Recently I was asked about investing in rental real estate with 401(k) funds and my response was why? The answer to their question was, yes you can invest your 401(k) funds into rental real estate but I am not so sure it is a good idea. Don’t get me wrong I think investing in rental real estate is one of the best investing ideas around. In fact my favorite clients are families whose entire business is rental real estate. I get to help them decide how many rentals should be inside each LLC, how should the ownership be transferred to the next generation, should the kids own outright or in a trust. All kinds of wonderful fascinating things to do with rental real estate. But I do not understand why you would want to buy rental property and hold it in a 401(k).
Let’s work through an example. The property is purchased for $150,000. $1,000 is collected each month as rent. Monthly expenses are approximately $600. So at the end of the year you have net income of $4,800. Depreciation expense for the year will be $5,000. So if you own this rental property in your name you will have an extra $4,800 in cash to spend during the year and come tax time you will have a loss of $200 to report to the IRS. So why would you want to own this property in your 401(K)? The 401(k) earned $4,800 but it lost out on the depreciation deduction and when it comes time to pull the funds out of the 401(k) you will pay tax on the $4,800 earned. It makes better sense to me to invest the 401(k) funds into other things and buy the rental real estate in your personal name or better yet in an LLC!
