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How to Use Your Retirement Savings To Invest In Real Estate Penalty Free

by | Jun 23, 2021 | Passive Income, Real Estate Investing, Real Estate Syndication

It is a known fact that most people haven’t saved enough for retirement. Americans live longer, social security may run out by 2035, many people’s net worth plummeted after the 2008 financial crisis, and Americans simply aren’t saving. 25% of Americans have no retirement savings at all!

Chances are, if you’ve saved anything for retirement, it’s not even enough to cover your projected grocery costs during your retirement years. Most people just wish and hope “magic” will happen and that somehow things will work out. All that finger crossing can be easily set aside once you learn the power of earning passive income through real estate syndications. 

In our article, The Predictable Way to Passive Income:  Data-driven ATM Syndications, we covered what an ATM Syndication is, why it’s a recession-resistant investment, and provided an overview of the investing and returns process.  ATM syndications are an excellent option for investors who wish to have a predictable, fixed, high monthly income stream.

In this article, you’ll learn two ways you can invest your retirement savings from your IRA or 401K into real estate syndications without triggering a penalty. Of course, we always recommend consulting with the tax and financial professionals in your circle. Still, when done correctly, real estate investments made with your IRA and 401K retirement accounts are not considered an early withdrawal.

 

How to Invest In Real Estate With Your Retirement Accounts 

Contrary to popular belief, investing in real estate with your retirement funds without triggering steep withdrawal penalties is possible.  Since real estate is among the most predictable and less volatile options for your retirement capital, it’s worth exploring passive income-generating group investments.

 Most people have an existing 401K or an IRA, either through an employer or online brokerage. Typically, these accounts are used to invest in mutual funds, stocks, and bonds – basically, anything on the stock market. However, few people realize that you can either: 

a) establish a Solo 401K plan or

b) roll your account into a Self-Directed IRA 

And begin reaping the rewards of distributions and appreciation on real estate assets inside your retirement account. 

Generally, real estate is assumed to be a very active investment, where you’d become a landlord and have to deal with tenants and toilets, but this is different! When you invest your retirement funds into a real estate syndication, you get to carry on with your life while your capital grows seemingly by itself. An experienced syndication team manages the asset, completes improvements, and creates efficiencies according to a business plan. You get to simply sit back and let the distributions roll in (more on how syndications work here).

 

Boost Your Retirement Savings Using Real Estate Syndications Inside Your Self-Directed IRA

With a bit of advice from trusted financial professionals in this specific niche and some paperwork, you can roll your existing IRA or 401K into a Self-Directed IRA, giving you the power to choose and invest in wealth-building tools like real estate syndications. 

As with any retirement account, a self-directed IRA has the potential to grow as distributions and tax-advantaged earnings accumulate inside. The difference is, instead of being limited to the stock market like in standard accounts, you’re in control. You get to select real estate assets that align with your investment goals, potentially allowing you to double your balance in about five years. Either a traditional or Roth IRA account can be used to fund a self-directed IRA.

 

Leverage Your 401K Balance To Invest In Real Estate Syndications

If you’re a small business owner with no full-time employees or are self-employed, the IRS has created a unique retirement plan for you – the Solo 401K. Again, check with the financial professionals who work in this specific niche to confirm eligibility and get the account set up. Once you get past those hurdles, you can use your retirement funds to invest passively in real estate syndications and grow your retirement funds with stability and long-term asset appreciation on your side. 

You can rollover a traditional IRA into a Solo 401K, then convert to a Roth Solo 401K. However, you cannot roll over a Roth IRA into a Solo 401K. It’s best to do the conversions after moving the funds over if you’re looking to maximize your account.

 If you think the tax rate will be higher when you retire, you might want to consider converting to a Roth Solo 401k. You would pay the taxes the year you convert, and distributions will be tax-free.

Again, all income and gains generated by your selected syndication deals will flow directly back into your Solo 401K account, passively creating wealth using the money you’ve already saved. You can freely choose real estate syndication investment deals projecting high distributions or appreciation (or both!) to build your balance quickly and catch up on retirement savings. 

 

What You Need To Know About The Rules And Tax Liabilities 

Investing with your accumulated retirement money has additional rules and restrictions around it, and the tiniest mistake can have big consequences. So, while we’re excited you’re enthused about investing in a real estate syndication with it, we’re going to nudge you again to do your research and talk with the tax and retirement fund specialists.

 One of the first significant rules is that when investing with retirement funds, the earnings have to go back into your retirement fund. You don’t get to “take-home” this income until you actually become eligible, i.e., retire. The strategies discussed in this article around self-directed IRAs and Solo 401Ks are opportunities to grow your retirement account balance with distributions and profits from the sale of the real estate (compared to the dividends and earnings from the stock market). 

 Financial professionals in this niche will help you set up your investment distributions properly. Still, beyond that, there are prohibited investment types, rules around who can or can’t live in the real estate you own, and tax obligations you should be aware of. Ideally, you’ll want to use a tax professional who handles these tax returns regularly. 

