IRA real estate investing is a great way for people to invest in real estate in their retirement account. Have you ever heard of buying real estate in your IRA or 401K? If not, you're going to be pleasantly surprised to discover that you have more retirement investment choices besides mutual funds and real estate can be a great place to grow your nest egg. If you already have some knowledge of investing in real estate in your IRA, hopefully you're opened minded because you're about to discover what most real estate investors will never know about IRA real estate investing.
IRA Real Estate Investing 101
The traditional and most popular way that most investors IRA real estate invest is to use a self directed IRA. IRS regulations require either a qualified trustee or custodian hold the IRA assets on behalf of the owner. If you have an existing retirement account with your employer, for example, you could roll over some or all of it into a self directed IRA managed by a custodian. Further, any future contributions you would want to make would need to be sent to the custodian as well. Then, anytime you wanted to make an investment, you would contact your IRA custodian and they would instruct you on what to do and how to do it. In other words, custodians are chaperones that watch over and approve any moves you makes. And they typically get paid on an annual basis based on how much money you have in your account. The more money, the higher the fees.
Little Known Alternative to the Self Directed IRA
Self directed IRAs have been the standard for real estate investors who want an alternative to stock and bonds in their retirement portfolio. But there is a little known alternative to the self directed IRA that can be a much better choice for active real estate investors that very few people know about. It has many benefits over the self directed IRA, which you'll discover here shortly. It's called a solo 401K, also known as an individual 401K or i401K.
Solo 401K Benefits
Here are the main benefits of the solo 401k over the self directed IRA for IRA real estate investing.
- Checkbook Access & Control: With a solo 401k, you are setting up your own 401k for your company and therefore, you can be the administrator. This will give you complete control over the bank account so you will have have the ability to write checks whenever you want. Direct checkbook access and control is much more efficient than having to go through a custodian for your every move. For example, what if you find a great deal and want to give a seller earnest money on the spot to secure it? With a solo 401k, you can cut the check right then and there, whereas with a self directed IRA, you have to wait for your custodian to give you the green light which could cause you to lose the deal.
- Leverage:You can apply the power of leverage by obtaining a non-recourse loan to help with the purchase and you will not incur the Unrelated Business Taxable Income (UBTI) issue like with a self directed IRA. This gives you greater opportunity to do more deals with less expenses.
- Less Restrictions: You can contribute more per year with a solo 401k over a self directed IRA and there are no income limits for Roth contributions. This helps those who want to sock more money away as well as those with high incomes.
- Second Chances:If you screw up and conduct a prohibited transaction, you can fix it with an i401k whereas with a self directed IRA, making a mistake typically leads to a liquidation of the plan. There are no second chances in the self directed IRA world.
- Lower Fees:The costs to maintain it are much cheaper than having to pay a custodian each year as a percentage of the amount in your account.
- Borrowing Capabilities: And perhaps the favorite above all of the other benefits is the ability to borrow from it, up to $50,000. And you can do whatever you want with the borrowed money so long as you pay yourself back (since technically, you are taking out a loan from yourself).
- Small Business: You need to have a small business. It doesn't have to even be an LLC or Corp, it can be a sole proprietorship or partnership, but a small business nonetheless and that's what most real estate investors have.
- Earned Income: You need the intent, or already be, creating some earned income as opposed to just passive income from rental property. Many real estate investors fit this requirement because a flip, a wholesale, a rehab and resell, an assignment, a commission or a property interest release fee can all be considered earned income.
- No Full Time Employees: You cannot have any full time employees outside of a spouse although you can have 1099 independent contractors as well as part-timers. any real estate investors are sole practitioners while other may have a 1099ed assistant.
- Competent Help & Support: Very few people and/or companies really know what their doing when it comes to setting up and supporting a solo 401K for real estate investors.
- Bank Account Set Up: It can be challenging to set up the bank account for an i401k because some bank officers simply don't know how to set them up.
- Title Insurance: Some title companies run into difficulties with getting their underwriters to approve the issuance of title insurance when the purchaser of the property is an individual 401k.
