If you’re thinking about your retirement, you might be wondering about adding a rental property to your overall investment portfolio. Owning rental property can be a great idea that pays dividends for years to come.
If you’ve already decided a rental property is right for you, the next step is to decide how you plan on financing it. An idea that many people have is using the cash in their 401k to fund all or a portion of the purchase. But can you even use your 401k to buy a rental property?
Are You Allowed to Buy Investment Property with a 401(k)?
No, you cannot directly use a 401k to buy an investment property. However, there are a couple of indirect ways you can use your 401k to invest in real estate.
What Is A 401(k)?
A 401(k) plan is a savings and investment account for retirement, which is available to many employees in the United States.
This plan allows the employees to contribute a part of their wages before taxes, which means that those contributions are only taxed when they are withdrawn during retirement.
A 401k can significantly reduce taxable income and potentially increase long-term retirement savings.
Alternative Ways to Use A 401(k) to Buy Rental Property
As mentioned, you can’t directly use your 401(k) to buy a rental property. But there are two ways you can indirectly tap into its funds for your investment property purchase.
Taking Out A 401(k) Loan
Some employers offer 401k loan programs that enable you to borrow against your retirement savings for property purchases.
These loans usually come with lower interest rates when compared to traditional mortgages. However, before considering these loans, there are some crucial downsides to keep in mind.
First, if you leave your job or default on the loan, you could face significant tax penalties and have to repay the loan immediately in full.
Second, as long as the loan is yet to be paid back, you cannot contribute any new funds to your 401k, which could negatively affect your overall retirement savings in the long run.
Rolling Over to Self-Directed IRA
It’s possible to roll over your 401(k) into a self-directed IRA. This option provides you with more investment opportunities, such as the possibility to invest in real estate.
With a self-directed IRA, you can either buy investment properties directly or invest in real estate investment trusts (REITs).
However, it’s important to note that there are risks involved with self-directed IRAs that you should consider before making any decisions.
First, you are responsible for managing the investments yourself, which can be time-consuming and require significant financial knowledge.
There are also strict rules and regulations governing self-directed IRAs, and if you violate any of them, you could face tax penalties.
Consider the Risks and Potential Benefits
Before using your 401k to invest in real estate, it is important to carefully consider the risks and potential benefits. Consulting with a financial advisor can help you make an informed decision about whether this is the right strategy for you.
Key Things to Keep in Mind
- Taxes: Any income or gains from your investment property will be taxed as income.
- Asset Considerations: Real estate is a big investment and can be difficult to sell quickly if you need to access your money.
- Property Management: Owning rental property requires time and effort to manage. Be sure you are prepared to handle tenant issues, maintenance, and repairs.
Consult a Professional: California tax laws, including those enforced by the Franchise Tax Board (FTB), may differ from federal guidelines. Errors in handling a Self-Directed IRA or Solo 401(k) can lead to severe penalties, immediate taxation of the entire account balance, and the loss of tax-advantaged status. Before making any investment decisions, we strongly recommend consulting with a qualified California-based tax advisor, ERISA attorney, or financial planner to ensure full compliance with current laws.
Talk With A Local Property Management Company
If you’re thinking of acquiring a rental property, a property management company can offer advice and insights that come from real-world experience. Property managers offer a wealth of knowledge that can help real estate investors of all levels, whether seasoned or brand new.
Scout Property Management in Fallbrook, CA
Scout Property Management is a full-service property management company in Fallbrook, CA, dedicated to helping investors and homeowners maximize their rental property potential.
Whether you own a single-family home or a multifamily property, our team of experienced professionals provides comprehensive Fallbrook property management services to ensure your property is well-maintained, occupied by qualified tenants, and generating consistent income.
Want to learn more about investing in real estate? Check out this blog on 14 Important Terms Every Real Estate Investor Should Know.
Frequently Asked Questions: 401(k) Real Estate Investing
Can I buy investment property directly from my current 401(k) account?
No. Most standard 401(k) plans offered by employers do not allow you to purchase real estate directly. To buy investment property, you typically need to roll your funds into a Self-Directed IRA (SDIRA) or a Solo 401(k) (if you are self-employed). This gives you “checkbook control” to invest in non-traditional assets like California rentals or fix-and-flips.
What is the difference between a 401(k) loan and a Self-Directed IRA for real estate?
- 401(k) Loan: You borrow up to 50% of your account value (capped at $50,000). You pay yourself back with interest, and you can use the cash however you like, including as a down payment on a California rental.
- Self-Directed IRA: There is no $50,000 limit; you can use the entire balance to buy property. However, the IRA must own the property, and all income (rent) must flow back into the IRA tax-free.
Can I live in the property if I buy it with my retirement funds?
Absolutely not. This is considered a “prohibited transaction” by the IRS. The property must be a strictly passive investment. You, your spouse, your children, or your parents cannot live in the home, use it as a vacation rental, or even perform the maintenance work yourselves.
Are there specific California taxes I should know about?
Yes. While federal law governs the 401(k) structure, California’s Franchise Tax Board (FTB) has its own oversight. If you use an SDIRA to buy property in California, your IRA may be subject to the Unrelated Business Income Tax (UBIT) if the property is debt-financed (purchased with a mortgage). Always consult with a California-based tax professional to navigate these state-specific nuances.
How do I handle repairs and expenses for the property?
All expenses—including property taxes, insurance, and repairs—must be paid directly from the retirement account. You cannot pay for a new water heater out of your personal pocket; doing so could disqualify the entire tax-advantaged status of your account.