Last updated on February 26th, 2019 at 12:16 am

Last Updated on February 26, 2019 by

You are probably thinking that you can use your 401k to buy investment property. Yes and No. Starting with the “no”. Federal law prohibits use of 401k funds to be used for investing in property. Now the “yes”. There is a method that may be available to some where you can “roll over” a portion of you 401k investment to a Self Directed IRA. See below.

Not all companies permit this partial roll over, if yours does than read on . If it does not, you have two other alternatives. First, you can borrow up to $50,000 from your 401k without penalty. You will have five years to pay it back with interest currently at 5%. The interest is paid into your account.

The second way is to withdraw funds if you are 59 1/2. There is no penalty after this age but you will have top pay ordinary income tax on the withdrawal. Even paying income tax, this may still be a good move depending upon the profitability of the project.

On to traditional IRA’s, you can roll over a traditional IRA if yours is with a provider that does not have a self directed option. In this case, locate a provider, arrange for the roll over then contact your current IRA provider to get it done.

Roth IRA’s require no special handling provided you have had the funds for five years or more (even if less than five years you can take out what you put in). There are zero taxes and penalties paid on rolling over funds from your Roth to a Self Directed IRA.

There are many rules if you are using pre-tax roll over funds. Here are the rules:

  • Funds must be paid directly to the attorney/escrow managing the purchase from your Self Directed IRA (SDIRA).
  • You can not manage the property in any way.
  • You can not donate time to repair or work on the property
  • You can not live in the property or use the property in any way
  • The property must be managed by a professional manager
  • All funds from rents must go back into the IRA from the Manager
  • Cost for all repairs will be paid by the IRA, no out of pocket from you
  • You can not buy the home later. (there is a way to do this legally)
  • Any type of property will quality, single family home, condo, multi-family, commercial etc.
  • You can put the property into an LLC
  • You can invest with others on an undivided share basis which means that everyone puts in the same amount.
  • Financing is permitted, your down payment and all closing costs will come from the IRA
  • If you sell the property, the sale must be handled by real estate agents and funds sent directly to the IRA
  • The IRA is actually buying the property for your benefit. The paperwork is a bit unusual.
  • Expect three to four weeks to get things set up with an new SDIRA provider.

Lots of rules but they all make sense. If you are buying for example a single family home for $100,000 and the downpayment and closing costs are $23,000, you need to insure you have adequate funds to cover this distribution.

You also need to be sure that rents will cover the mortgage and management cost otherwise the shortfall will come from your IRA. You will not be allowed to make up any shortfall.

About that 401k. While as mentioned above, you can not take a distribution from your 401k to directly invest in real estate without paying at minimum taxes and if you are under 50 1/2, a penalty. Some employer programs offer what is called an “in-service distribution”. This means that you can take a portion of what is in your plan and have it moved directly to a Self-Direct IRA (or other IRA).

With this transfer, there are no taxes or penalties. After the funds are in the Self-Directed IRA, the funds are available as the above paragraphs describe. Not all 401k plans permit this and when some do, they may limit the amount of funds, the source of funds e.g. employer contribution or limit distributions to those over age 50 1/2. If you are serious about zero out of pocket money for investing in real estate, it may be worth a call.

Please complete the contact form if you would like more information about this process, available properties and assistance with working out the cash flow analysis.