- Personal Discipline Perhaps the biggest drawback is also the i401K's biggest strength...relinquishing the custodial middleman for yourself. Some people have difficulty maintaining personal discipline when it comes to money. You CANNOT use the account for personal use. Co-mingling funds is a very big no-no in the world of self directed retirement accounts. So if you are the kind of person who spends every penny they earn and has little-to-no self control with money, perhaps you are better off leaving a custodian to watch over your nest egg because you may not possess the personal discipline necessary to protect it yourself.
You may be asking yourself, "If a solo 401K is so much better than the traditional self directed IRA, why haven't I heard of it until now?". First, it is relatively new, only coming into existence in 2001. A lot of people simply haven't ever been introduced to it. Second, it isn't as well known and typically, advisors advise clients on what they know best. Third, self directed IRA custodians can potentially make far more money off of people who have self directed IRAs versus solo 401Ks. Since you are the one handling all of the transactions yourself, there is less of a need to pay them for every little move you make. Fourth, it doesn't fit for people who don't have their own small business. And that's what you'll need to know next...the requirements.
Solo 401K Requirements
With a solo 401K, meeting the requirements can be ideally suited for real estate investors.
There are some others, but those are the major requirements, and as you can see, its almost tailor made for real estate investors.
Solo 401K Drawbacks
As with anything, there can be some drawbacks.
All in all, this is not a very big set of drawbacks, especially when you are working with the right people to get it set up and administered. If you are serious about setting up a solo 401k, email me at phil at freedom mentor dot com and I can email-introduce you to the guy who has forgotten more about individual 401ks than most people will ever know. He knows how to get it set up with the right paperwork, get you connected to a bank that will get the bank account opened quickly and easily and he has the materials you need to educate title companies on how to close and issue title insurance on solo 401k transactions. Again, this introduction is only for those who are serious about setting up a solo 401k.
IRA Real Estate Investing Conclusion
Die-hard self directed IRA supporters have been able to acquire "checkbook power" by setting up an LLC in conjunction with their IRA. But that requires setting up and paying the annual fee for an LLC which, in California for example, is upwards of $800. Plus, these staunch self directed IRA defenders still miss out on all the other great benefits of a solo 401k. Meanwhile, nimble and open minded investors are IRA real estate investing using the individual 401k and loving all the added benefits with such limited drawbacks. I hope this information helps you in your IRA real estate investing!
Hi Phil…If you were to buy “x” amount of properties with your Solo 401K, can your Solo 401k be attached to a lawsuit if one were involved in a court case (ie: accident) that demanded disclosure of personal assets?
Phil Pustejovsky says
Yes. The way I structure it is that each property is owned by a separate LLC and then my Solo 401K owns each LLC. Further, each property has a robust insurance policy and then an additional umbrella policy over them all.
Hi Phil I’m really interested in this I dunno much but pretty sure I have a 401 k I work for ups . Wheres my starting point please help me
Freedom Mentor says
Consider making application to become one of my apprentices and let’s see where it leads!
Can you use the Solo 401k for education for your business?
Freedom Mentor says
Great question! Check with you CPA but Solo 401k’s can be a versatile vehicle for self employed people.
Thanks for the info Phil. Do you know if you can set up an LLC within the solo 401k? What about multiple LLCs to hold each individual property? (Here in Idaho…. the LLC cost $100 to form and there is no annual fee associated with them.). Thanks!
Freedom Mentor says
Your Solo 401K can own as many LLCs as you want it to own.
Jeff Fullerton says
First Western Federal Savings Bank provides non recourse financing for IRA’s and 401 k’s in all 50 states.
Mystic Toad says
Phil. is it true that you are restricted to the amount that you can contribute to your IRA (say $2,000 per year), but the profits are not?
for example; if you did a fix and flip and borrowed $15,000 and made $40,000, couldn’t you put the $40,000 back into your IRA?
Phil Pustejovsky says
Technically, if the deal was done through your IRA, the $40,000 profit would STAY in your IRA. For those 65 years and older, do all your deals in a Roth solo 401K and you get to keep all the profits tax free!