invest in real estate with a 401k

Want to double down on the tax benefits of real estate investing with your 401(k)?

I get it. Fortunately, you have several options for investing in real estate with a 401(k) or 403(b) account.

Not all of them are created equal, however. And the more flexibility you want, the further off the beaten path you’ll have to venture.


Options for 401(k) Real Estate Investing

Sit down with your accountant or financial advisor to discuss these options to invest in real estate with a 401(k) and decide which one fits your goals best.

We’ll start with the easiest options and work our way to the more flexible but involved options.


1. Public REITs

Many 401(k) administrators already offer publicly-traded REITs as built-in options for investing. If you want to include publicly-traded REITs (real estate investment trusts) in your broader portfolio anyway, your 401(k) account is a convenient place for them.

Just bear in mind that public REITs don’t actually offer much diversification from stocks. There’s an uncomfortably close correlation between REITs and stocks, which defeats the purpose of diversifying your portfolio to include real estate. The correlation between U.S. REITs and the broader U.S. stock market is 0.59, which is comparable to the correlation between the total U.S. stock market and other sectors such as telecommunications stocks, energy stocks, and consumer staples.

If you want true diversification with uncorrelated assets, you’ll have to look further afield.


2. Borrow Money from Your 401(k)

Often the cheapest person to borrow from is yourself. Or at least, your future self, by borrowing from your 401(k) balance.

You’ll still pay interest, but at a lower interest rate than loans from banks. And that interest actually goes toward your 401(k) balance, not a lender.

You can use borrowed funds to cover the down payment on a rental property, closing costs, renovation costs, or anything else for that matter. Loans from your 401(k) are flexible, cheap, and don’t require lengthy credit applications. If you default, it doesn’t report on your credit history.

But you do pull cash out of your 401(k) account that would otherwise be invested and earning a return for you. It’s up to you to ensure you earn a higher return on your borrowed funds than you’d have earned if you’d just left the money in your 401(k) invested in stock index funds.

If you leave your job, you typically need to repay the loan balance quickly. And in the case of default, the IRS considers the balance an early withdrawal and hits you with both taxes and a 10% early distribution penalty.


3. In-Service Rollover to an SDIRA

With a self-directed IRA (SDIRA), you can invest in nearly anything you want, including real estate.

But can you transfer funds from your 401(k) to your IRA while you still work at a job? In most cases, you can; the Profit Sharing Council of America (PSCA) estimates that up to 77% of employers allow in-service rollovers to IRAs.

Of course, “can” is not the same as “should.” Self-directed IRAs require a custodian to oversee your IRA funds and keep you in compliance. And custodians charge for their services, typically hundreds of dollars each year.

That said, self-directed IRAs let you invest in anything from real estate crowdfunding platforms to direct property ownership to real estate syndications. Many of the members in our real estate investment club invest via their SDIRA.

If you invest with a self-directed Roth IRA, your investments compound tax-free. And at compound returns of 15–30%, like we aim for in our real estate investment club, that can mean doubling your money every few years, tax-free.

As a final thought, in-service rollovers can let you contribute huge amounts to your IRA. So long as you meet the income requirements, you can max out both your IRA contributions and your 401(k) contributions each year.

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4. Open a Self-Directed 401(k)

If you’re self-employed, you can open your own solo 401(k) or small business 401(k). And you can opt for a self-directed 401(k), where you control the investments similar to an SDIRA.

Even if you work a 9–5 job, you could open a self-directed 401(k) for your side hustle. Even real estate investing can count as being in business and eligible for opening a 401(k)!

Again, expect to pay fees to a 401(k) custodian or administrator. They take on most of the regulatory headaches and paperwork, but it still adds more complexity than just buying index funds or public REITs in your employer’s 401(k) plan.

In exchange for those downsides, you can invest in nearly anything you want. That could include fractional shares of rental properties, fractional real estate syndications — ranging from self-storage facilities to apartment complexes, mobile home parks to retail and beyond, property-secured debts, or direct property investments.


