Using your 401k to invest in rental properties
Real Estate Agent · Charlotte, NC · Member since 2017 · 7 posts · 2 votes
Does anyone have experience using their 401k to invest in rental properties? I understand the basics of the process but was hoping for some more personal insight! Comment with the good, the bad and the ugly. I’m curious to hear about your experiences!
While @Greg Scott it technically not wrong, I would suggest that he is answering the wrong question. If you were to ask is is better to invest in real estate with an IRA or personally, there are a variety of different factors to consider, and in many cases the personal investment will work out better.
But the real question is, would investing my IRA/401k in real estate help me grow my retirement savings more reliably than what the IRA is invested in today (likely stocks and funds)? That is a more apples to apples scenario to evaluate.
As a plan provider, we have worked with thousands of clients who have chosen to diversify their tax-sheltered savings into real estate and other alternative assets and achieved success. I'll let actual investors speak to your questions from real life experience, but wanted to help you approach the concept from the right starting point.
The main thing to do is research and chose professionals to work with, not only from the plan setup side, but with respect to your entire team of real estate, tax, legal, etc.
I'm not a fan of this approach for two main reasons:
While @Greg Scott it technically not wrong, I would suggest that he is answering the wrong question. If you were to ask is is better to invest in real estate with an IRA or personally, there are a variety of different factors to consider, and in many cases the personal investment will work out better.
But the real question is, would investing my IRA/401k in real estate help me grow my retirement savings more reliably than what the IRA is invested in today (likely stocks and funds)? That is a more apples to apples scenario to evaluate.
As a plan provider, we have worked with thousands of clients who have chosen to diversify their tax-sheltered savings into real estate and other alternative assets and achieved success. I'll let actual investors speak to your questions from real life experience, but wanted to help you approach the concept from the right starting point.
The main thing to do is research and chose professionals to work with, not only from the plan setup side, but with respect to your entire team of real estate, tax, legal, etc.
Can I give @Brian Eastman's post 2 likes? ;-) He hits the nail on the head. When my partners and I started investing in real estate, our Retirement Accounts were where we ALREADY had 80-90% of our assets. So the 'question' was "how do we best make use of THESE funds". For us, it was CLEARLY real estate.
Now if someone had 'cash on hand' and asked "should I invest DIRECTLY in real estate or PUT it into a Self Directed Account and THEN invest in real estate, I would lean heavily towards directly investing. One other thing to consider though is the power of a ROTH Self Directed Account over a long time, and how much tax free wealth that can bring over time.
Dan Dietz
I agree that for those who have most of their net worth tied up in a IRA and they want some diversification within the IRA, an SDIRA can be a viable solution for them. For anyone that wants to do more than that, I'll share my personal experience for comparison.
I've been with the same company for 25 years. Most of my career I maxed out my 401k savings. Unfortunately, while at your current employer, Federal law prohibits you from getting at most of your 401k funds. To discourage withdrawals, the government charges that 10% penalty for early withdrawal. Despite this, once I got good a real estate investing, I withdrew everything I could from my 401k and wish I could have taken it all out years ago.
Over the years, we have grown our real estate holdings to the point where last year my wife quit her job and manages our properties as her job, so she qualifies as a real estate professional. My effective federal tax rate for 2020 dropped to 1.2%. Not only am I not paying taxes on the cash flow of my real estate, I'm effectively not paying taxes on my W2 income. That gives us big chunks of capital to invest, growing our real estate business further. And, because I plan on continuing to invest in real estate the rest of my life, I can keep kicking the tax can down the road forever. If I had done this through an SDIRA, I would not be realizing the tax benefits I a getting today and I would pay higher taxes tomorrow as I withdraw funds from the IRA as ordinary income.
It is worth noting that you don't have to become a real estate professional to realize many of the tax benefits real estate offers. Even owning one little single family property offers tax benefits. If you are smart about it, you can start writing off things like office supplies, cell phone bills, mileage, etc. Unfortunately, the tax laws don't allow you to take advantage of most of these if you hold inside an SDIRA.
I assume you understand the requirements to qualify for a solo-401k vs a SD-IRA. Google.
