Of course they will rarely tell you that real estate investing is a good idea because financial professionals rarely will be unable to receive a commission on the assets invested in real estate. They aren't managing those assets for you, so they can't get paid. In the spirit of full disclosure, I am a Realtor so if you invest in real estate and work with me, obviously I get paid a commission.
Having said that, I am fielding more questions recently from my web site visitors about real estate investment with 401k assets.
It is important to realize that as an individual it is very difficult to diversify your own 401k plan assets into real estate, but there are two instances where it can work.
Self employed individuals can easily amend their current 401k plan to allow real estate investments with the 401k assets. There are many companies out there that will charge 1% - 3% of the value of the real estate to "hold" the real estate within a self-directed IRA, but self employed people do not need to worry about the high fees. Because your 401k plan is a trust and you are mostly likely the trustee of that plan, you can direct yourself to purchase a real estate investment with 401k assets with relative ease.
There are some drawbacks.
- You have to own the real estate out right, NO mortgages!
- You can not buy or sell the real estate from yourself as an individual, your children, or parents.
- You can not live in, use, vacation in, or benefit from the real estate while it is inside your 401k.
So it isn't all great news when it comes to real estate investment with 401k assets. But think about the drawbacks for a moment. A mortgage is beneficial because of the tax deduction you get with the interest. Your 401k plan does not pay taxes so you do not get a tax deduction. Therefore you wouldn't want a mortgage anyway.
The other two main drawbacks are to prevent fraud. Think about how easy it would be for your 401k plan to buy a parcel of real estate from you for an over inflated price. This could easily be accomplished with children and parents as well. That is the reason for the rules.
The part about not living, or vacationing in the real estate owned by the 401k plan is also so that you aren't benefiting from an asset that is tax deferred. It would be really great right? Pump tons of money into a 401k plan, buy a home with tax free money, and live in it! Yeah, except it would be considered a prohibited transaction and you would be hit with some hefty penalties if the IRS figured it out.
What if I don't have enough assets to buy the real estate in full?
Well I am glad you asked. This is a "trickier" situation, but can still be done. You will have to enter into a partnership with another entity and purchase a fraction of the property. It isn't the greatest situation, but it can be accomplished.
Even individuals that are not self employed could possibly diversify into real estate investment with 401k assets, but this is more difficult to accomplish. Most likely you will have to roll your 401k money out of your companies 401k plan and into a IRA. Then we can either find you a self-directed IRA custodian that will accept real estate as an investment, or maybe you can set yourself up with a side business that can adopt a 401k plan of your own and viola, you are self employed!
It may be possible to invest in real estate while still holding the assets within your companies 401k plan, but you will likely have to get some buy in from the boss. He will need to work with a third party administration firm that knows the ins and outs of 401k plans to provide guidance.
Either way I suggest that you work with a competent third party administration firm (I can provide you with a referral to a local and a national TPA that I know does great work) to ensure that you follow all the rules associated with real estate investment with 401k assets.
Although I have hit the high points, I encourage you to visit my website and then contact me so that you can talk more about your interest in real estate investment with 401k assets. There are currently thousands homes in the greater Phoenix area that are for sale for less than $100,000. If you are interested in jumping in to real estate investing give me a call.
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