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I Built a $1 Million Self-Directed 401(k) With Only 1-2 Real Estate Deals Per Year

by Marc Halpern, Part Time Investors LLC

November 22, 2021

Chances are that you are a part-time investor with a primary occupation outside of real estate, just like me. Chances are that you want to build a retirement plan with more than $1 million, with relatively low-risk investments and only make 1-2 investments per year, like I did. In this article, I will share the key concepts upon which I conservatively built my retirement plan to more than $1 million, “one brick at a time,” doing only 1-2 real estate investments per year (no stock market) and without driving myself crazy. On top of that, most of my self-directed 401(k) is tax-FREE (Roth) and generates significant tax-FREE passive income. This too will be discussed below.

[The author is not an attorney, not an accountant and not a financial advisor. Do not make any decisions or take any actions based on the content of this article. Perform deep due diligence and consult with licensed professionals in your state before making any investment decisions.]

In order to build a $1 million retirement plan with relatively low risk and relatively low intensity effort, like I did, it is important to recognize and COMBINE several crucial concepts. As we discuss each concept, one at a time, many of you will likely already know each one, but the power is when you COMBINE the concepts to gain the most benefit and use your resources efficiently.

Before we discuss each concept, be aware that if you don’t yet have a $1 million retirement plan, it is due to one of two realities…either you are not aware of this combination of concepts or you haven’t YET implemented the combination of concepts. Either way, let’s make sure we’re on the same page by describing each concept then combine ALL of them to achieve high performance.

First, I will refer to an example, which is one of four “tracks” on my journey. A track is a sequence of consecutive investments.

This track consists of three investments. The first two investments were single-family homes and the third investment was (and still is) in a fund that lends to land developers. All three investments were made in my self-directed Roth 401(k).

Performance Summary of This Track: This track (sequence of three investments) started with a Roth conversion of $75,000 of pre-tax money in my retirement plan plus $7,000 of Roth money. Five and a half years later, this self-sustaining track, with no additional investment of new money, had a value of $293,000 that generated (and still generates) $2,630 per month of tax-free positive cash flow and has $43,000 of cash that has not yet redeployed.

There are two aspects to this performance, growth and income. Based on the initial investment of $82,000 of Roth money that funded the first investment in a single-family home, the growth was a compounded 26% per year PLUS cash flow dividends of 38%.

This performance is impressive and not a fluke. All three investments were based on conservative decisions after proper due diligence. This performance is based on only three investments over 5.5 years, including more than half a year during which the funds sat idle uninvested. In other words, this was easily achieved as a part-time investor with a primary occupation outside of real estate investing. If you are a part-time investor, like me, this should get your attention.

Let’s review the three investments and see that there was no magic involved and no huge risk required (of course, there is always SOME risk).

Investment #1: On Jan 14, 2016, the Roth 401(k) bought (titled in the Roth-trustee) a bank owned 1,341 sqft 3 bed 1.5 bath single-family home twin in Atco, New Jersey, listed on MLS at a purchase price of $50,000. The property was renovated by contractors at a cost of $28,000. I did NO work on the property at all. My role was to “find ‘em and fund ‘em.” The buying costs (title work, etc) and holding costs (taxes, insurance, utilities) were $4,000. Thus, the total investment by the Roth was $82,000. The property was sold on April 30, 2016 at $140,000. The net proceeds after selling costs (commission, seller concessions, realty transfer tax, etc.) was $131,500. This is the only house flip done in the 401(k) in that calendar year. In other words, flipping is NOT a regular business of the 401(k).

Investment #2: Later that year, on Oct 30, 2016, the Roth 401(k) bought (titled in the Roth-trustee) an 1,886 sqft 4 bed 2 bath single-family home in Sicklerville, New Jersey, from an estate, listed on MLS at a purchase price of $80,000. The property was renovated by contractors at a cost of $40,000. I did NO work on the property at all. My role was to “find ‘em and fund ‘em.” The buying costs (title work, etc) and holding costs (taxes, insurance, utilities) were $5,000. The total investment by the Roth was $125,000.

This 4-bedroom home was rented from December 14, 2016 to March 15, 2021, including a period during COVID in which rent payments were reduced when the tenant lost his job. The property was sold on May 27, 2021 at a sales price of $240,000 directly (no commissions) to the sister of another tenant who was renting a SFH titled in the SD 401(k) located 100 yards away. The net proceeds from the sale were $239,000. The net cash flow from the 4.5 years of rental, AFTER taxes, insurance, vacancy, repairs and admin costs was $47,500.