We started our buying rentals into our SD-IRAs with equity trust. The tactic of buying rentals was a fantastic strategy and now cash flows $7k/mo (net) in my wifes solo-401k.
BUT starting out with Equity trust was a total (can not use enough emphasis) DISASTER!!!!! Equity trust may work for hard money loans but not for near real time needs of buying and managing rentals (paying contractors and depositing rent checks).
We eventuallyt wore out with ET and payed $$$$$$ to re-title and move from a SD-IRA to a solo-401k with advanta) as a self managed solo-401k under an LLC/S-corp we created to self manage our taxible rentals. Per my Dyches Boddiford / John Hyer seminars I will admit this is a weak setup (S-corp to self manage rentals that you hang a solo-401k off)... bla bla. More to this issue then fits in less then a high level weekend seminar.
BUT bottom line we have done fantastic buying rentals in both of our solo-K's. Everything everyone says bad is actuall true! Lost tax advantages, risks of Un Permited transactions (googleable). Yet we did much better then the stock market and zillions of percent better then hard money lending. HML has many problems no one talks about... Many private HMLs got out of that business a result (% of time your money is at work is one big issue).
Lots for you to learn!!! Just wanting to be a voice on the positive side.
In order to invest in real estate with your retirement account you need a "self-directed" account (one that allows you to invest in alternative assets). You have three options:
1. Custodial self-directed IRA. There are dozens of custodians offering this option, but it may not be the best to own and manager rentals as Curt explained above.
2. Checkbook IRA. Essentially this is a self-directed IRA on steroids. With this structure a special purpose IRA owned LLC is used to make the investments which allows you to bypass the custodian, eliminate transaction fees and have "checkbook control" over your IRA
3. Truly self-directed Solo 401k plan. This option is not for everyone. To qualify you must be self-employed or own a business w/o full time employees with earned income. However if you qualify it gives you tremendous benefits and several advantages over SD IRA such as contribution limits that are nearly 10 times higher, ability to take personal loan from it, exempt from UBIT on leveraged real estate and more. Here is a discussion on the topic that you may find helpful:
I am not as experienced as the fellows above me, but I can give it a shot haha.
I currently own 2 SFH rentals. As an eager up-and-comer, I have looked up several ways to proliferate my portfolio. All roads, for long term investing (for me) turn to BRRRR. As a medium earner (60k-75k/yr), I look for ways to build up the funds to start the BRRRR process. One thing I have been pondering is using my 401k as my own personal bank. Not from a withdrawal, but a 401k loan.
Idea would be, and correct me if I am wrong here: find a deal that fits the BRRRR strategy, pull out the funds from my own 401k loan (interest goes to me here). Complete the BRRRR process and take the funds out from the refinance and either put it into another deal, or back into my 401k if there are no deals available. No bank/HML/Private money. No qualifications or explanations needed to pull my own money out.
Some of the bigger fish and more experienced guys might or might not agree with this, but as a little fish trying to come up in the world, this makes sense to me...
Thoughts?
@Joseph Miller-Hall I suggest performing a withdrawal instead, at least for the moment. With the fee waived due to Cares Act hardship, now extended to September 2021, you could pull out that capital, perform a BRRRR, replace that capital all without taxes or fees. You could even take the full 3 years to pay back before taxes are due and it's still better than a loan.
The loan is amortized typically over 5 years and the stock is sold to pay lend you the money, meaning you don't earn while it's loaned. You do however pay a loan schedule over 5 years, meaning you will have two monster payments each month. FYI. This could vary depending on your provider.
What Joseph and Chris outline; do a loan or short term withdrawl from a IRA/401k, buy a rental, fix, rent, then cash out REFI (lucky if there's enough equity to get anything out since LTV max for cash out is 75%. Then pay back the loan.
The tactic we took starting many years ago was to open a self directed IRA I strongly advise against using Equity Trust, choose any other custodian ideally "check book control". Then buy rentals with cash inside the SD-IRA/solo-401k. You need to study up on Unpermitted Transactions, how you rehab, manage, collect rent etc all within the SD0-IRA ecosystem.