Active Real Estate Investing with a 401(k)

You can buy investment properties directly with a self-directed 401(k) or SDIRA. But it comes with some complications and downsides.

To begin with, only your down payment counts as a tax-sheltered investment. If you borrow a rental property loan, that portion of the property doesn’t count as an IRA asset, and you pay normal taxes on it. Only a percentage of your property counts as an IRA investment, with all its tax advantages. That adds plenty of wrinkles to your tax return (and forehead, in all likelihood).

Additionally, you can only take out a non-recourse loan when you buy properties with your SDIRA or self-directed 401(k). Non-recourse loans don’t allow the lender to come after you personally if you default. As you can imagine, few banks offer them. Check out North American Savings Bank as one lender who does, but expect a harder road to take out a non-recourse loan than a typical rental property loan.

In short, buying rental properties in a self-directed IRA gets tricky. Which is why I don’t do it, and neither do most real estate investors I’ve known.


Passive Real Estate Investing with a 401(k)

Most people who buy real estate with a 401(k) or self-directed IRA invest passively. In other words, they don’t buy properties directly, but instead invest in larger real estate projects put together by professional investors.

One common example is real estate crowdfunding investments. That broad umbrella covers everything from fractional ownership in properties to real estate investing funds to pooled or individual loans secured by real estate. For example, you can buy fractional shares in rental properties on Ark7 or Arrived, or pooled real estate funds on Fundrise, or secured short-term loans on Groundfloor. I’ve invested personal money in all of those and more.

Or you can go a step further and invest in private equity real estate syndications. One common “drawback” of these is the lack of liquidity and the long-term commitment of 2–7 years, but you probably won’t withdraw funds from your retirement accounts within that timeframe anyway. Another downside is the high minimum investment, typically $50–100K. But if you invest as part of an investment club where members pool their funds together, you can invest with far less. Many of the members of our Co-Investing Club invest with a self-directed IRA, and the minimum investment is $5K instead $50–100K.

That makes it a lot easier to diversify your real estate investments, spreading your money among 10–20 investments instead of a single property or fund.

Passive real estate investing in a 401(k) or IRA also keeps your accounting and tax return easier. Real estate crowdfunding platforms send you a 1099, and real estate syndication sponsors send you a K1. In both cases, you just plug the bottom line number into your tax return, rather than trying to calculate out which portion of your rental cash flow counted as retirement account income and which didn’t.

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Alternative: Do Your Stock Investing in Your 401(k)

Personally, I don’t invest in real estate with a 401(k) or self-directed IRA.

A diversified portfolio includes both stocks and real estate. If I’m going to own both anyway, what’s the point in jumping through all the extra hoops to buy real estate in a 401(k), when I could just hold my equities in my 401(k) and own my real estate separately?

After all, real estate comes with plenty of built-in tax advantages. Consider all the tax deductions for rental properties, or the on-paper-only write-off for real estate depreciation? For that matter, most real estate syndications let you take accelerated depreciation, showing a loss on your tax return even as you collect distributions in real life.

Imagine you hold 50% stocks and 50% real estate as your asset allocation. You can hold the stock portion of your portfolio in your 401(k) and IRA, to skip the headaches of working with a self-directed IRA custodian or a self-directed 401(k) administrator.


Final Thoughts

Before going out and signing up with the first overpriced self-directed 401(k) custodian you find, sit down and talk to a neutral tax professional. While you’re at it, talk to a few veteran real estate investors about their thoughts on real estate in 401(k)s.

I don’t bother with them, and neither do most real estate investors I know. But the option exists if you want to pursue it — just do so with caution and knowing all the pros and cons.


How do you plan to invest in real estate with your 401(k)?

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About the Author

G. Brian Davis is a real estate investor and cofounder of SparkRental who spends 10 months of the year in South America. His mission: to help 5,000 people reach financial independence with passive income from real estate. If you want to be one of them, join Brian and Deni for a free class on How to Earn 15-30% on Fractional Real Estate Investments.

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