The rent was collected by an independent third party by ACH withdrawal of the rent from the tenant’s bank account and direct deposit of the rent into the Roth account. As noted above, all repairs were performed by contractors. I did NO work on the property.

The financial summary of Investment #1 and Investment #2 was that $82,000 of Roth money was invested to buy a SFH that generated $131,500 of cash in the Roth account, of which $125,000 was used to buy and prepare for rent a second SFH ($6,500 remained in cash) that generated $47,500 in cash flow after vacancy, repairs and admin costs and $239,000 of cash in the Roth account. In other words, $82,000 of after-tax Roth money was converted into a total of $293,000 of after-tax Roth money.

Investment #3: On July 6, 2021, $250,000 of the $293,000 of cash in the Roth account was invested in a private placement that lends money to land developers that purchase land and “entitle” the land, then sell the land to home builders to build subdivisions (build-to-own and build-to-rent). The land development lending fund pays 12% preferred return plus “back end kickers” upon liquidity events which is when the land developer sells land to a home builder. Within three months of the investment, the Roth received by direct deposit $7,901 for an 85-day investment period which is 13.6% cash-on-cash return on the $250,000. Obviously, the investment in the land development lending fund is 100% passive with no active involvement by me, the beneficiary of the SD Roth 401(k).

To repeat the summary: Based on the initial investment of $82,000 of Roth money that funded the first investment in a single-family home, the growth was a compounded 26% per year PLUS cash flow dividends of 38%.

Yes, the details of each individual investment are boring. But the performance is not. Investing is about numbers and in order to understand if and how you can achieve this desired performance, it is important to understand the numbers and the assumptions that served as the basis for the decisions.

Now that you have seen the impressive numbers and the characteristics of each of the three investments in this track, let’s discuss the concepts that were applied to make the conservative decisions with relatively low risk that resulted in this impressive performance that was achieved without driving myself crazy.

Concept #1: Buying Distressed Real Estate at a Discount Creates Disproportionately High Value

People often say ‘buy low, sell high’ but the reality is that there are few asset classes that you can buy at a true and RELIABLE discount to fair market value AT THE MOMENT OF PURCHASE. If the price of a physical 1 oz gold coin at a given moment is $1,600, you can probably buy it on that day at $1,595 or $1,605, but you can’t buy it at $1,300 on that day. ‘Buy low, sell high’ might mean, buy today at $1,600, sell later (or much later) at $1,900 with the hope, not knowledge, that it will be worth $1,900 in the future (or far future) at some specific or unknown date.

In contrast, distressed real estate CAN be bought at a true and reliable discount to today’s fair market value. Let’s multiply the numbers above shown for the gold coin by 100. It IS possible (and done all the time) to buy a distressed single-family home worth $160,000 (after repairs) at a purchase price of $100,000 and invest $20,000 in repairs and $10,000 in other costs, for a total investment of $130,000, then RELIABLY sell it at $160,000 a month or two later. This significant discount is true and RELIABLE if you have done deep due diligence to confirm the numbers and identify/mitigate the risks.

In other words, you can create significant instant equity reliably, predictably and conservatively by buying distressed real estate after proper deep due diligence. Sure, you can buy stock options with discounts, but unless you have some insider information, the level of certainty of the instant discount of the stock is not as high as distressed real estate.

There are other distressed assets that you can buy at a significant discount, rehab and sell to make a profit such as non-performing notes or cars in need of repair. However, a key decision point for choosing real estate is the magnitude of the profit in one investment. In fact, the amount of instant equity from each distressed real estate purchase is large enough that you can do only 1-2 deals per year and build a significant nest egg.

If you combine the instant equity with the strategy of buy-fix-rent-sell then you can rack up some very significant gains if you wait to sell during a seller’s market, all while enjoying positive cash flow in the interim. As described above in Investment #2, my self-directed Roth 401(k) bought a distressed single-family home at a price of $80,000, invested $45,000 in repairs, buying, holding and selling costs (total investment $125,000), rented it for 4.5 years with a positive cash flow of $46,500 (after economic vacancy due to COVID, repairs and admin costs), then sold it and netted $239,000 after selling costs. Yes, this one investment RELIABLY and CONSERVATIVELY generated $160,500 of tax-free profit from a $125,000 investment over 4.5 years (ROI 128%), equivalent to 20% per year compounded return for ONE single conservative investment.

Of course, you can do a lot more than 1-2 deals per year and you can be a full-time investor if you like and accelerate your path to financial freedom by working harder. The reality is that usually about 5%-10% of REIA members (members of real estate investor associations) in the United States are full-time investors. The rest of us are part-time investors or wannabe investors. All I am saying here is that by doing only 1-2 real estate deals per year, like I do, you can achieve financial freedom and build a $1 million retirement plan like I did without driving myself crazy.

