Investing in real estate through 401k or IRA
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So, I recently found out that’s actually possible to use money in 401k or IRA to purchase real estate. Has anyone on FW had any experience with that? I see a lot of pros and very few cons, so need a devil’s advocate.
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@rubl
To my knowlegde (which could be old), you can use your 401 / IRA $ for your first house only without penalty. You will still need to pay income tax on the amount that you took out as those were deposited pretax. Good luck!!!
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No. I’m not taking out any money. I’m just investing in real estate instead of stock market or bonds or whatever.
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Yes. Because real estate is a sector in the market too. Certain 401ks may not offer mutual funds that invest in real estate so you might get more flexibility with an IRA. I’ve always been told that ETFs are the way to go because it offsets investing in any one region that may experience a downturn. I have about 3% in the Vanguard REIT. This article explains it pretty well. Hope this helps
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@rubl said in Investing in real estate through 401k or IRA:
No. I’m not taking out any money. I’m just investing in real estate instead of stock market or bonds or whatever.
+1 on ETF
Also, may want to look ar REIT
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@rubl Consider this a jumping off point for more research. I am not a CPA or tax attorney, I don’t represent one on the Internet and I’m definitely not your CPA/tax attorney. Talk to your CPA about this. I’m just a dog on the internet that has looked at this before.
If you’re talking about self-directed IRA or 401(k), then yes, that’s absolutely true. The IRS just prohibits IRAs from investing in life insurance and collectibles (more info here: https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-investments and also in IRS Publication 590-A: https://www.irs.gov/publications/p590a), so you can purchase real-estate.
Having said that, the following assume self-directed, here are the devil’s advocate reasons for not purchasing real estate in your 401(k)/IRA:
- loans are difficult to come by (usually 50% loan to value-LTV): Unlike a conventional or investor loan requiring 3-25% down, if you need to get a loan on the property, you can expect to put 50% down for the property. Depending on the property and how much you have in your portfolio, this can be difficult
- UBIT (Unrelated Business Income Tax): lets say you get the loan for 50% LTV and it generates $10,000 in rent (income) during the year. You actually owe taxes on 50% of the income because of the loan. As you pay down the loan, UBIT decreases but this is money out of your pocket (not the IRA)
- any/all expenses must go through your self-directed IRA administrator: so if you need to pay taxes, a plumber or any other reason for spending money, your administrator has to cut the check for you. This can cause delays and there are usually fees for something like this.
- none of the tax benefits: you can’t claim losses or depreciation within the IRA
This is a very simple/broad/illustrative example (i.e. these numbers aren’t realistic):
Say you have a rental property that cost $275,000, rental income are $10,000 for the year, it cost $8000 for various expenses (taxes, insurance, loan payment, repairs, property management). Depreciation is usually over 27.5 years, so depreciation is $10,000 a year.If owned individually/partnership/LLC/etc., your taxes look like this for the property:
$10,000 income
– $8000 expenses
– $10000 depreciation
= -$8000 “loss”This $8000 loss then gets applied to your taxes (assuming you are itemizing deductions on your personal/business taxes), reducing your tax bill, saving you $2000 if you’re in the 25% tax bracket, for instance.
Inside an IRA, it looks like this:
$10,000 rental income
– $8000 expenses
= $2000 profitApply UBIT (50% on income so, 50% of $10,000 = $5000).
Inside the IRA, you’ve “earned” $2000, tax-free/tax-deferred (depends on your 401(k)/IRA).
Outside, you now owe taxes on $5000.Someone may correct me and say you owe UBIT on the different ($10K income - $8K expense = $2K, so 50% $2K is $1K).
The point remains, you still end up owing taxes at the end of the day.
This looks better if you can purchase a property outright, but I have no idea what your situation is.
You already know the cons so I wont go through those.
If you’re okay with these cons, talk to a CPA, get real clear about what you want to do and go forth and conquer.
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Solo401k seems to avoid the UBTI issue.
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@venturion Yes. Here is an article that kind of started it all.
https://www.forbes.com/sites/greatspeculations/2016/01/26/how-to-buy-real-estate-with-leverage-in-a-401k-plan/2/#54e7d7d6341f
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@vilimo My whole point is diversification from the stock market. All of our money are currently invested in the stock market which is starting to worry me. REITs kind of defeat that purpose since they are a market answer to real estate- companies can go bankrupt, management fees (ridiculous management fees in REITs), etc.
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More info on Self Direct IRA and UBIT.
I am not affiliated with following nor own it, but it has good info.
https://www.watsoncpagroup.com/problems-with-self-directed-iras/
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Agree with @venturion that a Solo 401(k) could resolve UBTI issue and custodian issue.
This only works if you actually qualify for it, but it’s fantastic since you get a much larger contribution limit ($18K vs $6K if you’re under 50), more if you own a business and use it to contribute, and some other benefits.
Even without the UBTI/UDFI issue, you’d still lose out on the tax deductions.
Go with what works for your specific situation.
