Although it is not well known, you can use your 401k or IRA to buy investment property. This practice comes with some “gotchas” and rules; but if executed properly, it can help you diversify your asset portfolio and build some strong passive income during retirement. We have done our best to provide a complete overview of this practice, and our team is available to answer any questions.
This is just too risky and doesn’t make sense. The process we recommend is to use a self-directed IRA or 401k. If your 401k provider does not allow for self-direction, you can roll it over to an IRA and choose this option. There are many companies out there that can help setup a self-directed IRA.
Types of Retirement Plans eligible for Self-Directed IRA/401K Accounts:
- Traditional IRA / 401K
- SEP IRA
- Roth IRA / 401K
- Simple IRA
One of the main benefits of a real estate IRA/401k is to diversify your investment portfolio. By purchasing rental property, multi-family apartments, a commercial building, land, or even a rental property on the beach, you can tap into your IRA or 401k money without paying a penalty to invest in what you know. The real estate you buy must be a business property, not a personal residence, second home, or occasional rental. Also, you can’t use your IRA/401k to buy a property you already own; it has to be a new purchase.
If you want to buy rental property, you should open an IRA custodial account, transfer cash from an existing IRA account — or possibly a 401k — into the custodial account, and then purchase the real estate under the account name. Very specific rules outline what you can and cannot do to fund and manage this kind of investment, so make sure to get good advice.
You can also buy and sell real estate in a self-directed IRA if you are in the flipping business, there is no longer a limit on how many you can do per year but you can incur Unrelated Business Income Tax (UBIT). The profits on any transaction are be tax-deferred or tax-free and allow your IRA to continue to grow as a result of these tax advantages.
Other rules to note:
- You can mortgage the property, but we don’t recommend it. This is rare, it would need to be a non-recourse loan that would incur UBIT.
- You can’t do any of the work yourself; you must use an independent contractor for repairs.
- You can manage the property yourself, but it is recommended to use a property manager to rent and manage the property.
- You can’t live on the property or use it personally.
Using self-directed IRA or 401k funds to purchase income-generating real estate is a profitable strategy an ever-growing number of savvy investors are implementing, especially given current market conditions. You can use your retirement funds to buy real estate without incurring early distribution taxes or penalties, and you can realize the rental payments as tax-deferred income within your IRA or 401k (and in the case of Roth IRA funds, tax-free growth). Rent does not show up on your tax return. There’s also no Schedule E to file because the rent is seen as a return on investment within the IRA or 401k, not as income. The same is true with capital gains. Profits upon sale are seen as a return on investment to the IRA or 401k, and there is no Schedule E involved. All that is required is a one-time report of value for the self-directed IRA at year-end. In the case of a self-directed 401k, there’s no requirement for a year-end report if the value is less than $250,000.
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