Using 401k funds for Rentals / Real Estate Investment

[FrugalSaver]

I have accumulated significant, for me, funds in my 401k and am looking at ways to access those funds for real estate to diversify my portfolio.

I have a couple of self directed options: 1) a self directed brokerage account and 2) a self directed ROTH account as options; both managed by Charles Schwab

Anyone have any experience doing this and any thoughts?

[waltworks]

Why not just use after-tax dollars if you want to do some RE investing? Doing it via 401k (unless you have a solo 401k) is going to be hard/impossible.

-W

[Another Reader]

Self directed IRA's at brokers do not work for real estate.  You need a custodian that acts on the IRA's behalf.  There are several out there.  Be very careful, however.  Don't do any of the work, buy materials, or use the property yourself.  You will lose the IRA tax status if you do so.

[FrugalSaver]

Why not just use after-tax dollars if you want to do some RE investing? Doing it via 401k (unless you have a solo 401k) is going to be hard/impossible.

-W

Why would it be hard / impossible?

[maizefolk]

Buy REITs and call it good?

[waltworks]

Why not just use after-tax dollars if you want to do some RE investing? Doing it via 401k (unless you have a solo 401k) is going to be hard/impossible.

-W

Why would it be hard / impossible?

Because it has to be done at arm's length via a third party, as I understand it. Keep in mind too that the gains have to be put back into the 401k, so you don't get any money out of it that you can use for other purposes.

Again: why not just use after tax dollars to accomplish the same thing? Or REITs, which you don't need to do anything special to invest in.

-W

[SeattleCPA]

I have accumulated significant, for me, funds in my 401k and am looking at ways to access those funds for real estate to diversify my portfolio.

I have a couple of self directed options: 1) a self directed brokerage account and 2) a self directed ROTH account as options; both managed by Charles Schwab

Anyone have any experience doing this and any thoughts?

I have experience dealing with the tax accounting headaches created when people do what you ask.

This idea is terrible almost always terrible.

Some things to keep in mind:
1. You can't jack your profits by injecting any sweat equity
2. You don't get any of the usual tax benefits from your real estate investment (e.g., depreciation)
3. You convert preferentially taxed gains (like capital gains and unrecaptured Sec. 1250 gain) into ordinary income.
4. Your IRA or 401(k) will now need to file its own tax return, a 990T
5. Your create a headache for when you later need to do RMDs in retirement
6. You lose the ability to get a Sec. 1014 step up in basis

P.S. I think you can use REITs inside your 401(k) and get exposure to the asset class if you're interested in bumping your allocation to real estate

[FrugalSaver]

Why not just use after-tax dollars if you want to do some RE investing? Doing it via 401k (unless you have a solo 401k) is going to be hard/impossible.

-W

Why would it be hard / impossible?

Because it has to be done at arm's length via a third party, as I understand it. Keep in mind too that the gains have to be put back into the 401k, so you don't get any money out of it that you can use for other purposes.

Again: why not just use after tax dollars to accomplish the same thing? Or REITs, which you don't need to do anything special to invest in.

-W

This is money that represents a portion of my portfolio that I'd like to have in hard assets that I own (real estate).  One could always just buy a REIT but I already own some of those and the purpose is to get cash flow that I have more personal control over.

The money does have to go back to the 401k or tax advantaged vehicle but how is that different than buying stocks and retiring early on that money taking consistent distributions?  People do that all the time when retiring before 59.5 to access those funds.

MMM has written extensively on that subject. (Rule 72(t))

[Another Reader]

SeattleCPA's list is more complete than mine.  Another problem that should be included the difficulty of using leverage in these accounts.  Read the list carefully.  His analysis is correct and the implied advice to avoid doing this wise.

You are motivated to be a real estate investor.  If you have a good one in your area, join your real estate investors' association.  Do some additional reading of unbiased, analytical material about your ideas.  Use the opportunity to learn from other investors that have done or avoided doing what you are suggesting.

My approach has been to keep tax advantaged retirement assets in a paper portfolio.   I keep my larger real estate portfolio as a taxable portfolio.  I get all the tax benefits he describes, can arrange for and do work on the properties, and can finance them without entity complications.

