Real Estate IRA’s: Getting Started Right (Part 2 of 5)

September 19, 2017  --  Episode #273

Transcript    ∙    Links & Resources    ∙    Discussion



So you’ve found a great real estate deal… congratulations!  Yesterday, we looked at whether you should do that deal INSIDE or OUTSIDE of your self-directed retirement account.  Today, in Part 2 of 5 Simple Steps to Getting Started Right with Real Estate IRA’s, we look at the key question of whether you’ll get the biggest benefit from using a self-directed IRA or solo 401(k)… even if you don’t currently have both types of accounts.  I’m Bryan Ellis.  This is episode #273.



Folks, I’d like to begin with a word of thanks to all of you who have written to me about yesterday’s episode of this show, where we investigated the key question of:  Should you even do your next real estate deal inside of your self-directed retirement account?  The answer is frequently, but not always, yes… and the distinction is really important, as you’ve already discovered.

Today’s show page can be found at SelfDirected.org/273.

Ok, so you’ve found a great real estate deal.  You listened to yesterday’s episode of this show – which is linked on today’s show page at SelfDirected.org/273 if you missed it – and you’ve determined that YES, it does make sense for you to execute that deal inside of your retirement account.

But what retirement account?

Should you use a self-directed IRA or maybe a solo 401(k)?

Well, my friends, this one is pretty simple.

If you qualify to use a solo 401(k), you should.  Whether you’re talking about real estate or any other asset class, the rules for 401(k)’s are simply far more favorable than for IRA’s.

The biggest examples of that where real estate is concerned include the flexibility concerning prohibited transactions and the lack of income tax liability when doing leveraged transactions.

Let’s look at both of those very briefly.

First, the prohibited transaction rules are broadly similar between IRA’s and 401k’s.  You can learn more about those rules in my free e-Book called the Breaking Point, which is available for you to download from today’s show page at SelfDirected.org/273.

But where there’s big divergence between IRA’s and 401k’s with regard to prohibited transactions is in the ability to recover from them.

With IRA’s, by and large, a prohibited transaction means simply you’re going to lose 40-60% or more of your IRA.  It’s just a complete atomic blast inside of your IRA, and there’s really not much you can do about it once the IRS identifies your error.

With 401k’s, prohibited transactions are equally serious if left unaddressed.  But the real distinction is that there are ways built into the law that allow one to “correct” prohibited transactions in a 401k.

Yes, there will be penalties.  Yes, there will be legal fees.  Yes, there will be expenses.  But it is not necessarily a life-altering cataclysm, as is practically always the case with a self-directed IRA.

That difference, if no other, is enough for me to prefer the solo 401(k) over the self-directed IRA.

But it’s not the only difference.

If you plan to use leverage for your deal – in other words, to get a loan to finance it – then the solo 401(k) is much better there, too.

That’s because there’s a special kind of tax to which IRA’s are subjected if a debt-financed asset – like real estate – generates income – like rents.

Basically – and this is an oversimplification, but a good starting point – basically if you have a piece of real estate that was purchased in your IRA, let’s say half with cash and half with a loan, then for any income generated by that real estate, the portion financed by debt – half of it in this case – will be subject to a type of tax called unrelated business income tax.

So that could be a multi-thousand dollar bite out of your IRA every year.

Why is the 401k is superior to that?

Well, and again, this is a generalization, but a pretty good one:  Solo 401(k)’s just aren’t subject to that type of tax, period.

It’s a big distinction… and a huge advantage.

But here’s the thing:  Not everybody qualifies to have a solo 401(k).

A simple way to understand those qualification is this:  Solo 401(k)’s are only available to business owners, where the only full-time employees of the business are the owners and also optionally the owner’s spouse or spouses if more than one owner.

If that describes your situation, the solo 401(k) is likely a good fit for you.  If you don’t already have one, you should set one up immediately.

