How to Use Retirement Funds to Invest in Multifamily Real Estate

Oct 14

7 min read

When people think about investing in real estate, they often think first about the cash they have available to invest. But if you have been contributing to a 401(k) or IRA for years, you may already have another source of investment capital available to you.

Retirement funds can be used to passively invest in real estate, whether retirement is years away or you are already retired.

And you don't have to withdraw the money from your retirement account to do it. Instead, eligible retirement funds can be moved directly into a self-directed IRA (SDIRA), where they can be invested in alternative assets such as private real estate.*

When retirement funds are moved properly between compatible retirement accounts, the transfer is not considered a withdrawal, so you do not pay taxes or early-withdrawal penalties on the money you move.* Your SDIRA can then make the real estate investment, with distributions and eventual sale proceeds returning to the account. From there, you can reinvest those funds in another opportunity or choose other investments available within your account.

For investors who have spent years building their retirement savings, a SDIRA can open up an entirely different way to invest and diversify those funds.

So, What Is a SDIRA?

Most of us are familiar with the investment choices offered through a 401(k) or conventional IRA, such as stocks, bonds, mutual funds, and ETFs.

A SDIRA expands those choices.

It is an IRA that allows you to invest in a broader range of assets, including private real estate. And despite the different name, a SDIRA is not a separate tax category. It can be a Traditional IRA or a Roth IRA, with the same basic tax treatment associated with that type of retirement account.

If you have a 401(k) from a previous employer, those funds can often be rolled directly into a SDIRA. Funds held in an existing IRA can be transferred into a SDIRA as well.*

This is where things get interesting for real estate investors. Money that you have already accumulated for retirement may also become a source of capital for investing in multifamily properties or other alternative investments.

How Does Investing Through a SDIRA Work?

It's simpler than it might sound.

You open a SDIRA with a provider that offers self-directed retirement accounts and move the retirement funds you want to invest directly from your old 401(k) or existing IRA into the SDIRA.

You do not necessarily have to move your entire retirement account. Depending on your plan, you may be able to roll over or transfer only the portion you want to invest through the SDIRA.*

Here is the key: the money stays within the retirement account structure.

You are not cashing out your 401(k), putting the money into your bank account, and then investing it. When retirement funds are moved directly from one retirement account to another, the transfer is not considered a withdrawal, so you do not pay taxes or early-withdrawal penalties on the money you move.*

Once the funds are in the SDIRA, the account can invest in a multifamily syndication or other alternative investment.

From there, being a passive investor looks much the same as it would if you invested with personal funds. The operating team acquires and manages the property, executes the business plan, and ultimately manages the sale.

The difference is simply where your investment funds come from and where your returns go.

Instead of investing from your personal bank account, the investment comes from your SDIRA. Cash distributions return to the SDIRA, and when the property is eventually sold, the proceeds, including your original investment and any profits from the sale, are deposited back into the SDIRA.

Because the investment is held inside your SDIRA, you maintain the tax advantages of your retirement account.

With a Traditional SDIRA, cash distributions and proceeds from the eventual sale generally remain tax-deferred inside the account.* You can reinvest those funds without first paying personal income or capital gains taxes on the investment, allowing more of your retirement savings to remain invested over time. Instead, you generally pay income taxes when you eventually withdraw money from the IRA, just as you would with any other Traditional IRA.

With a Roth SDIRA, the tax treatment is different. Roth contributions are made with money that has already been taxed. Investment earnings can then grow within the account without being taxed to you personally as they are earned, and qualified withdrawals, including investment earnings, are tax-free.* When an investment is sold and the proceeds are returned to your Roth SDIRA, you do not personally pay capital gains tax on the profit from the sale.* The proceeds can remain in the account and be reinvested.

In either case, you can then choose to reinvest those funds in another real estate opportunity or other investment available within your account.

How Is Investing Through a SDIRA Different From Investing Personally?

The tax treatment of a real estate investment changes when the investment is held inside a SDIRA.

When you invest personally, depreciation and other real estate deductions may pass through to you and potentially offset taxable income. When the property is sold, you may also owe capital gains taxes and potentially depreciation recapture.

