Self-employed individuals with no employees other than a spouse can establish a Solo 401k with many of the same tax advantages as a traditional 401k. However, the Solo 401k has a unique advantage. Rather than being tied up in a stock portfolio, the Solo 401k can be used to fund real estate ventures.
Many real estate investors qualify for a Solo 401k simply because they are real estate investors. Other people who qualify, but may not realize they do include real estate agents, contractors and property managers.
These self-directed plans afford their holders tremendous flexibility.
Solo 401k funds can be used to purchase single-family, or multi-family homes, raw land and commercial properties. Basically, any kind of investment property can be acquired using the funds in a Solo 401k. (Primary residences are excluded.) Further, the owner of a Solo 401k can use the funds in the account to serve as a private lender to capitalize other investors. In this case, the holder of the Solo 401k becomes a silent partner in the investment. They can use the fund to engage in private placements as well as mortgage notes and trust deeds, among other investment options.
The only requirement is that the borrower is someone the IRS considers a non-disqualified person. This usually includes the owner of the retirement plan, someone who provides services to the plan or an individual who may eventually become a beneficiary of the plan — with the exception of certain categories of family members such as step-parents, step-children (unless adopted), siblings, aunts, uncles, cousins and friends.
Because you can take advantage of the tax-deferred nature of the 401k, wealth can accumulate at a faster rate than if the capital were loaned in the same types of situations as personal funds.
In some cases, an investor might be interested in an investment exceeding the amount available in their Solo 401k account. In these instances, the Solo 401k can be used to leverage non-recourse financing.
A non-recourse loan is secured by the property, as opposed to the Solo 401k account itself, so the IRS considers it a legitimate use of the account and its tax-deferred status remains intact.
However, because the loan is secured by the property, most financial institutions will require a larger down payment to ensure they’re covered in the event of a default. This typically amounts to 30 to 35 percent of the purchase price. The Solo 401k account must contain sufficient capital to cover this. In other words, if you’re looking to purchase an investment property that costs $700,000 and you have $210,000 in your Solo 401k account, you can leverage the account to gain control over the property.
You just have to make sure the Net Operating Income of the property in which you’re investing is capable of exceeding the monthly debt payments by 20- 25 percent. You’ll also be a bit more limited in the types of properties you can acquire with non-recourse financing. Among the exempt properties are raw land, rural properties, farms, commercial property and manufactured or log homes.
These strategies afford you the capability of using tax-deferred dollars to fund investments operating under your immediate control, as opposed to the whims of Wall Street.
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