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3 Ways to Fund a Real Estate Investment with Your Solo 401k

Many real estate investors are now considering a self-directed Solo 401k plan for real estate investment purposes.

The Solo 401k is a retirement plan designed for self-employed individuals without any other full-time employees other than the business owner and his or her spouse. Many investors qualify for a Solo 401k plan by taking part in real estate activities, such as being a real estate agent, a contractor, or a property manager.

With this self-directed retirement plan, participants have the unique flexibility to invest in real estate, among other alternative assets. Instead of having their retirement savings stuck in a stock portfolio, investors can now tap into this source of financing for their real estate ventures.

Let’s take a look at how a Solo 401k plan can fund a real estate investment:

real estate investment

Grow your retirement fund with real estate, not the stock market.

Direct Investing from a Solo 401k Plan

The Solo 401k plan is allowed by the IRS to invest in real estate. While some plan providers may restrict the options to certain investment products they offer, most plan owners can eliminate such restrictions by switching to a truly self-directed plan.

With a self-directed Solo 401k, the investment choices are virtually limitless. Real estate investors can use the funds to purchase a property, such as single family or multi-family homes, commercial buildings, even raw land.

While investing in real estate with a Solo 401k plan is not a complicated process, there are certain rules that plan owners need to follow.

The plan owner only acts on behalf of the plan. This means all income and expenses related to the property must go in and out from the plan itself. For example, the plan owner cannot use the Solo 401k funds to purchase the property and then use his personal money for repair and maintenance.

Private Lending – Use the Solo 401k Plan as a Bank

Aside from directly purchasing a property, the Solo 401k plan can act as a bank or a private lender that can extend financing to other investors. Among the investment options are private placements, mortgage notes, and trust deeds.

In real estate, the loan can be secured with a property. The plan participant then will not be involved in the rehab process or the leasing of the property. The plan will lend out its money and passively collect the principal and interest payments.

Because of this passive nature, private lending is a great option for the Solo 401k plan. The plan participant only needs to make sure that they lend to a non-disqualified person and perform due diligence on the lending venture.

Private lending in a tax-deferred or tax-free environment allows accelerating the growth of your wealth much faster comparing to lending with personal funds.

Using Non-Recourse Financing to Acquire Real Estate Investments

If the plan owner is interested in investing in real estate directly, but the Solo 401k does not have enough funds for the investments, there are other options:

  1. The plan owner can transfer funds from an IRA or a past employer 401k
  2. He or she can also make new contributions to the plan
  3. A non-disqualified partner can also join the venture

If all other resources have been exhausted, the Solo 401k still has a powerful source to tap into–non-recourse financing.

Conventional loans and mortgages are not allowed when using leverage to purchase real estate inside of a retirement account because they require personal guarantee. If the plan owner acts as the guarantor for the loan, that will be a prohibited transaction.

A non-recourse loan, on the other hand, only uses the property as collateral. There is no guarantor needed, the underlying property is the only security for the loan, hence the non-recourse option complies with the Solo 401k rules.

The non-recourse financing is available to both the Solo 401k plan and the Self-Directed IRA. However, the Solo 401k plan has a unique advantage: It can use non-recourse financing without paying the Unrelated Business Income Tax (UBIT).

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About the Author...

Dmitriy Fomichenko is the president and founder of Sense Financial Services, LLC, a leading provider of retirement accounts with "Checkbook" Control: the Solo 401k and the Checkbook IRA. Over the years he's instructed dozens of investment & financial planning seminars and mentored hundreds of investors.

To learn more about the Solo 401k plan, visit sensefinancial.com and read Dmitriy's full bio here: http://www.sensefinancial.com/dmitriy/

Comments

  1. Drew Reed says:

    I like how you said direct investing from a 401k plan is allowed by the IRS for real estate. I didn’t know that. My wife and I have a self-directed 401k, and we were planning on investing in lower-risk ventures because we didn’t think we had the cash for real estate. This might change that. I’ll have to look into it. Thanks!

  2. Primo S Quest says:

    I have a self directed 401K.

    My 401K Trust is buying a home for $715,000 cash which the 401K will rent hold and rent out for income and asset appreciation.

    The 401K only has $645,000 cash available to the sale. Is it allowed by the Self Directed 401K rules for the plan holder to lend the $70,000 cash to complete the $715K sales price as a bridge loan until the home is refinanced with a non recourse loan for up to 60% of the purchase price ?

    • Dmitriy Fomichenko says:

      You (the plan holder) is considered to be a “Disqualified Person” to your 401k plan and are prohibited from conducting any business with the plan or providing any services to the plan. Therefore what you proposing would not be allowed. You can get a loan from anyone else who is not a disqualified person. The loan must be non-recourse.

  3. King J Penson says:

    Could I use solo 401k Trust funds to finance a rehab job on a rental property owned by my LLC -as long as the profits -rent go back into the 401k Trust.

    • Dmitriy Fomichenko says:

      If the rental property is owned by your LLC – all rents and profits belong to the LLC, not to your 401k trust, so I’m not sure I am following you why you think you can put profits that belong to the LLC into your 401k.

      Now, to answer your question about using 401k funds to finance a rehab job, since the LLC is owned by you it is considered to be a “Disqualified Person” to your 401k. Any transactions between a plan and a disqualified persons are prohibited. You are not allowed to receive any direct or indirect benefit of using 401k funds. You can not finance a rehab job that your LLC owns using your 401k funds.

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