When your SDIRA owns the investment, those depreciation deductions generally do not pass through to your personal tax return. On the other hand, you do not personally pay capital gains tax or depreciation recapture when the property is sold.* Instead, the proceeds return to the SDIRA and remain within the retirement account.

There is one additional tax consideration when a SDIRA invests in real estate that uses debt, as most multifamily properties do. A portion of the income or gains associated with that financing may be subject to Unrelated Business Income Tax (UBIT), including tax arising from Unrelated Debt-Financed Income (UDFI).*

That sounds more complicated than the overall process needs to be. The important distinction is that UBIT is not an early-withdrawal penalty and does not mean you have taken money out of your retirement account. It is a separate tax that can apply to certain income earned by the account.

Why Might Retirement Funds Be a Good Fit for Real Estate?

Think about what retirement savings are designed to do: grow over a long period of time to support you in the future.

That can make them a natural fit for investors who want to add longer-term real estate investments to their portfolios.

A SDIRA can also give you another way to diversify. Rather than having all of your retirement savings invested in traditional assets, you can choose to allocate a portion to private real estate.

And because retirement funds are already intended for the future, some investors may be more comfortable committing a portion of those funds to an investment they do not expect to access right away.

Multifamily investing also gives you the opportunity to own real estate without becoming a landlord yourself. You are investing passively while the operating team handles the property, residents, renovations, financial performance, and execution of the business plan.

For someone who wants real estate to be part of their retirement portfolio without taking on another job, that distinction can be important.

How Does This Fit Into Your Retirement Portfolio?

Using a SDIRA gives you another way to invest your retirement savings, but the real estate investment itself still deserves the same evaluation as any other opportunity.

You want to understand the property, market, business plan, operating team, financing, projected returns, risks, and expected investment period.

Multifamily syndications typically are longer-term, illiquid investments, with estimated hold periods that may range from three to seven years. During that time, the investment may also generate cash distributions, although the amount and timing will depend on the property, investment structure, and performance.

That longer timeline may actually make retirement funds more comfortable for some investors to use, particularly when they do not expect to need that portion of their portfolio in the near future.

And you do not have to think about it as an all-or-nothing decision. A SDIRA can be one piece of a broader retirement portfolio that also includes more traditional and liquid investments.

Over time, you may choose to invest in additional properties, potentially building a portfolio across different markets, investment periods, or business plans.

Final Thoughts: You Can Put Retirement Funds to Work in Real Estate

One of the biggest misconceptions about retirement funds is that they are essentially off-limits until you retire.

They are not.

You may not be able to take the money out and spend it without tax consequences or penalties, but that does not mean it has to sit in the same types of investments until you reach retirement age.

If you have an old 401(k) or an existing IRA, you may be able to move those funds directly into a SDIRA and use them to passively invest in multifamily real estate without withdrawing the money or triggering early-withdrawal penalties.*

Your retirement account makes the investment, receives the distributions and sale proceeds, and gives you the opportunity to decide how you want to invest those funds next.

For investors who have accumulated retirement savings over many years, that can open up another way to diversify their portfolio and potentially build a collection of passive real estate investments, long before retirement arrives or as part of their investment strategy during retirement.

Ready to Learn More?

If you’ve been thinking about investing in real estate but aren’t sure where to start, or want to explore how multifamily investing can fit into your long-term financial goals:

*Retirement account eligibility, rollovers and transfers, prohibited transaction rules, tax treatment, Roth distribution requirements, UBIT/UDFI, and other requirements vary based on account type and individual circumstances. Direct rollovers and transfers between compatible retirement account types typically do not trigger current income tax or early-withdrawal penalties; Roth conversions and certain other transactions may have different tax consequences. Investments involving debt may generate UBIT/UDFI within a retirement account. This information is for educational purposes only and is not intended as tax, legal, or financial advice. Investors should consult their own qualified professionals regarding their individual situation. Investing involves risk, including the potential loss of principal. Projected returns are estimates, not guarantees, and actual investment performance may differ from expectations. Cash distributions, investment returns, and the return of invested capital are not guaranteed.