Should you buy real estate in an IRA or solo 401k?

Ultimate Real Estate Investor Tax Guide »

If you have an IRA (or a solo 401k account), and your preferred investment type is real estate, then investing in real estate within your retirement account is an intriguing option.  The big advantage of it is you don’t have to worry about paying taxes on your earnings within the retirement account.  And if you already have money in the IRA/401k, and you don’t like the idea of just putting it all in the stock market, then you may want to consider real estate an investment option.  There are some advantages, but there are also several disadvantages to be aware of.

Advantages

What is great about buying real estate within your retirement account is you can enjoy the benefits of real estate investing, including more stability than the stock market, and potentially higher returns as well. And since it’s in a retirement account, you won’t have to pay any income tax on it at the time you earn rent income, or even if you sell the property at a profit. If it’s a Roth IRA or a Roth-designated 401k account, then your profit is also tax-free even when you later take distributions from the account after you reach retirement age.

Disadvantages

Real estate is already tax-advantaged. Thanks to the magic of depreciation, most rental income is already tax-free, so you have to ask if there is enough advantage to having real estate in an IRA with all the other disadvantages of doing that.

Buying with a mortgage is difficult/expensive. You’ll usually need to buy the property with cash, which negates all the advantages of leveraged real estate. Some lenders do lend to people wanting to get real estate in their IRA, but the interest rates, fees, and down payment requirements are significantly higher. Also, when you use leverage, you then have to calculate and pay tax on Unrelated Business Taxable Income (UBTI). This is because investments within your IRA that use borrowing trigger a tax requirement that makes a portion of your tax-advantaged account taxable.

No cash flow. It’s worth pointing out that if you’re below retirement age, you can’t enjoy the monthly cash flow of real estate inside your retirement account. Any proceeds from rent or from selling the property go back into your retirement account.

You can’t do work on the property. You have to be completely hands-off from the property. You can’t put sweat equity into the property by doing any kind of work on it.

You and your family can’t stay at the property for any amount of time. You and your family can’t benefit from assets you own in your retirement accounts. So you can’t stay and the property, and your spouse, parents, grandparents, great-grandparents, and your decedents and their spouses can’t stay at the property. You also can’t buy the property from any of those family members, or from yourself (you can’t move a property you already own to your retirement account).

You must pay all expenses with the retirement account. Any expenses for anything related to the property have to come from the IRA/401k funds. So you have to keep plenty of extra cash in the account to cover any unexpected expenses that might occur. If you end up with an unexpected large expense and you don’t have funds in the account to cover it, you can end up in a difficult bind.

How To

To buy real estate in an IRA, you need a “self-directed IRA” (SDIRA).  There are many providers of self-directed IRAs. Look for one with reasonably low fees, and be sure they offer the option to invest directly in real estate.

To buy real estate in a solo 401k account, you need a truly self-directed solo 401k account. One of the reasons a 401k account is better than a self-directed IRA because you can avoid custodian/administration fees because you can be the administrator of the account yourself.


This article is part of The Ultimate Real Estate Investor Tax Guide.

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David Orr

I am a credentialed tax professional with a primary focus on tax preparation and advising for real estate investors. Have tax questions or want me to do your taxes? Contact us.

This article was written or updated in 2023 or 2024 and is current for the 2023 and 2024 tax years.

The information presented here is meant for guidance purposes only, and not as personal legal or tax advice.