Old Cars, Baseball Cards, and Real Estate?


Why does tax law treat real estate investing the same as investing in old cars, baseball cards, antique dolls, coins and Hummel plates?

People have been investing in land since time immemorial, long before stock markets existed.  Until lately, real estate has been a low profile, low risk way to accumulate wealth.  The housing crash gave real estate’s reputation for reliability a black eye, but it also popularized the REO-to-rental business.  Rising rents—which are still rising in most markets—created 8 percent returns on investment and cash flow derived from monthly rental payments that puts bucks in landlords’ pockets without requiring them to sell their assets, as do the vast majority of stocks, which pay no or negligible dividends.

Workers’ 401Ks are America’s piggy banks.  The average 401K reached $84,300 during the third quarter of last year, up more than 11% from 2012.  Workers who have been consistently contributing to a 401(k) plan over the past 10 years saw their average balance climb by 19.6% to $223,100 during the 12 months ending in June, 2013.

The vast majority of these folks who work for others have to jump through a half-dozen hoops if they want to use their hard-earned, tax deferred 401 K money to reap the kind of leverage, cash flow and returns on investment that have attracted millions to real estate.  They would have to take a distribution or take out a loan from their 401K in order to invest in anything aside from the selections—largely mutual funds—offered by their plans, which are managed outside of their companies by plan sponsors who know virtually nothing about real estate.  Few plans even include REITS or mutual fund REITS.

If you’re self-employed it’s easier.  You can set up either a SEP IRA or a Solo 401K and use the proceeds to buy an SFR.  With a SEP IRA, the most popular option, you must stay passive and can’t participate in the management of property at all.  With the lesser known Solo 401K, enacted in 2002, there are no requirements to be passive, contribution limits are higher and you can even flip as well as hold.  If an investor uses retirement funds to purchase real estate, then there is a potential tax liability called UDFI – Unrelated Debt Financed Income.  This applies when the investor purchases the property.  Like most other retirement plans, the SEP IRA is subject to UDFI.  The Solo 401(k), though, is not subject to UDFI, a tax on the portion of profits that can be attributed to the amount of the investment that was leveraged when a mortgage or a loan was used in conjunction with the retirement funds.

Estimates of the number of self-employed vary from 10 and 42 million according to Bloomberg.  That’s a lot of potential real estate investors, yet the numbers investing in real estate are probably only a miniscule percentage of the potential.  (There are no hard numbers on how many self-employed are using their tax-deferred accounts to buy SFRs, but if you’ve got evidence to the contrary please leave a comment and I’ll concede the point.)

In light of the huge interest in real estate, why are so few investors using tax-deferred options?

I would respectfully suggest real estate investing has a serious image problem.  Here’s an example where it’s hurting the industry directly in the pocket-book.  Read the news coverage about investing in real estate, not the self-promoting blogs, this topic and here’s some of the comments you’ll find.

Buying real estate in any individual retirement account, including a simplified employee pension or SEP IRA, is a complicated process.  The Internal Revenue Service has an extensive list of rules and regulations you must follow, and if you fail to observe all of them, your IRA may lose its tax-advantaged status, resulting in the entire IRA becoming immediately taxable to you.

How Do I Buy Real Estate in a SEP IRA?  By John Scissor, Demand Media in SF Gate

In theory, yes, you can own rental property in a SEP-IRA.  In practice, however, it can be a royal pain in the rear, not to mention an ill-advised choice.

Can we buy rental property in a SEP-IRA?  May 22, 2012 CNN Money

Yes, you can buy real estate in your IRA, Roth IRA, or other retirement account.  But it isn’t easy, Luscombe warns.  In fact, it is quite complicated — and you’ll face many issues that might invalidate your IRA-based investment.

How to buy real estate in an IRA.  April 2, 2013 MarketWatch

But there are so many complex rules and possible financial drawbacks to buying property through an IRA that it’s generally best not to do so.  Bill Fleming, managing director of PricewaterhouseCoopers’ Hartford, Conn., office, says there are “millions of rules” placed on real-estate investments in qualified accounts that can make it not worth the trouble.

Buying Real Estate Inside Your IRA By Kelly Spors Sept. 11, 2007 Wall Street Journal.

Had enough?  You’ll note that most of these comments relate to SEP IRAs, still the most popular option.  Almost no one in the mainstream media has written about using a Solo 401 to buy real estate, a good indication of how little awareness is out there.

