How to Buy Real Estate with 401(k) Funds: A Step-by-Step Guide

Real estate investing offers a powerful tool for growing retirement savings through tax-deferred growth and the opportunity to potentially achieve higher returns.

The short answer: Yes, you can use your 401(k) to buy real estate, but you must follow specific IRS rules and usually need to roll over funds into a self-directed IRA to avoid penalties.

For seasoned landlords, small business owners, self-employed individuals, and new investors alike, real estate can serve as a diversified, income-generating asset in a retirement portfolio.

Using 401(k) funds to invest in real estate provides greater control over your retirement plan, particularly when accessed through a self-directed IRA.

Investment options include:

• Raw land
• Single-family rentals
• Multifamily units
• Commercial property

Experienced investors use self-directed IRAs to avoid the early withdrawal penalty and access long-term tax advantages. But it’s essential to follow IRS rules to protect your retirement account.

Benefits of Using a 401(k) for Real Estate Investing

Investing in real estate with your 401(k) offers several compelling benefits. One of the main advantages is the ability to enjoy tax advantages, such as tax-deferred growth on your investment earnings. Real estate investments can also provide a steady stream of rental income, which can be reinvested within your retirement account to maximize compound growth.

Unlike mutual funds or stocks, real estate can appreciate in value over time, offering the potential for significant returns. By diversifying your portfolio with real estate, you reduce your reliance on traditional investments and open the door to higher returns.

However, it’s important to factor in expenses related to property management, maintenance, and other costs that come with real estate investing to ensure your investment remains profitable.

Understanding IRS Rules

The Internal Revenue Service (IRS) has strict rules for using 401(k) funds in real estate investments:

Key Compliance Requirements:

Rule	Description
No Personal Use	You can’t live in or vacation in the property
All Expenses Paid from IRA	Property taxes, maintenance, repairs must be paid from the account
All Income Returned to IRA	Rent and profits go directly to the IRA

Failure to comply may trigger:

• Loss of tax-deferred status
• Income tax liabilities
• Penalties and fees

Who Are Disqualified Persons?

According to IRS rules, a ‘disqualified person’ is someone with whom certain transactions are prohibited to maintain the tax-advantaged status of your account. This includes yourself, your spouse, and certain family members such as your parents, children, and their spouses.

These certain family members are considered disqualified persons, and transactions involving them are not allowed. However, family members such as siblings may not be considered disqualified persons, but direct lineal family members are.

Understanding and adhering to these rules is essential to safe and compliant investing.

Navigating Disqualified Persons

The IRS prohibits transactions between the retirement account and certain individuals known as disqualified persons.

Who Are Disqualified Persons?

• You (the account holder)
• Your spouse
• Your parents or grandparents
• Your children and grandchildren
• Any business entity owned by the above

Engaging with disqualified persons can result in severe tax consequences. Avoid direct or indirect benefits—such as renting to your children or contracting your own business.

Self-Directed 401(k) Plans

A self-directed 401(k) plan gives you the flexibility to invest your retirement funds in a wide range of alternative assets, including real estate. This option is especially attractive for self-employed individuals and small business owners who want greater control over their retirement investments.

With a self-directed 401(k), you can invest in various real estate options such as raw land, residential properties, or commercial properties, tailoring your investment strategy to your goals. To take advantage of these opportunities, it’s essential to work with a custodian who understands self-directed 401(k) plans and to strictly follow IRS rules to avoid penalties.

By doing so, you can use your retirement funds to invest in properties that align with your long-term financial objectives.

Working with a Custodian

When you choose to invest in real estate through a 401(k) or IRA, partnering with a custodian who specializes in self-directed accounts is essential. A knowledgeable custodian will guide you through the investment process, help you navigate IRS rules, and ensure your account remains compliant.

They also handle important administrative tasks, such as property management coordination and tax reporting, so you can focus on your investment strategy. When selecting a custodian, consider their fee structure, experience with real estate investing, and the quality of their customer service.