Now it’s definitely true that a solo 401(k) is a superior option to a self-directed IRA.  But that doesn’t mean you shouldn’t use a self-directed IRA.  It simply means that you have to be that much MORE CAREFUL to avoid prohibited transactions and to mitigate any current-year tax liabilities.

And I do have a word of warning for you about the solo 401(k):  If you don’t ACTUALLY qualify to use one, don’t do it.  When the IRS catches up to you, they’ll invalidate the whole thing, and you’ll be in a very, very bad spot tax-wise.

So where does this leave us, my friends?

Well, in part 1, we confirmed whether your next great real estate deal should be done INSIDE or OUTSIDE of a retirement account.

In part 2 – today – we decided whether to use a self-directed IRA or solo 401(k) to facilitate the transaction.

And in part 3 of 5 Simple Steps to Getting Started Right with Real Estate IRA’s – that’s the next episode of this show – we’ll figure out exactly which IRA or 401k PROVIDER you should use to do your deals, because my friends:  They are NOT all the same… and some of them could actually even bring you great harm.  And that episode is available to you by visiting today’s show page – SelfDirected.org/273 – and clicking the “Next Episode” link.

Hey, I do have a question for you:  Do you use an IRA or a 401k?  Why?  Have you ever considered using the account type opposite of whatever you’re using now?  Why?  Sound off and share your answer over at SelfDirected.org/273… we’d love to hear what you think!

That’s all for now, my friends.  But I do have a favor to ask of you.  And this may be a bit egotistical on my part, but I don’t think so.  Here’s the deal:

This show, Self-Directed Investor Talk, has a total of 447 ratings on iTunes.  That’s a lot.  It’s more than 7 of the current top 10 investing podcasts.  And of those, 430 – that’s 96.1% – rate the show 5 out of 5 stars.  But one person with thin skin heard a passing political comment I made, and decided to rate the show 0 stars on that basis alone.

That’s ok… I realize that for some people, politics may be their only barometer, and I make no apologies for anything I’ve said here.

But I would love it if – assuming you love this show – if you’d stop by iTunes and give us a nice rating so that this douchebag’s outlier rating isn’t the first thing that shows up in my ratings list, I’d really appreciate it.

And if you ARE that douchebag… it’s ok.  I forgive you.  Hehehehe

My friends… invest wisely today, and live well forever!


Links & Resources

Prohibited Transactions eBook


Get Exclusive
Investment Tips

Learn how to get more out of your self-directed IRA or 401k with exclusive tips and insights that I only share with my private newsletter subscribers.

What Do You Think

Do you use an IRA or a 401k?  Why?  Have you ever considered using the account type opposite of whatever you’re using now?  Why? 

  • Gerald says:

    Thanks you for the timely topic. I have been wondering which way to go and you definitely shed some light. The only part of the solo 401k I wrestle with is that I know in the future I will be building a team. Do you have an idea of how I would stay away from having a full-time employee? I guess an acquisition, disposition and lead manager could be commissioned or 1099. VA’s is just paid per job or service. An assistant or someone to work the phones could be part-time? What would you suggest to stay within the boundaries for a growing wholesaler who keep a few rentals?

  • Click here to subscribe

    Bryan Ellis

    I am host of Self Directed Investor Talk, which I'm told is America's #1 podcast and for affluent self-directed investors. I'm also something of an expert in self-directed IRA's, solo 401k's and 1031 exchanges. You can find more of my writing in some cool places like TheStreet.com, Entrepreneur.com, ThinkRealty and even Forbes (that was always one of my goals!). I live in metro Atlanta, Georgia with my wife and business partner Carole Ellis(she's a real business partner... not just because she's my wife... I'd want to work with her if I wasn't married to her... and I'd want to marry her, too). I also have 4 children ranging in age from 2 to 20 (yes, you read that correctly). It's my goal to be the name everybody thinks of when they think of Self-Directed IRA's and Solo 401(k)'s.