If you’re self-employed or a small business owner with a solo 401(k) or Roth 401(k) or if you’ve retired or changed jobs and have assets in an employer-sponsored 401(k), real estate investment is an attractive option for long-term growth potential.
Your employer won’t allow you to directly invest your 401(k) unless it’s an option in the plan, but there are ways for you to rollover or transfer your assets from an employer-dependent 401(k) account into a solo or Roth 401(k), if eligible, for real estate investment.
Solo 401(k) Eligibility
The solo or self-directed 401(k) was created by the IRS to aid:
- Self-employed individuals
- Small business owners with no other employees
- Individuals who generate a portion of their income through self-employment activities
To be eligible for a solo 401(k), the individual must have self-employed activity, including ownership and operation of the business. If the business is run with the intention of generating profits, the IRS will generally view the business as legitimate and eligible for the establishment of a solo 401(k).
Funding Your Solo 401(k)
You cannot rollover your assets into a solo 401(k) from a current employer. You must be retired, have left the employer, or be eligible under IRS guidelines. You have several options when it comes to funding your solo 401(k):
- In-kind transfer: Non-cash assets are moved from the employer-backed 401(k) account to a solo account and not taxable.
- Cash transfer: Cash assets are moved from the employer 401(k) to the individual account. Partial or full investment may be processed and not taxable.
- In-kind direct rollover: Assets from an IRA are transferred to a solo 401(k) account, and there’s no need for the liquidation of assets. This action must be reported for tax reasons and is not subject to tax withholding.
- 60-day cash rollover: This is the quickest way to fund your solo 401(k) from an IRA, but you have a 60-day period to deposit the check to avoid taxes and a 10% penalty for early distribution.
- Annual cash contribution: This is an option for self-employed individuals. Your solo 401(k) can be funded with annual cash contributions by your business tax return date. However, keep in mind that cash contributions have an annual limit. This number depends on your age and salary.
Solo 401(k) Investment in Real Estate
Your solo 401(k) plan needs to be through a provider that will allow you to invest in real property. Once you’ve chosen your provider and funded the account in the name of your plan, you must choose the method of purchasing the property.
There are four real estate investment methods using the funds from a solo 401(k):
- All cash: Using all cash, the individual owns the property free and clear. The property title must be in the name of the plan.
- Debt financing: By using a non-recourse loan or debt financing, you have the potential to leverage funds from your solo 401(k) for larger gains or multiple properties.
- LLC: Using a single-member LLC where the member is the 401(k) and the individual is the director of the LLC investments.
- Tenants-in-Common (TIC): Other investors, including the owner of the solo 401(k), can invest alongside the solo 401(k) in the same property. Certain rules apply and are outlined in DOL Advisory Opinion 2000-10A.
As an example, let’s say you’ve picked your provider, funded the account, and you’re using cash as your investment method. When you’re putting the offer together, your solo 401(k) is listed as the buyer, and the title must be in the name of the plan. Once you have the contract, you must make an earnest deposit using the funds from your solo 401(k). At closing, you (the trustee) sign the purchase documents, and the title will be transferred to the name of your solo 401(k) plan.
Remember that your solo 401(k) is a separate legal entity. Your property is funded through your solo 401(k) plan, and you are the trustee. Your investment property cannot be for personal use, and all money going in and out of the property must be through the 401(k) account.
With the right strategy, you can put your retirement savings to work through investment in real property.