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:
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:
- The plan owner can transfer funds from an IRA or a past employer 401k
- He or she can also make new contributions to the plan
- 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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