Self-directed Solo 401(k)’s, aka checkbook 401(k)’s, are retirement plans for self employed individuals or business owners without any full time employees other than a spouse. A checkbook 401k enables you to invest in real estate via rental property, house flipping, and more, while still receiving the tax advantages of traditional 401(k)’s.
Setting up a self-directed 401(k) plan for real estate investing is easy with ReSure Financial. They’ll help you customize a plan and accommodate all your investing needs. Visit ReSure Financial to get a free consultation and discuss whether a checkbook 401(k) or self directed IRA is right for you.
What a Solo 401(k) Is & How It Works
You can only use a “self directed” Solo 401(k) to invest in real estate. With a traditional Solo 401(k) account, contributions are tax deferred, and with a Roth Solo 401(k), you pay taxes on your contributions up front but gains are tax free. You must be a business owner or have self-employed income and can’t have any employees who work 1,000+ hours a year to qualify.
For more general information on solo 401(k), refer to our ultimate guide on Solo 401(k) rules, limits, and deadlines. For the rest of this article, we’ll discuss self directed Solo 401(k)s and how they relate to real estate investing.
Self directed Solo 401(k)s can be used to either fix and flip properties or buy and hold properties as a landlord. Regardless, all real estate transactions are conducted via your Solo 401(k) account in the name of your account. This means that the property is owned by your Solo 401(k). All profits are required to flow through your Solo 401(k) account and all expenses are paid out of it.
There is no commingling of personal funds and the property can’t be directly for your benefit, meaning that you can’t live in it. However, even though it’s self directed, unlike a self directed IRA, you can make your own investments and don’t need a custodian to do it for you.
Solo 401(k)s have an annual maximum contribution limit of $61,000. Rollovers from other retirement accounts don’t count towards these contribution limits. However, while Solo 401(k)s offers flexibility with the type of investment and contribution limits, it does have restrictions, too. You must be at retirement age of 59.5+ to take withdrawals from the account without an early withdrawal penalty of 10%.
How to Set Up a Solo 401k for Real Estate Investing
The type of Solo 401k needed to invest in real estate is “self directed”, meaning that you make investment decisions instead of the brokerage. You need a provider to set up the accounts and file the paperwork, but you can make the investment yourself. Once it’s setup, you can buy real estate through the account.
Here are the 5 steps to set up a solo 401k and use it to purchase property:
1. Open the Solo 401k Account
The provider (also known as the trustee), your attorney, or your accountant will draft the necessary self employed IRS documents to establish the account. You must prove that you qualify for a Solo 401k plan by showing proof of self-employed business activity that can be reported on a Schedule C.
The business can be an LLC, sole proprietorship, partnership, corporation or any business entity. However, an LLC set up solely to collect rental income doesn’t qualify since rental income is considered passive.
Opening your Solo 401(k) account will include filing the documents and establishing a trust, with the account holder as the trustee. Then a separate, dedicated business checking account will be opened at a bank of your choice for the funds to go into and any expenses to come out of. This process can take up to a few weeks.
To set up your separate business checking account, try Chase. Chase Business Checking accounts can be opened with as little as $25 and have some of the lowest fees available. Best of all, first-time Chase Business Checking customers are eligible for a $300 bonus.
2. Fund the Solo 401k Account
Once the account is established, you need to fund it. You can make an initial tax deductible deposit based on the allowed contributions according to your age and income. The alternative is to roll over funds from another retirement account which your new provider can help facilitate. This process is usually done within a week. We discuss funding your account in the section below.
Funding the Solo 401k with a Loan
Nonrecourse loans are more popular with commercial properties and aren’t used as often on residential properties, but they do exist. Qualifications are mostly based on the property and the overall deal, such as what condition the property is in and the equity in the property. Loan limits vary by lender and down payments and interest rates usually tend to be higher than with traditional loans.
If you need a nonrecourse loan to finance your purchase, check out this list of lenders that offer nonrecourse loans.
3. Choose a Purchasing Method
Now that the account is set up and funded, you can use it to purchase real estate. If you’re purchasing a property with cash, then you would use the funds like any other account and pay for the property from the retirement plan’s checking account. You usually write a deposit check and then another check or a wire for the remaining funds at closing. Each check will come from the plan but you can write the checks yourself.
Financing the Property
If you finance the property, you will need to speak with lenders that offer nonrecourse loans. A nonrecourse loan is much harder to get on a residential property because it doesn’t hold the borrower personally responsible if he defaults on the loan. Residential loans are generally recourse loans.
