401(k) Real Estate Investment Rules: What to Know Before You Invest

Investing retirement funds in real estate is a topic that generates a great deal of interest and confusion. While certain retirement accounts may allow exposure to real estate, the rules governing these arrangements are detailed and strictly enforced.

This guide provides an educational overview of 401(k) real estate investment rules, including IRS regulations, prohibited transactions, and structural considerations. It is not individualized financial, tax, or legal advice.

Can You Invest in Real Estate Through a 401(k)?

In limited circumstances, real estate may be held inside certain types of retirement accounts.

Most traditional employer-sponsored 401(k) plans restrict investment options to publicly traded securities such as:

• Mutual funds
• Exchange-traded funds (ETFs)
• Target-date funds
• Company stock

To hold real estate, individuals typically explore specialized retirement structures such as a self-directed 401(k) or Solo 401(k) (when eligible).

Eligibility depends on employment status, plan design, and IRS requirements.

IRS Rules That Govern 401(k) Real Estate Investments

When real estate is held inside a retirement account, it becomes subject to specific provisions under the Internal Revenue Code (IRC).

Two sections frequently referenced include:

IRC Section 408

Although originally focused on IRAs, Section 408 outlines permitted and prohibited asset categories in tax-advantaged retirement accounts.

Generally:

• Certain collectibles and life insurance are prohibited.
• Real estate may be permitted if held strictly for investment purposes.
• Personal use of the property is not allowed.

IRC Section 4975 – Prohibited Transactions

Section 4975 defines prohibited transactions involving retirement accounts.

Prohibited transactions may include:

• Personal use of retirement-owned property
• Transactions involving certain related parties (“disqualified persons”)
• Self-dealing or indirect personal benefit
• Lending between yourself and the plan
• Using plan-owned property as collateral for personal loans

If a prohibited transaction occurs, the IRS may treat the entire account as distributed, which can result in income taxes and potential penalties.

Because the consequences can be significant, understanding these rules before entering into an arrangement is important.

What Is a Solo 401(k)?

A Solo 401(k) is a retirement plan typically available to self-employed individuals or business owners with no full-time employees (other than a spouse).

Some Solo 401(k) plans allow alternative investments, including real estate, provided:

• The plan document permits it
• The structure complies with IRS rules
• Transactions avoid prohibited-party involvement
• Proper documentation and separation of funds are maintained

Not all custodians or administrators support these features, so reviewing plan documents and administrative capabilities is an important step.

Structural Considerations for Real Estate in a 401(k)

When real estate is held inside a retirement plan, individuals often consider:

• Whether the property will be owned directly by the plan
• Whether an LLC structure is used (if permitted by plan terms)
• How income and expenses will flow through the account
• Recordkeeping and compliance requirements

All income generated by the property must flow into the retirement account. All expenses must be paid from the retirement account. Personal funds generally cannot be commingled.

Because setup and administration can be complex, individuals often consult qualified professionals before proceeding.

Potential Advantages of 401(k) Real Estate Exposure

In certain circumstances, individuals explore real estate inside retirement accounts for reasons such as:

• Portfolio diversification
• Exposure to tangible assets
• Long-term income potential
• Tax-deferred or tax-advantaged growth (subject to IRS rules)

However, these potential benefits depend on proper structure and compliance.

Risks and Considerations

Investing in real estate through a retirement account involves additional complexity compared to traditional securities.

Key considerations may include:

Limited Liquidity

Real estate cannot typically be liquidated as quickly as publicly traded investments.

Administrative Requirements

Self-directed plans often require additional documentation, oversight, and professional coordination.

Prohibited Transaction Risk

Even unintentional violations can create tax consequences.

Unrelated Business Income Tax (UBIT)

If leverage is used through a non-recourse loan, portions of income may be subject to UBIT.

Because these factors vary by situation, reviewing your specific structure before implementation is advisable.

Local Considerations for New Jersey Investors

For individuals in Harrison Township, Mullica Hill, Elmer, Franklin Township, and surrounding South Jersey communities, state-level considerations may also apply.

When structuring real estate within a retirement account, individuals may review:

• State registration requirements
• Transfer taxes
• Property tax considerations
• Local real estate market conditions

Local compliance details should align with federal retirement plan rules.

Common Misunderstandings

Some individuals assume:

• They can personally manage or use the property
• Renting to family members is acceptable
• Minor violations result in minimal penalties
• Any CPA automatically oversees retirement plan compliance

Because retirement plan rules intersect with tax law and ERISA considerations, specialized knowledge may be required depending on the structure involved.

Is Real Estate in a 401(k) Appropriate for You?

A self-directed 401(k) structure may be considered by individuals who:

• Qualify for a Solo 401(k)
• Understand the administrative responsibilities
• Are comfortable with reduced liquidity
• Seek diversification within retirement planning

However, it is not appropriate for every investor. Evaluating suitability, compliance risk, and long-term retirement objectives is essential before making changes to retirement assets.

Final Thoughts

Real estate within a 401(k) is permitted in certain circumstances, but it operates under a detailed regulatory framework. Understanding IRS rules, prohibited transactions, and structural requirements is central to maintaining the tax-advantaged status of retirement funds.

If you are evaluating whether a self-directed 401(k) or Solo 401(k) aligns with your retirement planning goals, a structured conversation can help clarify available options and considerations based on your individual situation.