True this tactic wastes the tax advantanges of RE, but my wifes now a solo-401k but we started out in a SD-IRA, now owns some 15 rentals and net net cash flow each mo is $7k which you can take as taxible distributions if yoiu are older then 57.5yr old.
Read up on how / if you might qualify for a solo-401k. Generally; you need to be running an active business, for profit, making actual profit business. Can be any of; Sched C, DBA, LLC, S-corp. Even a lawn mowing servicre as an example.
Just mentoining another scenario. Best of luck.
I'm also a small fish on this site. And while I've been interested in real estate for quite awhile, I'm only just now really getting into it.
Speaking from personal experience, I used a 401K loan to buy my first house and I'm really glad I did. I bought my house 3 years ago and was making about $30,000/ yr. I was getting tired of reading about real estate and listening to podcasts and decided I was going to find a way to take action. I only took out a loan of $5,000 from my 401K. I'm in the Midwest so home prices thankfully aren't ridiculous. I was able to qualify for an FHA loan and put down 3.5% on a $55,000 house that needed some pretty basic repairs. I ended up house hacking, and while it didn't cover the cost of my monthly mortgage it allowed me to save quite a bit of money over time. I did take my time fixing up the house and using money that I saved up. Now I'm in the process of refinancing and the cash out I get from that I will be using to buy my 2nd property.
Firstly, you cannot invest direct from a 401k unless perhaps investing in REITs or the like.
You'd need to roll over 401k proceeds to an IRA and then set up a self directed IRA.
Once you do that, I would not recommend investing in RE directly for two reasons.
1) You can't invest in something that you have "sweat equity" in via IRA
2) Real estate is already very tax efficient. The benefit you will get is marginal. Rather use those dollars for a less tax friendly opportunity (i.e. a tech start-up for example).
While I agree with you to a certain degree, you are making a blanket statement in your recommendation, which is incorrect. This may apply to some, but certainly not for everyone. I will use myself as an example:
1) I do not want any "sweat equity" in my investments. When I first started investing I purchased several fixer-uppers and did all the work myself. I did so because I had very little money and I am handy so I replaced flooring, painted, replaced cabinets, etc. Not everyone will be willing to do that. And now I am not willing to do that. I don't want to work on my investments, now my investments work for me. Likewise many investors out there don't want any sweat equity.
2) You are trying to compare apples and oranges. Here is an apple to apple comparison: let's say you have $100K in your 401k/IRA. You can chose to leave it invested in the stock market subject market volatility and mediocre returns, plus you have zero control over the performance of the stock market. Or you can move those funds to self-directed IRA and buy investment real estate. And if you think you can get better returns and better growth with real estate, where you can use leverage and have much greater control over your investment - then the choice is obvious.
In 2013 I was presented an off market property in Phoenix. I wanted to buy it personally but did not have enough savings at that time. I did have funds in my Roth however. Purchase price was $110K, plus $10K in repairs. I got a non-recourse loan with NASB 40% down, so my out of packet cost was $54K. The property rented for $895 so it was cash flow positive. Today property is worth $270K and rents for $1,500. I will argue with that my benefit was not marginal! Do the math yourself to calculate the return, and remember that it will be tax free for me because of Roth.
Majority of my retirement portfolio is in real estate notes, I generally prefer notes over rentals inside of a retirement account, however each investment must be analyzed in order to determine what is best for each individual investor. There are number of factors should be considered such as investment experience, risk tolerance, retirement goals, age, etc. when making an investment decision. The bottom line is that everyone's situation is unique and requires unique approach to investing.
Not my rules or preferences regarding sweat equity - take it up with the IRS.
I'm telling you what the rules are.
I'm not arguing with the rules, I'm well aware that the IRS does not allow an individual to work on the property owned by his/her IRA. What I'm saying is that your point about "sweat equity" is a mute point for many investors. But you are absolutely correct - no "sweat equity" in an IRA-owned property. Furthermore you can't even act as an agent in a transaction involving you IRA, but that doesn't mean you should not invest in real estate with your IRA.