Real estate rentals and investments have long been the darling of self-directed IRA and Solo 401k plans. But, when it comes to retirement plans, rules are constantly changing. What might be legal one year brings a penalty the next. That’s why it’s critical you know everything about your plan before moving forward. Where does my money go? How much or when can I contribute? A Solo 401k offers multiple options, but you need to know the rules that come with them.
For example, someone can invest in rental property with their Solo 401k, as we’ve talked about before. But beyond the question of how you invest, you need to start thinking about details. Who manages that rental property? Can the retirement plan holder do it without penalty? Let’s take a look.
Lessons about Rental Investments and the Solo 401k
Unlike traditional corporate retirement plans, there are very few restrictions in a Solo 401k about investments. If you want to buy a rental property, you can use retirement funds to do that. And as we head through fall, it seems like a perfect time to do so.
Right now, mortgage interest rates are down below 4 percent, driving up home sales. In fact, for the first time since last September, the number of available houses actually dropped in June. So if more people are buying homes, why would a rental investment be a good idea? The answer comes from a look at the data. Current forecasts expect the increase in home sales to keep going through the fall, dropping the available home inventory by more than 4 percent. If there are fewer homes, then the prices start to go up. At that point, families may find they can’t afford to buy and decide to rent.
Now here’s where the first rule comes in. Let’s say you find the perfect house to buy, but it’s several thousand more than what you have in the Solo 401k. You’re allowed to get financing, but the rules say you can only use a non-recourse loan to do it. What is a non-recourse loan? If you were to default, the bank takes whatever you put up as collateral. But after selling that collateral, they can’t claim anything else.
That means your personal funds and other retirement assets are generally safe. Even if the bank forecloses on a rental investment owned by your Solo 401k, the bank can’t garnish your wages or freeze your accounts.
No Personal Cash from the Investment
Once you purchase the rental property, it will actually be registered under the name of your Solo 401k plan and trust. You then can sign on as the trustee of the plan without penalty, but you do have some restrictions.
Any expenses related to repairing or maintaining the property, including property taxes, must be paid only from the Solo 401k account. This is important. You can’t use your personal credit card to pay for storm damage or cash to repair the bathroom. As your 401k plan is the owner, all expenses have to come out of the account linked to that plan.
You also can’t do the work yourself. The IRS is very clear on this point, as the agency considers this the “furnishing of goods and services.” If a storm came through and damaged your back porch, you have to hire a contractor, using money from the 401k account to pay for any work done.
Remember a minute ago when we said you could manage the property? As odd as it sounds, you’re basically operating as an employee of your Solo 401k. Any and all rental income from the property has to go back into the Solo account. Even though it’s your retirement account, you can’t directly benefit from the revenue. That means you can’t set aside some of the rent revenue to pay your bills or buy a gift. It all has to go back into the account.
You also can’t live on the property. It doesn’t matter if it’s only for a week or if you want to let a friend stay there for free. Because the property was purchased by your Solo 401k, it can’t be used as your house or for any purpose other than a rental unit. The IRS is very specific on this point.
What is a Solo 401k?
Throughout this article, you may have seen us refer to a Solo 401k plan and not fully understood what that meant. It’s a retirement plan designed for self-employed people.
To qualify for a Solo 401k, you must either be self-employed or operate an owner-only business, one with no full-time employees. If you meet those requirements, then an individual can contribute up to $61,000 per year to the plan and double that for a business run by a husband and wife. If you have any questions, you can get some answers here.