How To Invest In Real Estate With A Solo 401k

Looking to open a Solo 401k plan? Get started today with just a few clicks – The Carry Solo 401k Plan is a featured-packed self-directed account that lets you invest in both traditional and alternative assets, take out a loan, or do a Mega Backdoor Roth conversion with a few clicks.

Purchasing real estate through a retirement account like the Solo 401k can be extremely tax-advantageous. Not only do you get tax deferrals until you retire, you also get tax-free withdrawals if you purchase through a Roth Solo 401k.

In other words, you don’t pay tax on any rental income that your property makes, you don’t pay tax when you sell your house for a profit, and with the Roth option, you just don’t pay any taxes at all.

However, there are a lot of nuances around real estate investments with a solo 401k. Because the purchased property is owned by your retirement account, there are certain rules and procedures you need to follow.

This guide will explain how to purchase real estate with a solo 401k account, the benefits and downsides, and important rules you must follow before, during and after the purchase.

Can you buy real estate with a Solo 401k?

Yes, a solo 401k can be used to invest in real estate. However, any property purchased must be for the sake of investing and/or earning rental income. You or any disqualified person are forbidden to use or live in the property owned by your Solo 401k.

Types of real estate you can buy with a Solo 401k

Benefits of buying real estate with a Solo 401k

The two biggest benefits of buying real estate through a solo 401k is tax-free compounding and tax-free withdrawals with a Roth option.

Tax-free compounding

With a Solo 401k, you don’t pay any taxes when you sell assets or make profits. That makes it a perfect retirement account to buy real estate from.

Any rental income that you make doesn’t get taxed and goes directly back into your Solo 401k account. If you sell the property at a profit, you don’t pay any taxes on the gains. The full amount goes directly into your Solo 401k account.

Here’s an example:

Let’s say you purchase a rental property for $200,000. Every year, the property makes $12,000 in rental income. 5 years later, the property value rises to $1.2 million and you decide to sell.

The $60,000 (5 years x $12,000 yearly rental income) you made renting out the property is all yours. No taxes owed.

The $1 million in profit ($1.2 million – $200,000) you made from selling the property is also all yours. No taxes owed.

Tax-free withdrawals with a Roth option

A Solo 401k comes with two different accounts: A traditional and a Roth.

Both accounts have tax-free compounding. But with the Roth option, you don’t pay any taxes when you withdraw from your account at the eligible age of 59½.

If you buy a property for $200,000 and it appreciates to $10 million, the entire profit of $9.8 million is all yours. You pay zero taxes when you take the money out.

If you bought the property through a Traditional Solo 401k, rather than Roth, then you would still need to pay taxes when you start taking distributions in retirement.

Downsides of buying real estate with a Solo 401k

There is only one downside to buying real estate through a Solo 401k, and it’s a pretty minor one.

If you purchased a rental or investment property WITHOUT a Solo 401k, and it decreases in value, you can normally write off the loss and deduct it from your ordinary income.

Through a Solo 401k, you can’t deduct losses. Any losses have no use, your retirement account just loses its value.

This is very small tradeoff compared to the benefits.

How to buy real estate with a Solo 401k

The process of buying real estate is actually quite straightforward, especially if you’re purchasing with all cash. However, it’s important to note that not all Solo 401k plan providers let you invest in alternative assets like real estate. Compare the different self-directed Solo 401k plans here.

Here’s what the steps would look like:

Step 1: Open your Solo 401k account

If you don’t have a Solo 401k account already, then you’ll need to open one first.

Some plan providers, like Carry, will help you with the entire process of opening an account and even assist in opening bank accounts.

Step 2: Open bank accounts

The real estate that you purchase with your Solo 401k belongs to your Solo 401k trust. You and your business are not the owners.

Therefore, you need to create separate bank accounts for your Solo 401k. You’ll need to create two different accounts: One for your traditional Solo 401k and another for your Roth Solo 401k.

Step 3: Fund your Solo 401k

You can fund your Solo 401k through direct contributions or by doing a rollover. You can rollover your cash/assets from another retirement plan you own into your Solo 401k.

Rollovers are the fastest, easiest way to fund the account since there are no limits to how much you can transfer over, and it doesn’t affect your yearly contribution limits.

Once your account is funded, you’re all set and can start looking into buying your first piece of real estate under your Solo 401k trust.

Step 4: Determine how you’ll pay for the property

There are four different ways to purchase the property. Let’s go through each of them one by one.

Step 5: Put together your offer

Once you’ve decided how you’re going to purchase the property, you can work with a title company or attorney to put together your purchase offer, listing the Solo 401k as the buyer. You are the trustee of your Solo 401k, so you will be the one signing all the closing documents.

Step 6: Send an earnest deposit

The purpose of an earnest deposit is to signify to the buyer that you’re serious in buying the property. It gives them confidence that you’ll follow through and actually buy it so that they can take their homes off the market.

Without an earnest deposit, a buyer can technically make a bunch of offers with multiple sellers. The sellers would then take their homes off the market, and then the buyer gets the freedom to choose whichever home they like.

To protect sellers, sending an earnest deposit is required when purchasing property with a Solo 401k. Usually, it’s around 1% to 2% of the total purchase price. The money will get cashed, held in a trust account or the broker’s escrow, and then be used towards the downpayment and closing costs.

IS AN EARNEST DEPOSIT REFUNDABLE?

Yes, an earnest deposit is refundable. Buyers can get most of the earnest deposit back even if they decide not to go through with the purchase, minus any cancellation fees. The purchase agreement should cover how the earnest deposit is refunded in case the sale doesn’t occur.

Step 7: Send the money, close the purchase

Now, all that’s left is to sign the rest of the property purchase documents and send over the funds by check or wire from your Solo 401k trust bank account.

As the trustee of your Solo 401k, you’re required to store all property closing documents such as the purchasing contract, Escrow instructions, settlement agreement, the deed, and any loan documents.

Important rules to remember

These rules are very important, and many people aren’t aware about them when they consider purchasing real estate with a Solo 401k.

A Solo 401k has strict rules around prohibited transactions. A prohibited transaction is when a disqualified person transacts with your Solo 401k account.

The rules are a bit tricky, but you can read the full explanation here.

Essentially, you have to completely separate yourself from the property owned by your Solo 401k. You can’t live there, you can’t stay there, you can’t work there, and the same goes for your immediate family members.

There are a lot of nuances and it’s one of the annoying parts of owning property with your Solo 401k. Let’s go through some of the major rules below.

“You” in the above rules refers to any disqualified person, not just yourself. Basically, you have to keep yourself and any disqualified person completely separate from the Solo 401k assets. You cannot transact with it at all, even if it’s for free. You must hire an outside third-party to handle all property management, repairs, upgrades, etc.

A Solo 401k built for flexibility and ease with an integrated investment platform. Learn more about The Carry Solo 401k.