Corollary Concept 1a: Deep Due Diligence is REQUIRED to Minimize Risk

Although obvious, it bears repeating that deep due diligence is essential to confirm that the numbers are correct or reasonable, including after repair value, repair estimate, buying/holding/selling costs and other costs. Proper due diligence includes assessing risks such as environmental, zoning, insurance, clear title and a variety of factors specific to the property and location.

Deep due diligence does require a few extra hours of due diligence effort on each deal but those hours are well worth the investment of time if you are a conservative investor, like me. In addition to greatly increasing your probability of success, the number of hours that will be invested by contractors will greatly outnumber the number of hours you will invest to confirm that your numbers are reliable and reasonable. Of course, your deep due diligence may reveal that your numbers are not as confident as you initially perceived. That might lead you to walk away for the deal. Conservative investors, like me, walk away from most deals presented during due diligence.

Concept #2: IRA’s and 401(k)’s CAN Invest DIRECTLY in Real Estate If “Self-Directed”

If you have a 401(k) at work or an IRA at a large brokerage house, your options to invest your retirement funds are limited to a menu of investments allowed by that custodian. Your company’s 401(k) plan might allow you to invest in company stock, mutual fund portfolios, guaranteed income funds and a few other options. Your company’s 401(k) will not allow you to invest your 401(k) in a single-family home rental down the street. Likewise, the big brokerage houses will offer you the opportunity to invest your IRA funds in a wide variety of securities and funds, but they won’t allow you to buy a single-family home rental down the street, private lend your IRA money to a local rehabber, buy into a certain apartment syndication, buy a discounted seller-financed mortgage note or buy ownership in a race horse. Company 401(k)’s and big brokerage houses are simply not set up to enable you to buy assets that cannot be bought and sold with the click of a mouse.

The good news is that there are special companies that serve as custodians for alternative investments by IRA’s and 401(k)’s. You can find a list of such companies by searching for “self-directed IRA custodians”.

If you want to invest your IRA or 401(k) funds DIRECTLY in real estate, you will need to set up a self-directed IRA account or self-directed 401(k) account (also called a “solo k” or “individual k”) with a custodian that specializes in such accounts.

You will need to learn, just like I did, the rules and procedures for investing self-directed IRA or self-directed 401(k) funds. All commercial “SDIRA” custodians have educational resources to help you learn the rules and procedures. There are MANY rules to learn (especially prohibited transactions, disqualified people, UBIT and UDFI) but it is worthwhile to learn the rules if your driving force is to build a $1 million retirement plan conservatively, like I did.

Concept 3: You Can Ramp Up a Self-Directed 401(k) MUCH Faster than a Self-Directed IRA When Starting Out

As you learn more and more about SDIRA’s and SD 401(k)’s, you will notice that there are similarities and differences between SDIRA’s and SD 401(k)’s. One of the differences GREATLY affects the rate at which you can ramp up the size of your retirement fund when you are starting out. I chose to start an SD 401(k) for my 1-person S-corporation rather than an SDIRA because the SDIRA‘s are limited to annual contributions of only $6,000 (through 2022; $7,000 if you are age 50 or older), whereas the annual contributions limits to a 401(k) are $19,500 in 2021 ($26,000 for 50 and older) and $20,500 in 2022 ($26,500 for age 50 and older). In addition to that, the employer can make contributions to an employee’s 401(k) with programs (such as matching, profit sharing, more) that can bring the total annual contributions to as high as $58,000 in 2021 ($64,500 for age 50 and older).

In other words, you can ramp up an SD 401(k) up to about 3-9 times faster than an SDIRA. That can easily reduce by a decade or more the time to achieve a $1 million retirement plan. I started my SD 401(k) at age 53.

For example, using Investment #2 described above in which I invested $125,000 of my self-directed retirement plan to fund a single-family home rental, had I tried to fund the $125,000 from contributions alone, it would have taken nearly two decades to accumulate the required amount (ignoring investment gains). Using an SD 401(k), it would take less than a handful of years.

Part of these rules includes the need to have an operating business to establish a self-directed 401(k). In my case, I had/have a consulting company that is an S-corporation so I was able to establish an SD 401(k).

There are many other differences between an SDIRA and an SD 401(k). For example, according to current law, an SD 401(k) requires RMD’s (required minimum distributions) starting at age 72 for both the pre-tax portion and the Roth portion, whereas an SDIRA does not have that requirement for the Roth portion until the death of the Roth IRA owner (the pre-tax portion of an SDIRA requires RMD's). Another difference is that if an SDIRA uses loans to generate profit (loans must be “non-recourse”), then the SDIRA will have to pay high “UDFI” taxes on the proportional share of the profit that was generated by the loan. An SD 401(k) does not pay UDFI taxes. There are MANY other differences between SDIRA’s and SD 401(k)’s and these examples are just a small window into the differences.

