Can You Buy Real Estate With Your 401k?

It is generally not possible to directly purchase real estate within a standard 401(k) plan. Most employer-sponsored 401(k)s limit investments to publicly traded assets, not illiquid property. However, indirect methods allow individuals to use 401(k) funds for real estate, often by transferring funds to specialized accounts or utilizing loans or withdrawals.

Rollover to a Self-Directed IRA for Real Estate Investment

A self-directed Individual Retirement Account (SDIRA) is required to invest in real estate using retirement funds, as traditional 401(k)s do not permit direct real estate holdings. An SDIRA allows for a broader range of alternative investments, including real estate, providing more control while maintaining tax advantages.

Funds from a 401(k) can be rolled over to an SDIRA under specific conditions. If an individual is no longer employed by the company sponsoring the 401(k), a rollover is typically permitted upon separation from service or reaching retirement age. Some current employer 401(k) plans may also allow in-service non-hardship distributions, which permit a rollover while still employed, though not all plans offer this option.

The rollover process can be completed through a direct or indirect rollover. A direct rollover, a trustee-to-trustee transfer, is the simplest method. Funds move directly from the 401(k) administrator to the SDIRA custodian, avoiding tax withholdings and penalties. To initiate, establish an SDIRA with a specialized custodian, then contact your 401(k) plan administrator to request the direct rollover, providing the SDIRA custodian’s details.

An indirect rollover involves 401(k) funds distributed directly to the accountholder. The individual has 60 days from receipt to deposit funds into an SDIRA or another qualified retirement account to avoid taxes and penalties. Failure to deposit within 60 days results in the distribution being treated as taxable income, plus a 10% early withdrawal penalty if under age 59½. Necessary information includes 401(k) statements and plan administrator contact details. Selecting an SDIRA custodian specializing in alternative assets like real estate is important, as not all financial institutions offer this capability.

Operating Self-Directed Real Estate Investments

Once funds are rolled into an SDIRA, strict Internal Revenue Service (IRS) rules govern real estate investments to maintain tax-advantaged status. A core concept is avoiding “prohibited transactions,” outlined in Internal Revenue Code Section 4975. These are transactions between the SDIRA and “disqualified persons,” preventing the accountholder or related parties from personally benefiting from retirement funds. Disqualified persons include the accountholder, their spouse, lineal ascendants, lineal descendants, and any entities they control.

Common prohibited transactions include purchasing property for personal use or occupancy by a disqualified person, or acquiring/selling property to a disqualified person. The accountholder or any disqualified person cannot perform services like repairs or renovations; all work must be done by independent third parties paid by the SDIRA. Using personal funds to improve SDIRA-owned property is also prohibited. Engaging in a prohibited transaction disqualifies the entire SDIRA, making all assets immediately taxable at fair market value. If the accountholder is under age 59½, a 10% early withdrawal penalty also applies.

A wide range of real estate assets can be held within an SDIRA, provided they are for investment purposes only. These include residential and commercial properties, raw land, mortgage notes, and Real Estate Investment Trusts (REITs). All income generated from the property, such as rental income, must flow directly back into the SDIRA, and all expenses related to the property, including property taxes, insurance, and maintenance, must be paid directly from the SDIRA.

Unrelated Business Taxable Income (UBIT) can apply to real estate held within an SDIRA. UBIT is triggered when the SDIRA generates income from a trade or business not substantially related to its tax-exempt purpose, or from Unrelated Debt-Financed Income (UDFI). UDFI arises when SDIRA real estate is purchased using a non-recourse loan, secured only by the property, not the accountholder’s personal guarantee. In such cases, the portion of income or gains attributable to the debt-financed portion may be subject to UBIT.

UBIT applies if gross income from unrelated business activities exceeds $1,000 annually and is taxed at trust rates. Annual fair market valuations of SDIRA real estate assets are required. The SDIRA custodian facilitates these valuations and handles necessary IRS reporting, including Form 990-T if UBIT is owed.

Using 401(k) Loans or Withdrawals for Real Estate

Accessing 401(k) funds directly for real estate purposes can be done through loans or taxable withdrawals, distinct from self-directed IRA rollovers. A 401(k) loan allows an accountholder to borrow money from their vested account balance. The maximum loan amount is typically 50% of the vested balance, up to a limit of $50,000. If 50% of the vested balance is less than $10,000, some plans may permit borrowing up to $10,000.

These loans generally have a repayment period of five years, with interest paid back into the accountholder’s own 401(k) account. If the loan is used to purchase a primary residence, the repayment period may be extended up to 15 years, depending on the plan’s provisions. Repayments are usually made through payroll deductions. A 401(k) loan is not considered a taxable distribution and does not incur an early withdrawal penalty, provided it is repaid according to the terms. If the accountholder leaves their job or fails to repay the loan by the due date, the outstanding balance is typically treated as a taxable distribution, subject to income tax and a 10% early withdrawal penalty if the accountholder is under age 59½.

Taking a direct taxable withdrawal (distribution) from a 401(k) for real estate or any other purpose is also an option, but it carries immediate tax implications. These distributions are taxed as ordinary income in the year they are received. If the accountholder is under age 59½, a 10% early withdrawal penalty usually applies, unless a specific IRS exception is met. This can significantly reduce the amount available for real estate investment.

Some 401(k) plans offer “hardship withdrawals” for immediate financial needs. While a hardship withdrawal might be considered for certain housing-related expenses, such as preventing eviction or foreclosure, or for costs related to buying or repairing a principal residence, it is still subject to income tax and the 10% early withdrawal penalty if the accountholder is under age 59½. Unlike loans, hardship withdrawals are permanent and cannot be repaid. The amount is limited to the immediate financial need, and the accountholder must demonstrate that the need cannot be met from other available resources.