Unfortunately, too few investors understand the benefits of investing in real estate through retirement accounts…or how to logistically do so.
In this article, we’re focusing on the top seven benefits of investing in real estate through your 401(k) or IRA. To make sure you have balanced information, we’ll also share a few potential downsides to watch for. And then we’ll explain the specific steps you need to take to start investing in real estate with your retirement account.
Let’s start planning for your retirement!
Top 7 Benefits of Investing in Real Estate Through Retirement Accounts
Here are the most compelling advantages of investing in real estate through retirement accounts (in no particular order).
1. Tax-Deferred or Tax-Free Growth
When you invest in real estate through a self-directed retirement account like a Solo 401(k) or Self-Directed IRA (SDIRA), income and gains from the property are not taxed annually. Instead, these tax-advantaged retirement accounts allow your money to grow tax-deferred or tax-free, depending on the account type:
With traditional accounts (such as an SDIRA, Self-Directed SEP IRA, Self-Directed SIMPLE IRA, or Self-Directed Traditional 401(k)), your earnings grow tax-deferred until you withdraw them in retirement. Contributions to these accounts are pre-tax, meaning that they are tax-deductible, which can reduce your tax liability for the years in which you contribute.
With Roth accounts (such as a Self-Directed Roth IRA, which is sometimes called a Roth SDIRA), qualified withdrawals are completely tax-free. This means rental income, capital gains from appreciation, and profits from sales can compound over time without being diminished by yearly taxes. Contributions to these accounts are after-tax, so they are not tax-deductible, but the tax-free growth can be a serious advantage, particularly for young adults (around 35 or younger) who are investing early with lots of time to build compounding returns.
With either structure, you’re reducing your tax burden. Traditional accounts reduce the burden on the front end, and Roth accounts reduce the burden on the back end.
2. Diversification Beyond Traditional Assets
Most retirement portfolios are concentrated in stocks, bonds, and funds. Real estate offers an alternative asset class that isn’t directly tied to market swings. In fact, real estate is proven to be less volatile than the stock market.
Diversification is key in protecting your wealth over time. By strategically allocating your capital across different asset classes, you can reduce market risk. Even within real estate, you can diversify further by choosing different locations, property types, or investment models (which we will discuss shortly).
3. Passive Returns
Whether you earn recurring income (perhaps through rental properties) or periodic profits (perhaps through the sale of real estate holdings), your returns are purely passive when you invest in real estate through your retirement account.
While there are many ways to create passive income from real estate, some methods require more active involvement than you might think. Take multi-family rentals, for example. Many investors who own the property directly handle the landlord responsibilities themselves. But when you invest in real estate through your retirement account, you are prohibited from investing your own time or energy in your holdings. Instead, you hire a property manager to handle operations on behalf of your retirement account, or you buy into professionally managed projects (like REITs or real estate syndication) instead of direct ownership. This provides the required separation between you and your retirement account’s holdings and allows for purely passive returns.
This passive income accumulates inside your account and can be reinvested into other opportunities. While you can’t personally benefit from the income before reaching retirement age (as per the IRS’s rules), passive returns still help your overall retirement balance grow without the need to trade your time for money.
Investors who choose opportunistic investments or those who add value to their properties through renovations can boost their returns further. Inside a retirement account, these returns are even more powerful since they’re not reduced by immediate taxation.
5. Protection From Personal Liability and Other Claims
When you invest in real estate through a retirement account, the property is owned by the retirement account, not by you personally. This adds a layer of legal separation between you and your assets, which can protect you in the event of lawsuits or financial claims.
As a common example, owning real estate through your retirement account can provide added protection in divorce proceedings. While retirement assets are still subject to division during divorce, they typically follow specific rules and require a Qualified Domestic Relations Order (QDRO) to divide, making them more structured and less vulnerable to arbitrary division or disputes than personally held property.
When it comes to inheritance, real estate held in a retirement account is subject to the beneficiary designations on the account. Holding real estate assets in a retirement account can help the property bypass probate and lead to a smoother transfer of assets.
6. Leveragability
One underrated benefit of real estate investing is the ability to use debt leverage to purchase assets more valuable than the amount of capital you have on hand. For example, with a 20% down payment, you might be able to purchase a rental property in which your tenants pay off your loan with interest. As your renters pay down your debt and the property appreciates over time, your net worth increases far more than it would have if you had been limited to investments you could purchase with cash on hand.