Concept #4: The Total Value of a Retirement Fund Grows MUCH Faster When You Don’t Siphon Off Money for Taxes After Every Investment

When my SD Roth 401(k) sold the single-family home rental of Investment #2 and netted $239,000 tax-free from the sale and $46,500 from 4.5 years of tax-free positive cash flow, my Roth turned around and invested $250,000 of that tax-free cash in a land development lending fund and didn’t have to siphon off a penny in taxes, legally.

In fact, the land development lending fund pays a “preferred return” of 12% plus “back end kickers” upon liquidity events (when the land developers sell the “entitled” land to home builders). That means that the $250,000 Roth investment in this fund generates AT LEAST $2,500 per month on a regular and reliable basis, which is more than double the monthly cash flow of the single-family home rental that generated the profit to buy the land development lending fund investment.

You should compare this 2-deal sequence in my SD Roth 401(k) with doing this 2-deal sequence using “regular money.” If I would have bought and fixed the distressed single-family home rental using $125,000 regular money, rented it with $46,500 of positive cash flow and sold it after 4.5 years, I would have had to pay capital gains on $114,000 of profit, plus tax on some combination of depreciation recapture and the positive cash flow. That tax would amount to tens of thousands of dollars that would be gone irreversibly and not be available for redeployment into the next investment.

I know that some of you will say that you could achieve the same using a 1031 exchange. So, let’s address that issue.

Concept #5: Tax-FREE Roth Funds are MUCH Better than Pre-Tax 401(k), Pre-Tax IRA or 1031 Exchange…Hundreds of Thousands Dollars Better on the First $1 Million

A “1031 exchange” (still allowable by law at the time of writing) is a method to legally avoid paying taxes after each real estate deal using the buy-fix-rent-sell strategy, by using the proceeds of such a real estate deal to fund the next real estate investment, subject to a variety of requirements and bureaucratic restrictions. These restrictions include the requirement to hold the property more than a year, must use a “qualified intermediary”, must complete the next investment within 180 days and more. The strategy has been referred to as “defer, defer, defer and die.” In other words, you can DEFER paying the taxes on profits from real estate deals indefinitely by doing a sequence of 1031 exchanges.

One caveat with a 1031 exchange is that you are DEFERRING taxes, not ELIMINATING TAXES (unless you die). If you want to finally cash out the last investment to get a big chunk of money so you can buy your dream yacht, you will need to pay all the deferred taxes that you didn’t pay along the journey. The more successful you are with 1031 exchanges, the more taxes you defer. So, the wealth you are building is subject to all those huge taxes you deferred and deferred and deferred!

However, there is a way to eliminate those pesky taxes after a string of successful 1031 exchanges and that is to DIE. According to current law, when you die, your heirs enjoy a “stepped up basis” as the new basis for determining the capital gains when THEY sell your 1031 exchanged real estate after you die. That saves your heirs a whole lot of money in taxes if you built a lot of equity in those properties during your lifetime.

I don’t know about you, but I have a problem with having to die to realize the tax benefit! If I work hard and work smart to build a nice nest egg by buying distressed properties, renovating them, renting them and selling them for a big profit at the end, I would like to enjoy the proceeds DURING MY LIFETIME! I love my kids but I am not willing to die just so they can minimize taxes.

When I invest my self-directed Roth 401(k) funds using the buy-fix-rent-sell strategy that generates massive profits in both income (cash flow) and growth, I can enjoy every penny of it tax-FREE after age 59 1/2 as long as my Roth was open 5 years or more. This is a RETIREMENT fund and it is intended to be enjoyed in retirement which is just fine after age 59 1/2.

What about comparing an SD Roth 401(k) to a pre-tax SD 401(k) or an SD Roth IRA to a pre-tax SDIRA?

The easiest way to explain the answer is by an example.

My pre-tax SD 401(k) bought a distressed single-family home in June 2015, renovated it, rented it and sold it to the tenants in June 2021. The total cost to purchase and repair the property was $122,000. The sale price was $208,000 with net proceeds of $207,000. The positive cash flow (after taxes, insurance, vacancy, repairs and admin costs) was $67,800. In other words, the total profit over the six years was $152,800 (125% ROI over 6 years = 14.7% per year compounded return).