Nonrecourse loans include some apartment loans and blanket mortgages as well as certain commercial bridge loans. You can check out our following guides for more information on specific nonrecourse loans:
4. Make an Offer on the Property
You will make an offer yourself on a property after doing your due diligence, like researching the neighborhood and running comps on the property. Keep in mind that all real estate related activities must be funded from your retirement account. The offer paperwork will also be made in the trust’s name. This means that your Solo 401(k) account will be the one that actually owns the property.
5. Close on the Property
The final step will be closing on the property. You generally have an appraisal, property inspection and title report just like buying any other property. The only difference is that the funds must come from an approved nonrecourse loan or directly from your trust account.
Again, all paperwork will be in the trust’s name. All future maintenance and other costs will be withdrawn from this account and all future property related earnings will be deposited into it.
For more information on self directed solo (401)k plans and how to invest in real estate, contact ReSure Financial. They’ll walk you through each step of the process and help you with the necessary paperwork. Setting-up a solo 401(k) with ReSure Financial costs $750 and maintenance is $150 per year. Consultations are free.
Solo 401k Providers
Solo 401(k)s aren’t widely mentioned outside of attorneys and tax professionals, but here are a few providers that offer self directed Solo 401ks for real estate investing. These firms specialize in managing self directed Solo 401ks and allow you to invest in your interests at your own pace.
Below are 3 reputable Solo 401(k) providers:
Broad Financial offers an upgraded retirement platform for Self Directed Solo 401ks. They offer real time investing, checkbook control and no transaction fees. Instead of the usual per transaction fees, they offer a one time annual fee. A custodian is not required for Broad Financial’s services.
Rather, a trust account is opened with the account holder as the sole trustee. You then open a checking account at any bank and have what is known as “checkbook control”. This lets you control your own retirement assets using your Solo 401(k)’s checking account. You can essentially write a check for a deposit on a house from this account.
This dedicated account is used to pay all of the property’s related bills. It saves money on transaction fees and requires less paperwork. It also allows you to borrow up to $50,000 from your real estate 401k and use it for whatever reason you see fit.
Another Self Directed Solo 401k provider is American IRA. They provide the option for checkbook control and they act as the record keeper while you, the trustee, make the investing decisions. You can consolidate other retirement accounts into this one, but only new Roth contributions are allowed in a Solo 401k; existing Roth funds can’t be transferred.
You can borrow the lesser of $50,000 or 50% of your account value for any purpose. However, these loans must be paid back within 5 years. They offer the same advantages of other providers such as no transaction fees and less IRS paperwork, as well as tax savings and more control over your investments.
My Solo 401k Financial
My Solo 401k Financial is another Solo 401(k) provider that offers checkbook control to the account holder, while they act as the trustee – or record keeper – of the account. You can use your account to invest in real estate and other alternative investments like precious metals and tax liens. They can set up your account in as little as one business day, and then you can fund it with rollovers or contributions.
My Solo 401k Financial also allows you to borrow from your account, up to 50% of the account balance with a minimum loan of $1,000 and a maximum of $50,000. They specialize in Solo 401ks so are familiar with the required paperwork and the IRS deadlines and can guide you through the process. They even help you understand the investment rules and are available for customer support 6 days a week.
Solo 401(k) Qualifications
To qualify for the Solo 401(k), you must be a business owner or self employed. Your business can’t employ any full time staff besides your spouse. “Full time staff” is considered anyone who works 1,000 or more hours per year. This business doesn’t have to be your only source of income but you do have to operate it with the intention of generating income.
This means that you’re allowed to have a full time job with a separate 401(k) and still qualify for a Solo 401(k). For example, if you’re an accountant and have a 401(k) at your place of employment but you have a side consulting business that doesn’t employ anyone else, then you qualify for a Solo 401(k). You can also qualify if you’re a self employed freelancer earning 1099 income, but you must be able to show profit and losses on a Schedule C form to qualify.
Unlike a self directed IRA, you can purchase a fix and flip property with a Solo 401(k). You can buy it all cash or use a nonrecourse loan, as long as you keep the profits in the Solo 401(k) until retirement age. There aren’t any time constraints on selling the property and there aren’t any restrictions on the type of property you can buy.
If you flip no more than one property per year and the IRS doesn’t feel like you’re running a real estate business from the Solo 401(k) account, you don’t have to pay capital gains tax. However, if you flip more than property a year or the IRS thinks you’re trying to avoid paying taxes, the capital gains tax will be due and a penalty may apply.