 

Prohibited Transactions and Disqualified Persons

When you open up a Self-directed IRA or Solo 401K, make sure you understand the rules with opening and maintaining an account.  There are prohibited transactions and disqualified persons that the retirement account is not allowed to transact with. For example, funds cannot be used to invest in insurance or collectibles.  Or you can not use funds to purchase a house and have your lineal ascendants or descendants live in the house.

 If you’re the analytical type and are interested in every nuance and detail related to prohibited transactions, here’s a great article. As you’re exploring the idea of investing with your retirement savings, it’s a great idea to have a basic understanding of how to avoid prohibited transactions in your IRA.

Unrelated Business Taxable Income (UBTI)

Investing using funds inside your retirement account comes with significant advantages because most income is tax-free until distribution, which is usually way down the road. You should, however, be aware that most real estate investments held within a Self-Directed IRA or solo 401K will generate taxable income

 While we’re going to give you an overview of UBTI and how it affects UBIT and UDFI inside self-directed and solo accounts here, make sure you review the details for yourself in IRS Publication 598. It says that if you’re using funds to carry out a trade or business unrelated to the exempt purposes of your account, you’re subject to tax on the gross income (income after any directly related deductions). 

 Just like all investments or financial deals, it doesn’t matter how much money you make. It’s all about how much you keep. Taxes on income aren’t something to be scared of, rather something to be informed about. 

 

Unrelated Business Income Tax (UBIT)

As explained above, Unrelated Business Taxable Income (UBTI) will trigger either UBIT or UDFI; both are described below. Any time you earn income in a way that was initially unintended by the IRS inside your retirement account, you’ll need to pay some form of taxes on that money. 

So, even though your account is recognized as tax-exempt, it’s going to be liable for tax on unrelated business income generated by your real estate investments, which is Unrelated Business Income Tax or UBIT, for short.

 In regards to your passive real estate syndication investments, you’ll receive a K-1 from the sponsor team for all your real estate syndication investments each Spring. It’s very common to file for a tax extension every year you are invested in a real estate syndication.  

 Your K-1 will detail your on-paper gains or losses for your investment, and if the UBTI is more than $1,000, your tax professional will help you complete Form 990-T and remit the income taxes due from your IRA Account. 

 While you generally won’t have to pay taxes until about year 3, after all on-paper losses have been applied, we want you to know what to expect on the backend. 

Unrelated Debt-Financed Income (UDFI) 

Another fancy acronym you should be aware of before diving into real estate investments with your retirement funds is UDFI. Unrelated Debt-Financed Income means that if the property in which you’re invested generated income while the asset was financed, the portion of the profit realized through the debt may be subject to tax.

 If the real estate property has any level of indebtedness at any time during the taxable year, it is considered a debt-financed property. While UDFI is only applied to the profit portion related to the debt, you may owe tax if a leveraged property generates income or if a financed property is sold for profit. 

 Since most large real estate properties like syndications are purchased using leverage, you and UDFI will likely have to become acquaintances. Again, your tax professional will carry out the calculations, review your K-1, and assist you in filing the necessary paperwork.

 Keep in mind that the depreciation on your investment asset may prevent on-paper profits even though the property has been providing distributions, so, likely, you’ll not owe UDFI taxes for the first few years. 

 

Penalty-Free Growth Inside Your Retirement Account

Although UDFI and UBIT can seem scary, an experienced tax professional should be able to guide you through the process effortlessly. There’s much misinformation out there because tax-related issues are generally confusing, but we have to tell you about them. Transparency is essential, right?

 Remember, even with a few taxes or fees, the potential growth is astronomical compared to that traditionally possible with the stock market. Experts estimate that when invested in the stock market, you have the potential to double your balance every 6-8 years (based on 10% average return) – It’s called The Rule of 72

 But we’ve seen it time and time again, that doesn’t always work out. The stock market doesn’t make 10% every year, and a recession can wipe people’s entire life savings in one fell swoop!

 On the other hand, we’ve repeatedly seen real estate produce passive income that doubles the balance in 5 years or less. With quarterly distributions and profits at the sale of these tangible assets, real estate syndications offer excellent levels of security, passive income, tax breaks, and opportunity you just can’t find anywhere else.

 If you’re interested in investing in our next real estate syndication deal with your retirement funds, start consulting with your financial and tax professionals now because it takes a little time to convert your accounts. Next, make sure you’re a member of the BlueDoor Investor Club AND schedule a call so you’ll get notified when our next syndication opportunity is available. We can’t share all our opportunities until we’ve actually spoken

We can’t wait to help you catch up on those retirement savings!

Want to Learn More?

Ready to learn more about passive investing? Join our community and sign up for the BlueDoor Investor Club. Next, schedule a call so we can learn more about you and your investing goals. We’ll stay in touch with you through a series of newsletters, blogs, and educational content. Our members will be notified first when a syndication deal passes our stringent guidelines and becomes available.

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