrella of the IRA or 401k. Income from trade or business activities like flipping is subject to a trust tax known as UBTI. The idea being that we cannot have tax-exempt entities like retirement plans, churches, etc. driving taxpaying businesses out of business by competing with them on an un-level playing field.
Even with such taxation, however, it can be quite beneficial to flip houses in an IRA. If the net after-tax return from a flip is better than the income from being a landlord or hard money lender (not to mention owning shares of Exxon or Facebook), then perhaps that is the highest and best use of those IRA dollars.
Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
11y
In a way, pretend that it's someone else's money. You cannot use it in such a way that the money will go into your own pocket, it has to go back to the plan.
For example, if you were to take a portion of the money and put it in your own personal bank account, then you'd have to pay taxes (and penalties) for taking that money.
If you use the money to buy a property, you cannot self-manage that property or do any work on that property yourself. Pretend it was someone else's money -- would you work for free? Of course not, you'd get compensated. The rental income and expenses would go back into the retirement account.
Now keep in mind that you CAN generally take a personal loan from the Solo 401(k) plan, and pay it back with interest. That limit is 50% or $50,000 whichever is less. So in that one sense you could personally benefit from the Solo 401(k) plan however you are paying the plan back with interest.
You could also loan out other money as an investment out of your Solo 401(k) to other real estate investors, and get a return. (Example: they are doing a flip.)
There are many ways to use your Solo 401(k) for real estate investing. I've given some broad sweeping examples and generalizations and so you'd need to check with your own financial situation and Solo 401(k) plan administrator (and financial adviser, and maybe CPA) to make sure what is right for you.
Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
11y
@Craig Brooksby
UBTI is documented in IRS publication 598. There is a specific method of calculation, but for simple rough estimates you can assume the net profit of the transaction being taxable at trust tax rates.
http://www.irs.gov/pub/irs-pdf/p598.pdf
2014 Trust Tax rates follow
So, if you were to make about $30K on a transaction, figure you are going to give up about 33% and end up with a $20K return to the IRA. If that $20K return represents a better ROI than other opportunities, flipping the property can make sense.
Residential Real Estate Broker · Beaverton, OR · Member since 2014 · 335 posts · 149 votes
11y
@Matt Fisher I use my solo 401k to make personal loans to other investors, and get a nice return that goes straight back into the 401k. I have also purchased a rental property (paid in full since it's hard for a trust to get a loan) which brings about $1000 a month back into the 401k.
As mentioned above, there are some pretty restrictive rules about how you can use that money, for example, I'm a Realtor, but when I sell the rental property, I will have to hand it off to another Realtor since I am restricted from earning a commission on the sale.
Investor · Des Moines, IA · Member since 2013 · 137 posts · 49 votes
11y
Thanks @Randy Johnston
Those are great ideas. It's easy to see those conflicts of interest when they're clearly laid out, but harder to recognize without others that are experienced with them! Lots to learn...
@Matt Fisher I use my solo 401k to make personal loans to other investors, and get a nice return that goes straight back into the 401k. I have also purchased a rental property (paid in full since it's hard for a trust to get a loan) which brings about $1000 a month back into the 401k.
Randy, it is actually pretty easy to get a non-recourse loan for 401k or IRA for a rental. There is only few nationwide lenders who offer these types of loans and will typically need about 40% down, but the terms are very reasonable. I'll be glad to provide you with the list of lenders for future use.
Since Solo 401k is exempt from UDFI tax on leveraged real estate unlike self-directed IRA, using financing with reasonable terms will help improve your ROI.
Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes
11y
I don't see the point of using IRAs for rental property of flipping. Rental property is already tax sheltered to a large extent due to depreciation deductions. You lose all of that in the IRA. Flipping exposes you to UBTI taxes so you just lost the tax shelter of the IRA. Self directed IRAs are great for investments that generate passive income that would otherwise be taxed as ordinary earnings. Interest from private lending, tax lien interest etc all are good ways to use IRA's as all the interest is tax sheltered in the IRA but would not be outside. For rentals its far better and less restrictive to use non-retirement funds.
Self Directed IRA & 401k Advisor · Wenatchee, WA · Member since 2014 · 2k+ posts · 2k+ votes
11y
@Account Closed
There is nothing incorrect with your logic, however....
If you can generate better returns for your IRA than you can with other options available to your IRA such as the stock market, then you have achieved your goal. It does not matter that the tax benefits of the IRA are different than the tax benefits of investing with non-qualified funds. That is going to be the case regardless of how you invest with an IRA.
IRA investing is very different from after tax investing. But, investing in what you know and generating better returns with a safer underlying asset is definitely a good reason to consider holding rentals, being a hard money lender or even flipping houses within an IRA or Solo 401k.
My wife and I are beginning to pool funds to begin a real estate investing venture. I have a 401k from a former employer that I would like to leverage to our new business. I have been researching "Checkbook Control" Solo 401(k)s here and on the web... I like the idea of being able to cut a check from my 401(k) to use in my business! It's easy to find info on WHAT they are, however it isn't exactly clear HOW I can use those funds in real estate endeavors.
I would like to hear how you have used these funds in your RE investing. As always, the more creative the better! Conversely, are there any prohibited transactions I should watch out for?
Here's how investors that have worked w/ us have leveraged their Self Directed IRAs
Straight Loans (equivalent of Hard money)
Investment in to LLC that then invests in Real Estate (The investor was not a member of the LLC- the IRA was)
Purchased the property out right in the name of the IRA (this included funds from the IRA for renovation & flip)
Purchase of notes, performing & non-performing
Partnered w/ their IRA- This is rather complicated but possible to do.