The right custodian can make the process of managing your self-directed account smoother and more efficient, helping you maximize the benefits of your real estate investments.

Investing with Your Current Employer

Using a 401(k) from your current employer may be limited by plan rules. Here’s how to approach it:

Steps to Take:

• Review your plan’s investment rules
• Speak with your plan administrator
• Explore direct rollover or in-service distribution options

Your eligibility for rollovers, loans, or in-service distributions may depend on the amount and type of contributions you have made to your 401(k).

Tip:If you’re a self-employed individual or small business owner, consider a Solo 401(k) or SEP IRA. These options offer more control and flexibility. Some plans also allow you to take loans against your 401(k) contributions for certain purposes, including real estate purchases.

Purchase Real Estate

Buying property with 401(k) funds involves several clear steps:

1. Set up a self-directed IRA through a qualified custodian.
2. Fund the self-directed IRA with sufficient funds, either by a direct rollover from your 401(k) or by contributing eligible funds, to cover the purchase and all related expenses.
3. Choose your real estate investment (e.g., raw land, rental property).
4. Make sure all expenses related to the purchase are covered by the IRA. Note: You cannot use the property as your primary residence when purchasing with retirement funds.
5. Title the property in the name of the IRA (not your own).

Reminder: Withdrawing funds from your 401(k) to purchase real estate may trigger taxes and penalties unless done via a rollover. Follow IRS rules closely to avoid taxes and penalties.

Withdrawing from Your 401(k) Without Penalty

Accessing your 401(k) funds without incurring penalties requires careful planning and an understanding of the rules. Generally, you can withdraw funds penalty-free once you reach age 59 1/2.If you separate from your employer at age 55 or older, you may also be eligible to withdraw funds without penalty.

Another option is to take a loan from your 401(k) account, which can be used for a home purchase or to cover other expenses, but it’s important to repay the loan according to plan rules to avoid potential taxes and penalties.

Each withdrawal or loan comes with specific requirements and potential tax consequences, so it’s wise to consult a financial advisor or tax professional before making any decisions. This ensures you can access your funds when needed while minimizing taxes and avoiding unnecessary penalties.

Income Tax Considerations

When investing in real estate with retirement funds, be aware of tax implications:

Tax Treatment Overview:

Scenario	Tax Impact
Traditional IRA	Rental income taxed as ordinary income upon distribution
Roth IRA	Qualified withdrawals are tax-free
Leveraged Deals	May trigger UBIT (Unrelated Business Income Tax)

Distributions from a traditional 401(k) are subject to income taxes, regardless of penalties.

Even with tax-deferred growth, improper withdrawals or violations can result in taxable income. You must pay income tax on most withdrawals unless you use a Roth account or qualify for an exception. Consider strategies to avoid paying unnecessary taxes or penalties, such as using exceptions for first-time home purchases or exploring alternatives to minimize tax liability. Always consult a tax advisor.

Real Estate Investment Strategies

There are multiple ways to invest in real estate using a self-directed IRA. Your retirement funds can be invested in real estate to diversify your portfolio:

• Buy and Hold: Steady rental income and appreciation. This approach allows your real estate investments to grow tax deferred within your retirement account.
• Fix and Flip: Higher return potential but more risk
• REITs: Hands-off investing with liquidity

Pick a strategy aligned with your risk tolerance, goals, and time horizon. Use your IRA to diversify beyond mutual funds and potentially generate higher returns. Actively manage your real estate investments to maximize returns and maintain compliance.

Conclusion

Using your 401(k) to invest in real estate can unlock access to tangible assets, greater control, and significant tax advantages. By converting to a self-directed IRA, following IRS rules, and steering clear of disqualified persons, you can build long-term wealth through smart, compliant investing.

Contact DSCR Loan Experts today to explore your real estate financing options with confidence. Whether you’re purchasing a rental, expanding your portfolio, or seeking creative funding solutions, our team is here to help you unlock the power of your retirement funds.

Schedule a free consultation now and start turning your 401(k) into real estate wealth!

Frequently Asked Questions