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5 Things to Know About 401K Real Estate Investing

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“You need to save for retirement!” Most adults have heard this sentiment at least once. We know the importance of saving for retirement (and starting early). What a lot of people don’t know is that you can actually use a 401K retirement fund as a way to invest in real estate. 

Wondering if you should take your retirement fund in a new direction? Here are 5 things to know about 401K real estate investing.

#1: 401K real estate investing itself is illegal.

We say “401K real estate investing” but you can’t actually use your 401K by itself to invest in a property. However, you can open a self-directed IRA and move the funds from your 401K to that IRA, tax-free. By this method, you’re taking existing 401K funds and still using them for real estate investing, just not from the 401K itself.

#2: 401K real estate investing can massively grow your retirement funds.

One of the biggest reasons people move forward with 401K real estate investing is, quite simply, to grow their retirement funds at a faster rate. Consider this:

In a regular 401K…

  • Your max. contribution is $19,500 per year (as of 2020).

If you use a 401K to invest in a rental property…

  • A property that generates $1,000 per month in rental income will lead you to an additional $12,000 per year that can go towards retirement.

Over time, investing with your 401K/self-directed IRA can substantially help you grow your retirement portfolio in ways that the max. contribution alone cannot. One thing to note: the income you generate from a rental property has to go back into your IRA. But hey, that leaves you with more funds for even more rental properties!

#3: When done correctly, you’ll pay little to no taxes.

Another huge advantage to 401K real estate investing is that it’s extremely tax-friendly. You’ll need to find a self-directed IRA that allows real estate investing first, then you can move your 401K directly into that IRA without having to pay any taxes. 

#4: You can borrow money based on how much is in your IRA.

As SFGate mentions, “While you cannot borrow against an IRA, you can usually borrow half of the value of your 401(k) account, up to $50,000. However, if you purchase real estate with funds outside of your 401(k), you no longer have any tax advantages attached to your purchases.”

Often, the specific type of loan used for these transactions is called a non-recourse loan. These loans have special rules (for example, you generally can’t use a non-recourse loan to flip a property, and you can’t use it for a property that’s a primary residence) so study up on them carefully.

#5: You can’t manage the rental property yourself.

The only way you’ll get the full tax advantages of 401K real estate investing is by hiring a property management company. You can’t be the one managing your rental property when it’s purchased using your 401K/self-directed IRA. This differs from traditional rental property investing, though you can still purchase a vacation rental property (it doesn’t just have to be for long-term tenants).

Similarly, you cannot live in a 401K/IRA property. You can’t vacation in it, and you also can’t pay for renovations or other sweat-equity. Again, do some thorough research on the rules beforehand (or hire a tax advisor) because you could otherwise miss out on tax breaks.

*Bonus* #6 You can find your next investment property here at RealtyHive.

RealtyHive connects highly motivated sellers and buyers through our time-limited events with properties for sale worldwide! Whether you’re looking for a gorgeous condo to turn into an Airbnb in Thailand or want to rent apartments or houses for families, you can find real estate potential here. Look through our listings today!

What Is a Non-Recourse Loan?

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Owning a rental property can be a great investment and added source of income. A non-recourse loan is a specific type of loan that’s used to finance a rental property. With a non-recourse loan and rental property in mind, you could be well on your way to building your financial portfolio.

What’s the difference between a recourse and non-recourse loan?

If you fail to pay your mortgage and have a recourse loan, the lender will take your property and you’ll still have to pay the difference on your loan.

A non-recourse loan is a safer option for borrowers. In the event you can’t pay your mortgage, the lender will still take your property but you won’t pay what’s left on the loan.

How does a non-recourse loan work?

Non-recourse loans are unique in that they work with self-directed IRAs or Solo 401ks (individual retirement accounts). In order to qualify for a non-recourse loan, you have to have enough in your IRA to put down at least 40 percent of the property down, plus reserves.

What can a non-recourse loan be used for?

Non-recourse loans can be used to purchase the following types of property:

  • Residential: We’ll list the specifics of residential properties that qualify below.
  • Agricultural: You can buy agricultural land and lease it out, generally for crops or livestock.
  • Commercial: From commercial office buildings to smaller spaces that will be used as businesses, a non-recourse loan can finance this endeavor.
  • Multi-Unit: Apartment buildings or houses that have multiple units available also qualify.

It should be noted that a non-recourse loan can not be used towards renovation. If you see a fixer upper you like, know that this type of loan will not finance that project.

Residential Qualifications

There are some very specific guidelines to whether a home qualifies for a non-recourse loan or not. While this may vary slightly from lender to lender, this serves as a good rule of thumb:

Year

Houses need to be built after 1940. If you find a great pre-1940s home with a solid foundation and little need for renovation, you may still qualify.

Location

The property needs to be in the US (Hawaii and Alaska included). International properties don’t qualify.

Price

Houses need to be at least $70,000.

Residence

You cannot live in this property, nor let anyone in your family or friends live there. You have to use it as an investment/rental property. It cannot be your primary residence.

Roof

A single unit in an apartment likely won’t work, because houses only qualify for a non-recourse if they have their own roof. Terraced (row) homes or any type of residence where you aren’t responsible for your roof won’t work.

What kind of rental property can I turn the house into?

The property can become a regular rental, such as for long-term tenants, or a vacation rental! Choosing the right avenue for renting should be based on the property’s location and the area’s needs. For example, a house near a college town is a great rental property for students; a cottage in the mountains would be better as a vacation rental.

Are there any other financial qualifications?

Yes, though these will vary by lender. You will need:

  • A good credit score (aim for at least 700, preferably higher)
  • Proof of your self-directed IRA and a letter from your IRA account holder
  • Income/expense statements, generally from the past two years
  • A solid DSCR (debt service coverage ratio — it indicates how likely you are to profit from this investment), usually about 1.25

Again, these requirements aren’t the same for every lender, but they serve as a general idea.

Whether you’re breaking into the real estate investment world for the first time or are a seasoned vet, look through RealtyHive’s database to find your perfect property. From owning homes to owning rental properties, our time-limited events can help you find what you’re looking for.