In each case all profits went back to the IRA. What many of the investors we worked w/ would do if they needed funds immediately was to pull only what they needed out of the IRA & pay the tax & penalties on that amount. The rest remained in the account tax free & growing.
Investor · Des Moines, IA · Member since 2013 · 137 posts · 49 votes
11y
Thank you @Account Closed nailed it. I think I can do better than my current (stock) investments, but more importantly, I'll be leveraging a potential pot of money that I didn't realize until lately that I had at my disposal. At this early point in my investing career it's more important to feel like I have multiple funding pools to draw on for my first investments. There is so much stress initially (from lack of real-world knowledge) that having less pressure on funding makes it that much easier to get started.
Eventually, I will have access to 'better' funding mechanisms, but for now, I'm much more comfortable cutting my teeth with my funds. And even if I don't keep up with the stock market, I'm learning first-hand and investing in something that I have some modicum of control over.
Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes
11y
@Brian Eastman I am not suggesting that you should pick stocks instead of REI for an IRA. But there are many means to invest in REI. Rentals are just one way. Tax advantaged accounts could be used to hold notes, private lending, tax liens or many other REI strategies that truly benefit from the tax sheltered structure. I suppose if you have no other source of funds then maybe its okay to use IRA to buy rentals but I would consider that the last resort source of funds.
Real Estate Broker · MA · Member since 2013 · 361 posts · 297 votes
11y
When it comes to UBIT, you have to focus on the after-tax return. I'll happily pay the taxes all day long, if my after tax return on a flip is 20% or more for a 6 month investment.
Since the trust tax rates are pretty flat and the corporate tax rate is a bit more gradual, it can make sense to use a "blocker" corporation. The 401(k) owns the shares in a C-corp and the corporation pays income tax on profits. The dividends returned to the 401(k) are tax deferred or tax free, like any passive investment. An LLC with an election to be taxed as a C-corp can also be used.
Your personal marginal tax rate also matters. I can get a higher after tax return for a flip in my 401(k) than if I was to flip with personal funds.
As always, seek the advice of a qualified accountant or tax attorney who understands this area of tax law.
Professional · Carlsbad, CA · Member since 2012 · 12k+ posts · 1k+ votes
11y
Matt Fisher Q: My wife and I are beginning to pool funds to begin a real estate investing venture. I have a 401k from a former employer that I would like to leverage to our new business. I have been researching "Checkbook Control" Solo 401(k)s here and on the web... I like the idea of being able to cut a check from my 401(k) to use in my business! It's easy to find info on WHAT they are, however it isn't exactly clear HOW I can use those funds in real estate endeavors.
ANSWER: If you are looking to use retirement funds to finance your new or existing real estate business, a Rollover as business startup (ROBS) arrangement may be a good fit.
The operating company rules in connection with real estate must be satisfied so make sure to work with competent compliance professionals if you decide to pursue the use of 401k rollover funds to finance a start up. To give you an idea of the requirements, at least half of the Corporation’s assets would need to be invested in real estate that is directly managed or developed by the Corporation.
You can give us a call for a free consultation with our Harvard Law attorney.
Visalia-Fresno, CA · Member since 2009 · 1k+ posts · 863 votes
11y
I have purchased a couple properties with my 401k using a loan. Having your retirement account, line of credit and personal cash available at a moments notice can create a return that would be hard to calculate at times because of the "opportunity cost".
Investor · Des Moines, IA · Member since 2013 · 137 posts · 49 votes
11y
@Mark Nolan I've looked into the ROBS option, but I didn't think it fit well. It sounds as though it's better suited for larger 401(k)s and mine is only 5 years old (but I had company match to 8% and I put in more at times). Also, as I understand it there are some additional startup costs.
@Franklin Romine Thanks for your input. I had thought the same thing. I could quickly utilize it and in creative RE, that's the difference between no deal and big profit! Cash is king.
Investor · Des Moines, IA · Member since 2013 · 137 posts · 49 votes
11y
I spoke with my attorney yesterday about setting up my LLC. He definitely isn't an expert at 401(k) and didn't claim to be (he's good at RE though) and he suggested it's better to use the solo 401(k) to loan to my biz, but thought it was very complicated to put real estate into the plan... I've read that there are lots of specific rules, but I've never really thought of it as 'complicated'. What do you guys/gals think?
Unfortunately, your attorney's reaction is not uncommon, and is based entirely on his lack of familiarity with this field.
Yes, there are specific restrictions that come with using tax sheltered retirement funds to invest in real estate. Everything must be kept at arm's length and you may not benefit in any personal way until such time as you start taking distributions from the IRA or 401k in retirement.
If you utilize your Solo 401k in a manner where you think of yourself as a fund manager deploying the capital to it's highest and best use, and not as "joe landlord" using the retirement capital to fund "your" real estate deals, then you will be just fine.
Such a plan provides the opportunity to put that retirement capital to work in real estate, invest in what you know, and hopefully achieve better results with that retirement savings than if you left if in the good hands of the folks on Wall Street.
Take the time to research and learn about the process of using a self directed IRA or 401k. Speak with some of the folk in the industry who participate here at BP. Find an attorney or CPA locally who is at least somewhat familiar with the process. You might find there is tremendous opportunity.