Access to capital represents a significant obstacle for many new investors. Meanwhile, those already familiar with real estate investing are more than aware of the numerous possibilities that exist for securing money. There are, in fact, several viable methods investors may use to gain access to capital. Of these methods, using 401(k) to buy real estate may be the most underutilized strategy. There are countless investors who don’t even realize it’s possible to tap into their retirement accounts to invest in real estate. So I’m here to break down the strategy.
While buying real estate with 401(k) funds has proven invaluable for today’s investors, there are several rules that must be followed. There are limits to this particular strategy, not the least of which include:
Buying real estate with 401(k) funds is recognized as a retirement strategy by the Internal Revenue Service (IRS), which means any resulting profits must be returned to the account from which they originated.
401(k) funds may not be used to buy a personal residence, nor may it be used to buy a home for friends and family.
In order to self direct 401(k) funds, the retirement account must be held by a custodian who permits self direction.
[ Do you control your finances or are your finances controlling you? Find out how real estate investing can put you on the path toward financial independence. Register to attend a FREE real estate class, upcoming in your area. ]
Buying real estate with 401(k) funds is not only a great way to initiate one’s investment career, but the process isn’t as hard as many assume. In fact, tapping into a retirement account to fund a real estate deal is as simple as having a qualifying retirement account.
Not only does a prospective investor need a retirement account; they also need to be able to self direct it. Other than that, investors simply need to assume responsibility and mind due diligence. After all, self-directed retirement accounts are the responsibility of the individual making contributions. Therefore, before choosing to self direct their own retirement funds, investors must know what they are getting into.
Aspiring investors who don’t yet have a 401(k) that is able to be self directed will need to contact a custodian who allows account holders to self direct the funds in their retirement accounts. The custodian will be able to help investors through the steps required to transfer funds from their old account to one that is able to be self directed. From there, it’s simply a matter of using the allocated funds to buy real estate.
Today’s most prolific investors are more than aware of the benefits associated with using a 401(k) to buy real estate, but new investors may be less than familiar with the concept of self directing retirement funds. In order to spread the word on how useful this alternative form of financing can be, I’ve made a list of the benefits that are associated with using a 401(k) to fund a real estate deal. As with everything else, however, there are a few “downsides” that need to be taken into consideration as well. Nonetheless, here’s some of the most popular pros and cons investors need to consider before self directing their own 401(k).
Implementing a 401(k) real estate purchase has become synonymous with a number of benefits, not the least of which include:
Profits realized on a real estate investment that are returned to the retirement account from which they came are tax deferred.
Income generated through rental properties is permitted to accumulate in the retirement account, where it may grow tax deferred.
Self-directed retirement accounts award investors the ability to invest their money in safer and more tangible real estate assets.
Real estate investors may diversify their portfolio with a number of different property types: condos, raw land, commercial property, rental units, and more.
Buying real estate with 401(k) funds promotes a wider degree of freedom. Investors choose where their money is best spent. Traditional 401(k) funds, on the other hand, are distributed by a custodian who chooses where to put the funds based on the investor’s aversion to risk.
Using 401(k) to buy real estate is something anyone with a retirement account can do—if their custodian allows it.
Buying real estate with 401(k) funds may be the only option some investors have, which will allow many people to invest who otherwise may not have been able to.
Unlike relying on other alternative forms of financing, using 401(k) funds to buy real estate won’t coincide with any borrowing fees.
Buying real estate with 401(k) funds isn’t without a few caveats. While there is significant upside to using 401(k) to buy real estate, investors need to be aware of the following:
The Internal Revenue Service intends for the funds in a 401(k) to be reserved for retirement. Therefore, any money earned from selling or renting a real estate asset must be returned to the retirement account from which it came. However, as stated above, returning the funds to the original 401(k) allows them to grow tax deferred.
There are a number of IRS restrictions that prevent investors from participating in certain types of real estate transactions. Therefore, investors need to see whether or not their particular exit strategy is viable before they self direct their retirement accounts.
Investors are prohibited from buying real estate for their own personal use, which means they can’t buy a home to use as their own personal residence; the same holds true for family members.
Using 401(k) to buy real estate assets has proven to be an incredibly useful financing strategy for investors of every level. At the very least, tapping into retirement accounts to self direct funds into real estate has awarded countless people the opportunity to invest in real estate who may have otherwise been unable to. At its pinnacle, however, buying real estate with 401(k) funds is one of the greatest investment strategies in use today. Not only will savvy investors gain access to the funds they need to initiate a deal, but the profits returned to the retirement account are allowed to grow tax free. Few financing strategies can offer the same benefits one may gain access to by using their 401(k) to buy real estate.