Maximize Your Retirement Funds: The Pros & Cons of Real Estate Investing Through SDIRAs & Solo 401(k)s

Investing in real estate through a Self-Directed Individual Retirement Account (SDIRA) or a solo 401(k) can be a great way to grow your wealth and diversify. After all your financial advisor tells you to diversify, so why not diversify into real estate and other assets outside of the stock market?  Before you use retirement funds, understand the challenges. Here’s a breakdown of the pros and cons:

Pro – High Return on Investment. Real estate has consistently been one of the most profitable long-term investments, with high returns driven by appreciation, rental income, and property improvements. The power of compounding in a tax-advantaged account like a Roth SDIRA only enhances the potential for substantial wealth accumulation over time.

Con – Custodial Oversight. The IRS requires SDIRAs to be managed by a certified custodian, which means every investment and disbursement must be approved and processed through them. This dependency can create bottlenecks, slow down decision-making, and introduce additional costs. Setting up an LLC within your SDIRA can grant “checkbook control” for faster transactions, but you still need to ensure proper compliance. There are a lesser number of custodians, so be sure to find someone that can handle a SDIRA/Solo 401(k). It’s not JP Morgan, Northwestern Mutual, Edward Jones, etc.

Pro – Control Over Investments. Unlike traditional IRAs that limit you to stocks, bonds, and mutual funds, SDIRAs grant you full control over your investment choices. Want to invest in a real estate syndication? You have the freedom to decide, which can lead to higher returns if managed well.

Con – Control Over Investments. This is a con if you are not well versed and educated in what you are investing in. Traditional stocks if diversified, tend to go up 8% annually on average over a long period of time. Investing in a real estate deal can be very profitable, but you’re investing larger amounts ($50k+), so there is more risk of that investment losing money.

Pro – Asset Protection. One major benefit of investing through an SDIRA is creditor protection. Even if you face financial hardships or declare bankruptcy, your SDIRA assets remain protected from creditors, providing a solid safety net for your retirement. 

Con – Unrelated Debt-Financed Income (UDFI). Using leverage within your SDIRA to buy property introduces Unrelated Debt-Financed Income tax. If a property held in your SDIRA generates income while under debt, a portion of that income may be taxable, potentially diminishing your overall returns. Talk with your CPA to determine if and how this would affect you.

 Pro – Tax-Advantaged Growth. The tax benefits of an SDIRA are compelling. Whether you choose a traditional or Roth structure, your investments enjoy either tax-deferred or tax-free growth. With a Roth SDIRA, your gains are never taxed as long as you follow the rules, maximizing your ability to reinvest profits and build wealth

Con – No Traditional Real Estate Tax Benefits. You will not be able to take depreciation to offset investment or income gains if you invest through your IRA. A big advantage of real estate investing is the tax benefits that it offers, but this is not the case with an SDIRA

 Con – You Typically Can’t Use 401k Funds With You Current Employer. The money in your 401K with your current employer is often times not accessible. If you have a big chunk of money sitting in that account, you can ask that it be moved to a different custodian, but you may be met with a hard no. Once you change jobs, quit or retire, you can move that money.

If you’re thinking about using your SDIRA/Solo 401(k) to invest in real estate, here are three things to remember:

• Prohibited Transactions: Avoid using SDIRA funds for personal benefit or conducting transactions with disqualified persons like family members.

• Funding Restrictions: Ensure all investment-related expenses are paid through your SDIRA. Mixing personal funds with SDIRA assets can lead to serious tax consequences.

• Disqualified Persons: Understand the rules surrounding transactions with disqualified persons to keep your SDIRA compliant.

Passive real estate syndication through self-directed IRAs or Solo 401(k)s offers a great alternative to traditional stock market investments. By harnessing the power of real estate, investors can benefit from steady income, potential appreciation, and risk mitigation, all while leveraging the tax advantages of retirement accounts. With an SDIRA, you can maximize the potential of old retirement funds, creating financial growth and independence.

Disclaimer: The information provided in this blog post is for educational purposes only and should not be considered financial or investment advice