MI Real Estate

THE INS AND OUTS OF CREATING A SOLO 401K TO INVEST IN REAL ESTATE

With so many advantages to Solo 401k plans, small businesses and those who enjoy self-employment must consider this excellent strategy as a part of their retirement planning. As a resource for investing in multi-family syndications and other types of real estate, it would be negligence if we didn’t offer our readers this information.

As an exciting solution to retirement income, using your Solo 401k to invest in real estate is a great option for many small business owners. However, aside from being cost-effective to set up and a terrific tax efficient system, I’m sure you have questions about how to use this retirement plan to invest in real estate. So, keep reading to learn more.

WHO IS ELIGIBLE FOR A SOLO 401(K)?

A one-participant 401(k) plan is a retirement account that the IRS allows for small business owners. You will also see it referred to as a Solo 401(k), solo-k, uni-k, and one-participant k.

In other words, if you are a small business owner with no employees, you, and your spouse or bonafide partner are eligible to contribute to a Solo 401(k).  Of note, the business can have employees under 21 years of age, which is great because there are additional tax benefits to those who employ their children.  However, these employees would not be eligible to participate in the Solo 401(k).

There is one other exception to the no-employees rule allowable by the IRS. This is important to know because it increases the amount you can contribute as a family.

  1. First, your spouse or partner elects to make deferrals as your employee.
  2. Then, as the employer, you make a profit-sharing contribution of up to 25% of compensation for your spouse.

WHAT ARE THE GUIDELINES FOR A SOLO 401(K) PLAN?

Before delving into more details, here is a breakdown of the basic facts surrounding a Solo 401(k).

Eligibility rulesNo age or income restrictions but must be a business owner with no employees.
Contribution LimitTotal of up to $56,000 in 2019, with an additional $6,000 catch-up contribution if 50 or older.
Taxes on ContributionsTraditional 401(k): Contributions are pre-tax, which reduces taxable income for the year.
Roth 401(k): Contributions are after-tax dollars.
Taxes on Qualified Distributions in RetirementTraditional 401(k): Qualified distributions are taxable as income.
Roth 401(k): Qualified distributions are tax-free.
How to Open a Solo 401(k) accountIf you have an employer ID number, you can open a Solo 401(k) through online brokers.

Tip o’ the Hat to What is a Solo 401k?

• CONTRIBUTION LIMITS OF A SOLO 401K PLAN

As you can see in the table above, there is a contribution limit of $56,000 in 2019. Additionally, for those 50 or older, that is a contribution limit of an extra $6,000.

However, with the Solo 401(k), you can contribute as two people:

  1. Employee:
    1. Contribution limit: Either $19,000 in 2019 or 100% of compensation, whichever is less.
  2. Employer:
    1. Additional profit-sharing contribution of up to 24% of your income or net self-employment income.
      1. Your net profit less half of your self-employment tax and the plan contributions you make as an employee.
    2. Compensation limit: $280,000 in 2019.

Additionally, you must keep in mind that if you also participate in a 401(k) at your day job, the limits apply to contributions across all plans.

Additionally, you can contribute using pre-tax or Roth (after-tax) funds. For more information about using the Roth option to invest in real estate, click here.

WHEN CAN I INVEST IN REAL ESTATE WITH MY SOLO 401(K) PLAN?

A small business does not have to be profitable to use its Solo 401(k) to invest in real estate, but the entire amount of the investment must be from the Solo 401 (k). Additionally, you may not occupy the investment property. It is for investment purposes only.  Also noteworthy, there are ways you can rollover from one retirement account to another.  One great example is separating or retiring military service members, who can rollover their Thrift Savings Plan to a Solo 401(k).  Generally, any time you leave one employee 401(k) plan, you can transfer into a Solo 401(k).

Furthermore, your income and gains from real estate investments are tax exempt. For example, suppose you buy a property for $300,000 and sell it for $500,000. Your $200,000 earnings are tax-free.

If you are a small business owner and want to take advantage of all the great benefits of a solo 401(k), it’s important to stay informed. Here is a helpful link to the information you need to know. Self-Employed Individuals – Calculating Your Own Retirement-Plan Contribution and Deduction.

YOU HAVE THE FREEDOM TO SELECT YOUR INVESTMENTS

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The convenience of a Solo 401(k) is in your ability to select the investments rather than the limitations of a brokerage. This gives you the freedom to invest in real estate, small businesses, precious metals, hard money loans, and stocks.

You are the trustee of your plan and that gives you the ability to make investments that are as easy as writing a check or making a wire transfer.  You also benefit from not having to pay fees to a custodian.

When your 401k bank account is open and funded, as the trustee you use one of the following purchasing methods to invest in real estate. However, keep in mind that you purchase the property not in your name but in the name of the Solo 401k plan.

Also note that because the plan is purchasing the property, in order to comply with regulations, all fees that are associated with the transaction must also be paid from the Solo 401k plan, not the individual.

• SELECTING A PURCHASING METHOD

As the trustee of your plan, your task is to choose from these three types of purchasing methods for the Solo 401(k) plan:

  1. Purchase 100% of the property with all cash and no loan.
  2. Enter into a tenants-in-common (TIC) transaction using all cash only.
  3. Purchase 100% of real property using leverage (Solo 401(k) non-recourse loan).

• SOLO 401(K) NON-RECOURSE LOAN BASICS

Non-recourse loans are loans that your Solo 401(k) borrows to invest in real estate and other assets.

The interesting caveat with this type of loan is that “non-recourse” means the lender is unable to go after you as the trustee or the Solo 401(k) account balance. Instead, the lender can only foreclose on the property.

You can seek non-recourse loans through select banks or hard-money lenders. They are usually set up for 15 to 25-year loan payoff periods but can be set up for any term period.

Interestingly, when applying for your non-recourse loan, the qualifications are quite different than a conventional loan. Because the loan is in the name of your 401k plan – not you – they will not require your employment history, income, W-2’s, or tax returns. What’s more, because you use your EIN on all loan documents, this loan will not appear on your personal credit report.

• INVESTING IN REAL ESTATE SYNDICATIONS

One of the best reasons to invest your Solo 401(k) in multifamily syndications are the tax benefits of owning rental property.  With depreciation deductions, cost segregation/accelerated depreciation, depreciation recapture, investing in multifamily syndications give you a selection of amazing tax benefits.

When investing in real estate syndications, you and other investors pool your money and purchase properties that are otherwise out of your price range.  As an example, if you have $60,000 to invest, instead of buying one property for $60,000, you and 10 other investors each invest $60,000.  With 25% down, you all could buy a $2.4 million property!

Another attractive feature of investing in multifamily syndications is it’s a truly passive income. The sponsor of the syndication does all the heavy administrative work and all you do is sit back and watch the checks roll in.

Of course, this only brushes the surface of the benefits of multifamily investing. To learn more, here are some informative links.

WHERE DO I GO TO FIND INFORMATION?

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