When a 401k invests in real estate, it is commonly referred to as 401k real estate. All 401k plans, from large company to self-employed 401k plans, may be invested in all types of real estate-for example, commercial real estate, residential real estate, foreign real estate, real estate notes, real estate tax liens. However, the key to investing your 401k in real estate is twofold–the prohibited transaction rules must be followed and the 401k provider must be welling to administer the 401k in some capacity, whether fully or partially. These are the two main requirements.
There are basically two types of 401k plans. The first type is for big and medium size companies and the second is for self-employed business owners. While most big and medium size companies do not allow for 401k real estate investments, most self-employed 401k plans often referred to as Solo 401k may invest in 401k real estate because the self-employed business owner is often in-charge of selecting the Solo 401k plan investments.
However, in order for the Solo 401k to invest in 401k real estate, the prohibited transaction rules must be followed before, during and after the 401k real estate purchase. Jurisdiction over all 401k plans including Solo 401k are handled between the Department of Labor (DOL) and the Internal Revenue Service (IRS). The Solo 401k prohibited transactions are found in IRC 4975 and ERISA Sec. 406(a).
Basically, the Solo 401k prohibited transactions with respect to 401k real estate detail the following:
The Solo 401k owner cannot live in the 401k real estate owned property.
The Solo 401k owner cannot rent out the 401k real estate to certain family member, such as her spouse, son, daughter, father, or mother and father.
All 401k real estate expenses must be paid by the Solo 401k.
There are 3 ways in whic 401k can invest in real estate, which are:
The first is by outright purchase–the Solo 401k uses all cash for the property purchase
The second is to partner with the Solo 401k owner, in which case the Solo 401k and the Solo 401k owner’s both put up funds and as a result, title to the real estate property is listed in both in the name of Solo 401k and the individual’s name, and at their respective percentage of ownership.
The third is to use debt financing–the Solo 401k obtains a non-recourse loan from a bank or private investor and then purchases the 401k real estate.
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