Can You Use Your 401k to Buy Land?

A 401(k) is an employer-sponsored retirement savings plan designed for long-term growth through investments like mutual funds and stocks. While intended for retirement, these funds can be used to purchase land, but this process requires navigating specific rules. The methods for using retirement funds to buy land are governed by strict Internal Revenue Service (IRS) regulations designed to preserve the account’s tax-advantaged status.

The primary methods are taking a loan from the 401(k) or rolling the funds into a self-directed account. Each approach has distinct requirements and potential consequences that must be understood before proceeding.

Using a 401(k) Loan

Accessing funds through a 401(k) loan is possible if the employer’s plan allows it. Not all plans permit loans, and those that do may restrict the purpose. Some plans only allow loans for a primary home purchase or medical expenses, while others permit borrowing for any reason, which could include buying land. You must check your specific plan documents to determine if a loan is an available option for this type of purchase.

The IRS sets limits on how much can be borrowed. An individual can borrow the lesser of $50,000 or 50% of their vested account balance. For example, if you have a vested balance of $80,000, you could borrow up to $40,000. If your vested balance is $120,000, the loan is capped at the $50,000 maximum. Interest is paid back into your own 401(k) account at a rate set near the prime lending rate.

Repayment terms require that most loans be repaid within five years, with payments made at least quarterly, often through payroll deductions. A risk arises if you leave your job before the loan is fully repaid. In that event, you have until the tax filing deadline for that year, including extensions, to repay the balance or roll it over into another eligible retirement account.

Failure to repay the loan by the deadline results in tax consequences. The IRS treats the outstanding balance as a taxable distribution, meaning it will be subject to ordinary income tax. If you are under the age of 59½, you will also face an additional 10% early withdrawal penalty on the amount.

Rollover to a Self-Directed Retirement Account

An alternative to a 401(k) loan is moving funds into a self-directed retirement account. Unlike an employer-sponsored 401(k), a Self-Directed IRA (SDIRA) or a Solo 401(k) for self-employed individuals allows for a broader range of investments, including real estate and raw land. This approach is a transfer of retirement assets from one qualified account to another, not a withdrawal.

Performing a rollover depends on the 401(k) plan’s rules. An individual can roll over their 401(k) funds after separating from their employer. Some plans may also permit “in-service distributions,” allowing current employees to roll over funds once they reach a certain age, often 59½. Consult the plan administrator to understand the specific eligibility requirements.

To avoid immediate taxes and penalties, funds should be moved via a direct rollover, where the plan administrator sends the money directly to the new account’s custodian. An indirect rollover, where you receive a check to deposit within 60 days, is possible but carries more risk of error. A qualified custodian that specializes in alternative assets is required to hold the assets and ensure compliance.

The self-directed account, as a legal trust, purchases and holds the title to the land, not the individual. All transaction documents must be in the name of the retirement plan. All income and expenses related to the property must also flow through the retirement account.

Rules for Purchasing and Holding Land

The IRS imposes strict regulations on real estate within a self-directed account to prevent personal benefit. These regulations focus on “prohibited transactions,” as outlined in Internal Revenue Code Section 4975. A prohibited transaction is any improper dealing between the retirement account and a “disqualified person” and can result in the disqualification of the entire IRA, triggering immediate taxation and penalties.

A “disqualified person” includes the account holder, their spouse, ancestors (parents, grandparents), lineal descendants (children, grandchildren), and their spouses. It also extends to entities in which a disqualified person has a 50% or greater ownership interest. The retirement account is forbidden from buying land from or selling land to any of these individuals or entities.

The prohibition on personal benefit extends beyond the purchase. The account holder and other disqualified persons cannot use the land for any personal purpose, such as camping, hunting, or building a vacation home. Any use of the property by a disqualified person is considered a prohibited transaction, even if they pay rent to the IRA.

All costs, including the purchase price, closing costs, property taxes, and insurance, must be paid from the self-directed account. Using personal funds for these expenses is a prohibited transaction that jeopardizes the tax-advantaged status of the account.

Tax Considerations for Land in a Retirement Account

Tax implications can arise from how the land is used or financed. One concern is the Unrelated Business Income Tax (UBIT). This tax applies when a tax-exempt entity like an IRA generates income from a business not substantially related to its retirement purpose. While passive income is exempt, active business operations can trigger UBIT.

If the IRA-owned land is used for active business, the net income could be subject to UBIT. Examples include developing the land by subdividing it and selling lots, operating a farm, or running a parking lot. If the gross income from such a business exceeds $1,000 in a year, the IRA must file Form 990-T and pay the tax, which is calculated using high trust tax rates.

UBIT can also be triggered by using debt. If a self-directed IRA uses a loan to purchase land, a portion of the income or gains may be classified as Unrelated Debt-Financed Income (UDFI), a form of UBTI. The loan must be “non-recourse,” meaning the lender’s only collateral is the property itself, not the IRA’s other assets or the account holder’s personal assets.

For example, if a property is purchased for $100,000, with $50,000 from the IRA and $50,000 from a non-recourse loan, then 50% of the net income would be subject to UDFI tax. This applies to both rental income and capital gains when the property is sold. This tax liability reduces the investment’s overall return and must be considered before using leverage.