OriginColo

Last month, I purchased my first rental property with pre-tax retirement funds.  The whole process evolved rapidly (12 days to be exact), from structuring the self-directed 401k to negotiating and closing the purchase.  Luckily, I had previously researched the basic structure of self-directed retirement accounts, so I had an idea of how the process worked and was able to make things happen quickly; additionally, the stars aligned for the deal to happen!

I was introduced to the out-of-state property owner through a client that I am currently working with.  A few casual text messages on Wednesday turned into a successful closing Monday, 12 days later.  After a quick verbal agreement on terms, it was off to the races.  Here are the factors that had to be addressed to make this deal happen (2,3, and 4 happened in parallel):

1. Establish the self-directed 401k – 2 days
   1. Draft IRS compliant 401k documents
   2. Sign and notarize required documents
   3. Get an EIN for the newly established company
2. Funding the self-directed 401k – 4 days
   1. Opening a checking account in the name of the 401k trust
   2. Carefully coordinating a partial rollover of IRA funds into the newly created bank account (if this is not done correctly, a 1099R may be issued incorrectly with taxes & penalties due!)
3. Funding the Real estate Purchase – 1 day
   1. Wire funds from 401k trust checking account to Title Company
4. Contract/Title/Closing process – 9 days (5 business days)
   1. Execute a real estate contract with the newly formed 401k trust as the buyer
   2. Coordinate with the Title Company to provide title insurance
   3. Coordinate payoff info for seller’s loan
   4. Remote signing and notarization of Seller’s closing documents and overnighting back to Title Company

Establishing a Self-Directed 401k

Many have heard of a self-directed IRA, but fewer, including me until recently, have heard of a self-directed 401k.  For self-employed individuals or those that have a W2 job and some self-employed income, I suggest the 401k path.  Here are some of the benefits of a 401k over an IRA:

With the flexibility of the self-directed 401k over the IRA, I naturally opted to use it for this real estate transaction and other future investment ideas.  In IRS terms, the 401k I structured is referred to as a Solo 401(k), a Solo-k, a Uni-k, or a One-participant k.  The added feature I opted for is that it is self-directed, allowing me to invest in typical investments (stocks, bonds, ETFs, mutual funds) as well as alternative investments (real estate, notes, tax liens, crypto currency, precious metal, and more).

I utilized a third-party company to draft the required documents to form the 401k, associated with a previously established S-Corp, which took about 24hrs and cost $795 plus $125 annually covering any changes or documents that need generated on an annual basis.  There are, however, cheaper companies out there—I’ve seen pricing as low as $550 for the initial setup and $100 annually.  I opted for a company that seems to have significant knowledge based on their website info, blog, and is also able to provide the more complex ROBS 401k programs (Roll Over for Business Startup).  Once I received, signed, and returned the appropriate documents, I applied for and received an EIN from the IRS in the name of the 401k—this process is fairly simple to do on their website and you immediately get the EIN.

Funding the 401k and then funding the real estate purchase

I like options; this is why I wanted a self-directed retirement account in the first place!  I had initially tried to setup a brokerage account with the same company that held my IRA.  That didn’t work!  The typical large investment companies will help you structure an individual 401k, but not an account that is self-directed allowing you to purchase real estate, crypto currency, etc.  Unfortunately, it took me about 24hrs to figure this out after drilling them with questions.  Having already lost precious time in my rapidly moving real estate transaction, I opened a trust account at a local bank and had the funds wired in.  Officially, I performed a rollover into a qualifying plan.  The most important part of this is ensuring that the brokerage company fills out the 1099R correctly—more specifically, box 7 needs to be marked G.  One more note on a rollover: it takes time to liquidate the IRA account assets and comply with Brokerage Firms’ internal processes, so ultimately my rollover started on Tuesday and the funds weren’t in my 401k trust account until Thursday.  Once my 401k was officially funded, I immediately wired funds to the Title Company and confirmed that they had arrived the next day.  That was Friday and closing was the following Monday!  Like I said early on, the stars aligned!

Contract/Title/Closing process

On Wednesday evening, 4/18, the out-of-state seller and I exchanged a few text messages and then had a great phone call.  We had verbally agreed to terms.  The two major factors that concerned me were: not having my 401k structured, and they wanted to close by the end of the month—this was only 12 days away!  Challenge accepted!  I immediately contacted the company that helped me structure the 401k and provided all the required info—the only problem was I wouldn’t get the 401k documents for 36 hours as they needed a full business day to provide them (that meant Friday). The next day (Thursday) I wrote up preliminary contract for the seller to review, provide edits, and fine tune the negotiation.  Late Friday, after the 401k was officially established, the contract was officially put in writing for the seller to sign.   The seller executed the contract on Saturday, and the Title Company started their work on Monday.  Everything went smooth on the Title Company’s end.  There was a little back in forth and bit more negotiating when we received the preliminary settlement statements.  On Thursday prior to closing, our final settlement statements were in hand, and I wired my funds.  One last check with the Title Company to ensure the funds arrived and to check on coordination with the out-of-state seller identified a big problem! There was a mis-communication about the seller needing to sign remotely as they were in a different state and also traveling out of their state the next day!  Fortunately, we were able to quickly coordinate getting them the closing documents that they could sign and notarize, and overnight back to the Title Company the following day.  By Friday evening, the funds were with the Title Company along with the seller’s signed closing docs.  I signed my portion of the documents on the following Monday, right on time!

If I had this to do all over again, I would definitely structure the 401k well in advance.  The process as I did it was stressful; closing a real estate transaction in 9 days is tough enough, considering 4 of those days were weekends, let alone structuring and funding a 401k to make the purchase.  With all the upsides to self-directed 401k, I wish I would have started it the same day I started my S-Corp!