[maizefolk]

I think the message from people upthread is that even if you could manage to do this, and are willing to put up with all the complications and pay for all the other paperwork that it would entail, because of all the arms length rules that would have to be followed you wouldn't actually have:

... cash flow that I have more personal control over.

And this assumes you get good accounting and tax advice and don't make a mistake that counts as a prohibited transaction and get your IRA disallowed, having to pay income tax on the entire value of the account in a single year.

[waltworks]

If you want more cash in "personal control" then a 401k rental RE setup is probably the exact opposite of your ideal scenario.

-W

[SeattleCPA]

FrugalSaver, because you're thinking about your 401(k) and investing in real estate, you might be interested in considering the option of just going with  401(k) and traditional asset classes... and then alternatively the option of skipping the 401(k) and doing direct real estate investment.

Both options have compelling aspects, though I believe most people find the "IRA and/or 401(k)" option works best--in part because it's easiest.

About a year ago, I tried to make a strong case for both choices at my blog--and you might be interested in peeking at both posts:

Why real estate can be a better way to save for retirement than something like an IRA or 401(k)

Why IRAs and 401(k)s can be a better way to save for retirement

[Mr Mark]

I have accumulated significant, for me, funds in my 401k and am looking at ways to access those funds for real estate to diversify my portfolio.

I have a couple of self directed options: 1) a self directed brokerage account and 2) a self directed ROTH account as options; both managed by Charles Schwab

Anyone have any experience doing this and any thoughts?

I'd recommend spending $10 and getting the recent Biggerpockets Real Estate Tax book  https://www.amazon.com/Book-Strategies-Savvy-Estate-Investor-ebook/dp/B01BWDHLTQ written by 2 CPAs who specialise in US Rental Tax strategies. They have a couple of chapters specifically on the topic of self directed 401k and Solo (k) as potentially valid strategies for real estate investing but there are a few loopholes to be navigated.

I've just finished reading it on my kindle and it was an eye opener.

Apparently you'll be able to roll your existing 401k into a self directed type and then via that vehicle invest in rental real estate.

[arebelspy]

Apparently you'll be able to roll your existing 401k into a self directed type and then via that vehicle invest in rental real estate.

Yes, this self directed IRA is what everyone in this thread (Another Reader, SeattleCPA, waltworks, etc.) were addressing.  :)

I agree that it's not something to do lightly.  It has many pitfalls, and many drawbacks.

It's best suited for someone who wouldn't invest in paper assets due to their feelings about the stock market; someone who wants real estate, and only the hard asset kind, and is willing to navigate the pitfalls in order to do that.

That should be pretty rare, IMO.  REITs are probably the better solution for the vast, vast majority.

[Metric Mouse]

If you want more cash in "personal control" then a 401k rental RE setup is probably the exact opposite of your ideal scenario.

-W

This.

[Proud Foot]

Why not just use after-tax dollars if you want to do some RE investing? Doing it via 401k (unless you have a solo 401k) is going to be hard/impossible.

-W

Why would it be hard / impossible?

Because it has to be done at arm's length via a third party, as I understand it. Keep in mind too that the gains have to be put back into the 401k, so you don't get any money out of it that you can use for other purposes.

Again: why not just use after tax dollars to accomplish the same thing? Or REITs, which you don't need to do anything special to invest in.

-W

This is money that represents a portion of my portfolio that I'd like to have in hard assets that I own (real estate).  One could always just buy a REIT but I already own some of those and the purpose is to get cash flow that I have more personal control over.

The money does have to go back to the 401k or tax advantaged vehicle but how is that different than buying stocks and retiring early on that money taking consistent distributions?  People do that all the time when retiring before 59.5 to access those funds.

MMM has written extensively on that subject. (Rule 72(t))

What portion of your 401k would you tie up in your rentals?  You would want to make sure that you have enough investments other than your rentals to cover the difference between your distributions and the net rents.  Also, I don't know the answer on this, but you would need to know how the properties are valued for the RMD calculation.  You would not want to get into the situation where you have to liquidate a whole property to have the cash for the RMD.