So, with their clout with media and the politicians in Washington who control the tax code, the powers-that-be in Wall Street are doing an excellent job of convincing the average Americans to keep their bucks in bonds and stocks while they raid the real estate world with cash-flush hedge funds and REITS.  For the average American Joe, one of the handful of new REO-to-Rental REITS may be the only way he will be able to participate in the opportunities offered by the REO-to-Rental business.

Photo Credit: zilverbat.

About Author

Steve Cook is the editor of Real Estate Economy Watch and writes for a several leading outlets in addition to BiggerPockets, including Equifax and Total Mortgage. He also provides communications consulting services to leading real estate companies. Previously he was vice president of public affairs for the National Association of Realtors.


  1. I was taught real estate and real estate investing on a basic level. I didn’t learn about LLC, Corporations, IRA’s etc….until later on in my investing and real estate career. Understanding the benefits of a 1031 exchange was very foreign to me as an investor. As I continue to read and educate myself on this site about the huge benefits of this real estate investment vehicle I am amazed at how I am still just scratching the surface. Great Article!

  2. Great article and from somebody who started out with a jobbie job and used to contribute the max to 401K’s, I learned the hard way the complications involved if you want to use that money to invest in real estate. The only real reason why anybody should contribute to a 401K is if you are getting a match from the employer and don’t contribute more then that.

    Build the nest egg through real estate to begin with to save the headaches down the road. 401k’s and IRA’s regulations were lobbied / created by the big investment institutions and they have no desire to have the rules changed to make it easier for their play money to leave the market.

  3. Jeff Brown

    Good stuff, as usual, Steve. Though I’ve helped folks invest in RE using their various plans, it’s after I couldn’t talk ’em out of it. Usually cuz the down payments were much higher, sometimes double, plus the higher interest rates with shorter ammo periods. But since it beat the stock market eight ways from Sunday, why not, right?

    On the other hand, investing in first position notes from the same plans really tends to turbo charge both the capital growth and the annual income. That route is currently proving to be very popular, especially with the 40 and over crowd.

  4. First, let me say that I’m glad you’re making people aware of real estate as an investment inside retirement plans. I do have to disagree with some of the “experts” you’ve quoted.

    Bill Fleming’s input:

    How to buy real estate in an IRA. April 2, 2013 MarketWatch

    But there are so many complex rules and possible financial drawbacks to buying property through an IRA that it’s generally best not to do so. Bill Fleming, managing director of PricewaterhouseCoopers’ Hartford, Conn., office, says there are “millions of rules” placed on real-estate investments in qualified accounts that can make it not worth the trouble.

    Well to be honest, there are NOT “millions of rules” there are a few rules against self dealing, but that’s about it. The TRUTH of the matter is that any real estate transaction you can do outside an IRA or 401K, you can do INSIDE a retirement plan, as long as the transaction doesn’t involve you or a restricted party (family members, business partners, etc.).

    I practice what I preach. In June of 2012 I put $130 into my Roth 401K which formed an LLC within my plan. By August I had acquired 4 duplexes and a 3 unit. Not bad for $130. The profit from those units allowed me to buy another duplex in July of 2013. To maximize my investment, I bought the 2013 Duplex on a land contract. Yes, I’ll hear all sorts of screaming about “seller financing” inside a 401K, but my point is it’s legal. It does incur some UBIT, but that was very small compared to the advantage of extending the payments rather than paying cash. Incurring Unrelated Business Income Tax is NOT a rule against acquiring real estate inside a 401K.

    Check out the federal register. A very wealthy individual in Texas moved a 62 unit apartment building out of his IRA to mitigate the taxes on distributions. Real estate is the only asset class that allows this.

    So I encourage people to investigate using real estate inside their 401Ks and IRAs. Where else can you do a no-money down deal and have all the profits come to you tax free forever? Walk into a stock brokers office and tell them you’d like 5000 shares of IBM, and you’ll pay them from the profits. Wraps, subject-tos, lease options, tax liens and any other strategy can be used in IRAs and 401Ks. Anyone who says otherwise has ulterior motives.

  5. Dmitriy Fomichenko

    Good article, but I have to agree with Mike’s comments above that the way mainstream media presents real estate investing in a retirement account is incorrect. Millions of people are doing it successfully, as long as you follow the rules (which are not difficult to understand), don’t engage in a transactions with a ‘disqualified person’ and your investment transactions are ‘arms length’ – real estate investing in an IRA is pretty straight forward.

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