Solo 401(k) Fees
Solo 401(k) fees vary based on the provider you’re using to manage the account and the type of Solo 401(k) account you choose. The self directed Solo 401(k) is the type of account that lets you invest in real estate and gives you the most checkbook control for choosing your investments.
Common solo 401(k) fees include:
- Initial set up fee: $795 -$995
- Annual fees: $125
- Service fees: $5-$25 per transaction
- No additional transaction fees if you have checkbook control
3 Types of Solo 401(k) Contributions
Business owners can contribute to their Solo 401(k) retirement plan in 1 or more of 3 ways: elective referrals, employer nonelective contributions and rollovers. Unlike normal 401k accounts, you can contribute between $18,500 – $61,000 annually. With Solo 401(k) accounts, rollovers from other retirement accounts don’t count towards your contribution limit.
Below are the 3 ways you can contribute to your Solo 401(k):
1. Elective Deferrals
Elective deferrals are funds that participants choose to set aside, but aren’t required to set aside, to contribute to their retirement plan as part of their pre tax compensation. It can be automatically deducted from your paycheck if you receive one. If not, it can be done at the end of the year. The 2018 contribution limit is $18,500 for those under 50 years old and $24,500 for those 50 years or older, which are the same limits as normal retirement accounts.
2. Employer Nonelective Contributions
The second type of contribution is an employer nonelective contribution. Since you’re considered the employee and the employer of a Solo 401(k), this is basically just a way to make a second contribution to your retirement plan. Your contribution can be up to 25% of your compensation.
Your “compensation” is considered your earned income, which is your net earnings from self-employment after deducting half of your self-employment tax, and contributions for yourself. Therefore, your contribution can be up to 25% of your net earnings. It should be calculated based on what you will report on your current year-end tax returns. However, it is flexible and can be changed at any time based on your business’ profitability.
3. Rollover from Existing Retirement Plan
Third, participants can roll over funds from their other retirement plans such as an employer 401k or an IRA, to fund their Solo 401(k). A Roth IRA can’t be rolled over to fund the Solo 401(k). There are no set limits for rollover contributions.
The IRS caps total yearly contributions to a participant’s account at $55,000 in 2018. These don’t include catch up contributions which are permitted for those 50 years and older. These catch up contributions allow individuals 50+ years old to contribute more than the allowed annual contributions. Catch up contributions are capped at $6,000 annually, which makes the total maximum annual contribution $61,000.
How to Use a Solo 401(k) to Invest in Real Estate
Solo 401(k)s are often used to buy and hold real estate investments but can also be used for fix and flips. The process is much like buying a property in your own name or an LLC’s name, with just a couple minor changes. For example, you can’t use personal funds to purchase real estate and all paperwork is in the Solo 401(k)’s name, including property ownership.
1. Purchase the Property with a Solo 401(k)
When you identify a property, you must write the offer in the Solo 401(k)’s name. However, you don’t need the trustee to write the offer for you. Instead, you can do it yourself. You research the neighborhood, find a property and make an offer, just like you would do when buying a property in you or your company’s name.
When you pay for the property, the funds come from a wire or a check from your retirement account. No commingling of personal funds is allowed. With a Solo 401(k), you typically have checkbook control, meaning that you can write a check or wire funds directly from your Solo 401(k) account without having to rely on a custodian.
Most properties purchased with funds from a Solo 401(k) are paid for with cash from the retirement account via a rollover or annual contributions. This is because if you need to finance the property only nonrecourse loans are permitted. A nonrecourse loan is secured by collateral – usually a property – but isn’t guaranteed by the borrower.
2. Manage the Property with a Solo 401(k)
Once you buy a property, all rental income from the property will be made out in the Solo 401(k)’s name and go into the Solo 401(k) account. All expenses associated with the property including property taxes, maintenance, management fees, and financing costs, need to be paid from the same account. Just like with other IRA accounts, retirement funds can’t be commingled with personal funds.
You can manage the property yourself or hire a property manager, but you can’t pay yourself to manage the property and you can’t perform any repairs to the property yourself. You can’t live in the property while it’s held in the Solo 401(k) account since it violates the IRS policy on benefiting from the asset. The same rules apply for all disqualified people, which include family members and spouses. Still, it’s possible to own a property jointly as a tenancy in common.
3. Sell the Property with a Solo 401(k)
If you decide to sell the property in your Solo 401(k) account, you can easily do it without the help of a trustee or custodian. All of the profits from the property will be tax deferred until retirement age as long as they are put back into the Solo 401(k) account and distributions aren’t taken. If you have a Solo Roth 401(k), you pay taxes on the profits up front but then any subsequent gains are tax free.