How much tax would I owe if I took a distribution of the $274,800 cash that was left in the pre-tax SD 401(k) account from this one single-family home deal over 6 years? The answer is A LOT, since I would owe tax on every single penny of the $274,800. No matter how I split the distributions over a period of years, the taxes that will be paid on this $274,800 (and growing) will be many, many tens of thousands of dollars.

That is the ONLY distressed single-family home that I bought and rented in my SD 401(k). I realized that the more successful we are in investing pre-tax retirement funds, the bigger tax liability we create down the road for ourselves or for our heirs!

What should I have done before purchasing this single-family home in June 2015 in my pre-tax SD 401(k)? I should have done a Roth conversion! The cash I would have needed to raise and invest to do the Roth conversion would have paid for itself by not having to pay taxes on the $274,800 that is now in my pre-tax SD 401(k) and still growing and still creating more tax lability!

Please be aware that today (November 2021), a new law is being negotiated in Congress that, if passed, will eliminate to the ability to do Roth conversions at all income levels. So, I or my heirs, might have to live with this tax liability in the future without the ability to reduce it by Roth conversion.

Concept #6: Asset Protection Considerations

When an asset, such as a single-family home rental, is owned by a self-directed 401(k) or IRA (in the name of its custodian or trustee), it is unlikely that the asset is subject to claims brought against the beneficiary of the IRA or 401(k) except in limited cases such as the beneficiary attempting to defraud the IRS. That means that from the standpoint of the beneficiary, the ownership of real estate in the name of the custodian or trustee of the retirement plan, there is a measure of asset protection that insulates (to some degree) the equity in the real estate from personal liabilities of the beneficiary.

Of course, if someone is injured in the property owned in the name of a custodian or trustee of an IRA or 401(k), the injured person can bring a lawsuit against the owner (custodian or trustee of the retirement plan) and put the equity in the asset at risk. For that reason, the retirement plan should get liability insurance (and even umbrella insurance) for the rental home it owns.

Concept #7: Leverage and UDFI

Most money made in real estate investing is achieved by leveraging OPM (other people’s money). Self-directed IRA’s and self-directed 401(k)’s can use loans to invest in real estate. Those loans must be “non-recourse” loans which means that the beneficiary cannot be personally responsible for the loan. Such loans are not easy to get with conventional lenders, but there are lenders that specialize in making non-recourse loans to SDIRA’s and SD 401(k)’s. Such non-recourse loans require low loan-to-value (high down payment) and usually have loan minimums, unless they are made by private lenders. Such non-recourse loans for single-family home rentals by non-private lenders usually require that the homes are rented or rent ready and do not need a lot of renovation to be rent-ready. Non-recourse lenders want to see cash flow fast.

As noted above, even if your self-directed retirement plan can get a non-recourse loan, the profits that are generated from the leveraged portion of the investment are subject to tax called UDFI (unrelated debt-financed income).

Concept #8: UBIT

If a self-directed retirement plan operates a regular business, as opposed to making investments, it is likely to be subject to a hefty 37% tax called UBIT (unrelated business income tax), depending on the specifics and frequency of the business. For example, a self-directed retirement plan will be subject to UBIT if it executes in a given year many short-term deals such as many house flips (buy-fix-sell), wholesales many contracts for the purchase of houses, quick flips many notes and other high-volume deals related to real estate. You should consult with a tax attorney who specializes in SDIRA’s/SD 401(k)’s to learn how many such deals are considered acceptable as not being conducted as a regular business. Long-term single-family home rentals, shares in private placement apartment syndications managed by others and many other investments are considered “investments”, not “operating businesses.”

One must be very careful listening to gurus who promote doing 10 wholesale deals per year in a SD Roth retirement plan without paying any taxes. Tax experts specializing in SDIRA’s will likely tell you that is an “operating business,” not an “investment” and as such subject to UBIT. There are ways to minimize the taxes paid on operating businesses (such as a restaurant for example) owned by a self-directed retirement plan, but you need to consult tax attorneys who specialize in such strategies. Contact me offline if you want a reference to such tax attorneys with that specialized expertise.

The major reason that I built my SD 401(k) doing only 1-2 real estate deals per year was my personal desire to be a part-time investor with minimal effort limited to “finding ‘em and funding ‘em.” A side benefit of never doing more than one flip in any year in my SD 401(k), none in most years, is that my retirement plan was not conduct a regular business.

These are the concepts I used to build my self-directed 401(k) to more than $1 million, most of which are tax-free Roth funds, with relatively low-risk investments and only make 1-2 investments per year, without driving myself crazy.

If you want to learn more about how to be a successful part-time investor like me, buy my 25-hour Smarter Investing Home Study Course. Contact me about any discounts that are offered from time to time.


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