Creative Real Estate: Rental Property Investing with a Solo 401k
As an active part of any real estate investment community, you’re quite likely to be aware of creative financing. It’s fascinating to hear stories from other fellow investors. Did you ever use creative financing for a real estate deal? If yes, then congratulations, you are on the right path. However, if you haven’t done so, we’re going to discuss an interesting investing strategy using your retirement fund.
Buying a rental property with a Solo 401k plan
First, let’s talk a bit about self-directed Solo 401k plans.
Solo 401k is a qualified retirement plan designed specifically for self-employed professionals and owner-only businesses and their spouse. The only eligibility criteria you need to satisfy is the presence of self-employment activity and absence of full-time employees. As per the existing rules, you can contribute up to $61,000 to your Solo 401k plan in 2018 (double that for husband and wife business).
While many financial institutions offer Solo 401k plans, not all of them are equal. You would want a self-directed Solo 401k plan that allows alternative investments, including real estate, mortgage notes, tax liens, tax deeds, and more. Traditional financial institutions and brokerages have restrictions in their plan documents and only allow investments they sell (stocks, bonds, ETFs and mutual funds). To be precise, truly self-directed retirement plan documents do not have those restrictions.
How does the process work?
In order to start, you must have legitimate business to sponsor the plan (can be in any shape or form such as an LLC, S-corporation, Partnership, sole-proprietorship, etc). The business adopts the plan, and the plan and trust created. The next step is to fund your Solo 401k plan, which can be done by ether a rollover from another qualified account such as Traditional IRA, 401k plans, 457, 403b, Simple IRA, SEP IRA, thrift saving plans, Keogh plans, and even defined benefits plans or making a new contribution. Roth 401k can be rolled over into Roth Solo 401k plan. Rollover from Roth IRA however is not allowed.
- Once you have funded your self-directed Solo 401k plan, choose an investment (i.e. rental property) for your plan. The property selection process is pretty much the same, except the exclusion of disqualified person. Never enter into a transaction that involves a disqualified person, as it will be considered as a prohibited transaction, inviting unwanted penalties and taxes.
- Use your retirement funds to purchase the property, and if you require financing you must only use a non-recourse loan (here is a list of non-recourse lenders).
- Your self-directed Solo 401k plan will hold the title of the property. You will sign on its behalf as the trustee of the plan.
- Any expenses directly related to the property (repairs or maintenance, property taxes and insurance, etc.) must be paid from the Solo 401k only. Likewise, any rental income generated by the property must flow back to the plan itself.
- You or any other disqualified person cannot benefit directly from the property. You cannot live in the property or use it for any purpose whatsoever except as a rental.
Is it the right solution for you?
Investing in real estate with your retirement funds offers better investment returns, but at the same time, it does require a thorough understanding of the plan rules and associated guidelines. It’s the right solution if you are looking for high-growth investments. Further, professionals lacking the necessary capital to invest in real estate can use their self-directed Solo 401k plans to start real estate investing. In the end, it’s a personal decision, and if it helps you achieve your financial goal, it’s worth considering.