This results in tax savings when you begin taking distributions at 59.5 years old (mandatory at 70.5 years old). For example, you will usually be in a lower tax bracket once you reach retirement age. If you have a traditional Solo 401(k), this means that you’ll pay less in taxes on the back end than you would’ve otherwise. With a Solo 401(k), capital gains on the sale of a property aren’t taxed, so it only makes sense to open a Roth if you intend to reinvest the profits in other assets that can appreciate in value.
Solo 401(k) Real Estate Investing Example
Using a traditional Solo 401(k) as an example, let’s say you buy a property for $100,000 with a nonrecourse loan, and it’s a rental property that is already seasoned with tenants. You earn $1,000 per month in rental income and your property management fee is $100 per month.
Your taxes, maintenance and insurance are $150 per month and your mortgage payment is $400 per month. Your monthly income in your Solo 401(k) account is therefore $450 ($1,000 income – $550 expenses).
After 10 years, you reach retirement age of 59.5 and have therefore accumulated $54,000 in rental profits. Up to this point, you’ve paid no taxes on your profits because all rental income and all expenses flow in and out of your Solo 401(k) account.
Now, you decide to take 20% of the profits out of the retirement account as a withdrawal, which is $10,800. You will only be taxed at your current retirement tax bracket. Let’s assume your tax bracket taxes upon retirement is 15%, so you will pay $1,620 in taxes on the rental income you withdrew. If you had realized that same amount of rental income at your higher tax rate during your working years, let’s say a 30% bracket, you would’ve paid $3,240 in taxes.
- This results in tax savings on your rental profits of $1,620.
However, one of the major tax savings of a Solo 401(k) is capital gains tax. Assuming that you’re not operating a house flipping business from your retirement account and are holding your properties long term, you don’t have to pay capital gains tax as long as the funds stay in the account until retirement age of 59.5.
Then, you decide to sell your property, which has appreciated 30% over the last 10 years. You will not have to pay the capital gains tax of 15%-20% on the profit from the sale once you start taking withdrawals. So, you will save 15% of $30,000.
- This results in capital gains tax savings of $4,500.
Benefits & Drawbacks of a Solo 401k
If you qualify for a Solo 401(k), there are some substantial benefits that you will receive. Tax deferment, or in the case of a Roth Solo 401(k), tax free capital gains growth, is a major benefit.
It also has higher limits than a traditional IRA and allows you to diversify your investments.
Benefits of a Solo 401(k) include:
- Tax savings through deferment or tax free savings on capital gains
- High contribution limits and extra contributions if your spouse works for your business
- Diversified investments including real estate holdings which can offer wealth building through appreciation
- Loan capabilities which can help grow your business
- Early withdrawal option if you’re going through a financial hardship
Solo 401(k)s have plenty of advantages but also has some drawbacks. Many of these potential drawbacks surround the time it might take for you to execute checkbook control and the lack of people who are familiar with administering a Solo 401(k).
Drawbacks of a Solo 401(k) include:
- Employer is yourself so there is no traditional employer matching
- It’s not a widely used retirement savings plan so not all accountants and financial advisors are familiar with it
- You will have to fill out IRS paperwork and pay attention to their guidelines and contribution limits to ensure that you are in compliance
- Traditional firms charge high management fees
- It’s time consuming if you choose to direct it yourself
Who a Solo 401k is Right For
A Solo 401(k) is right for a small business owner who wants to invest retirement savings into real estate and who meets the requirements of having no other full time employees except a spouse. It’s also right for an individual with a full time job as well as a side self employment income, but who still meets the requirements of having no other full time employees working at his business.
It’s ideal for a non employee who otherwise wouldn’t have an option of a tax saving retirement plan that allows for investing in real estate. If you’re a savvy real estate investor who wants to research and choose your own investments, then a Solo 401(k) for real estate investing is usually a good fit. It’s also right for an investor that likes the high contribution limits that a Solo 401(k) offers.
A Solo 401(k) is a smart retirement plan for those individuals who qualify. It allows a small business owner to have tax deferred or tax free, with a Roth, savings as well as use retirement funds to invest in assets that wouldn’t otherwise be available. However, it does have strict qualifications and you must stay within the IRS’ contribution limits.
If you’d like to hold real estate in your retirement account, a checkbook 401(k) or self directed IRA can be a good option. Setting up a plan with an experienced team that will help you navigate the regulatory complexities will ensure you remain compliant and headache free. Contact ReSure Financial for a free consultation.