Leverage can still be used when investing in real estate through your retirement account but to a lesser degree than when investing outside of your retirement account. Some retirement accounts allow you to use non-recourse (unsecured or collateral-free) loans to purchase property. This means your account can buy real estate with borrowed money, without putting your personal credit at risk. While leveraged investments come with additional risk and tax implications, they can increase your potential returns by allowing you to control more valuable assets with less capital.
7. A Balance of Flexibility and Control
Unlike a traditional IRA or 401(k), where your investment options are limited to a set of mutual funds, a self-directed account gives you access to real estate, which is an exceptionally large asset class, encompassing many different property types and investment models.
You can choose to invest in residential or commercial properties, raw land, mobile home parks, private notes, REITs, or even crowdfunded real estate platforms, whatever suits your goals and risk tolerance. This flexibility lets you build a retirement portfolio that reflects your personal expertise and strategy.
At the same time, it provides more control than simply investing in real estate-based securities (like mutual funds or ETFs (exchange-traded funds) comprised of real estate companies). For example, many real estate syndication platforms allow you to choose the specific project(s) you want to invest in, which is very different from a REIT or fund system that requires you to invest in the whole fund.
Possible Downsides of Investing in Real Estate Through Retirement Accounts
Before you open your Self-Directed Retirement Account to start buying real estate, consider the following potential drawbacks.
1. You Can’t Use the Property
The IRS prohibits you and your disqualified persons (parents, grandparents, kids, grandkids, spouses, kids’ spouses, and fiduciaries) from living in, vacationing at, or personally benefiting from a property held in a retirement account. You can’t even make repairs or handle lawn care yourself at a property owned by your retirement account.
This is one reason why crowdfunding and syndication projects are so attractive as retirement holdings; you have the built-in distance of the project’s sponsor to keep the asset separate from your privately owned holdings.
2. Limited Access to Funds
Since the property is held within a retirement account, you can’t access rental income or profits before retirement age (at least 59.5 years old) without triggering taxes or early withdrawal penalties.
While this restriction can feel like a negative, it can actually be helpful. The limited access acts as a deterrent that could prevent you from making any impulsive decision to withdraw funds, which would deplete your retirement savings and leave you in a compromised financial position once you retire. However, if you plan to retire early, this strategy might not be the right fit for you.
3. Complex Rules and Requirements
The IRS has strict regulations for real estate in a retirement account, including prohibited transactions and uses of the property. Mistakes can lead to taxes, penalties, or even the disqualification of the account as a tax-advantaged account. This is why third-party custodians are often required for the administration of the account. Even if a custodian is not required (as is the case with Checkbook IRAs and 401(k)s), you may want to involve a certified financial planner (CFP) and certified public accountant (CPA) with a specialty in taxation.
How to Invest in Real Estate Through Your Retirement Account
Here is a simple five-step overview of how to invest in real estate through your retirement account:
Open a qualified retirement account. Select a custodian or provider that allows real estate investments and understands IRS rules for alternative assets. Then open your Self-Directed or Checkbook account with your chosen provider.
Fund your account. Contribute new funds (within IRS limits) or rollover existing retirement savings from a traditional IRA or 401(k).
Identify a qualifying real estate investment. Find a property/project that fits your goals and meets IRS guidelines.
Direct your custodian to invest in the property. The account itself must be listed as the owner/investor, and all income and expenses must flow through the retirement plan.
Track your progress and remain compliant. Enjoy watching your retirement account grow while making sure all gains remain inside the retirement account until you reach retirement age.
Invest in Syndication Through Your Retirement Account with Gatsby
With real estate syndication surpassing private equity as the investment model of choice for passive real estate investors, there is a growing interest in investing in syndication through 401(k)s and IRAs.
Gatsby Investment proudly accepts retirement accounts as one of the ways to invest through our platform. With an exemplary track record of successful real estate investment projects, we continue to attract both new and repeat investors.
Specializing in the in-demand Los Angeles market, we focus on creating much-needed housing inventory through new multi-family developments. These projects have historically provided exceptional returns for investors while increasing the sustainability of our local housing market.
To invest in real estate with Gatsby through your retirement account, simply:
Choose “Retirement Account” as your investment method.
Enter the account information, as well as information about any custodian.
Get verified as an accredited investor online (at no cost to you), as required by the Securities and Exchange Commission (SEC) for this type of investment.
For Self-Directed accounts, we can coordinate directly with your custodian for the necessary documentation and funding. For Checkbook accounts, you can place your investment by sending funds via wire or ACH.
Track the progress of your investment project through the convenient online dashboard.
Take advantage of the many benefits of investing in real estate through retirement by investing with Gatsby today!
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