How to invest in Madrid real estate via your solo 401(k) plan
Many people are generally unaware of this, but you can invest in a number of assets through a self-directed retirement account. This includes Madrid real estate! There are two types of self-directed retirement accounts that you can use to invest in real estate: a solo, or “checkbook”, 401(k) or a self-directed IRA. This article will focus on investment through solo 401(k) plans, and a following article will focus on investment via self-directed IRA’s.
What is a solo 401(k) plan?
Solo 401(k)’s are retirement plans for self-employed individuals or business owners without any full-time employees other than a spouse. A checkbook 401k enables you to invest in real estate via rental property and house flipping while still receiving the tax advantages of traditional 401(k)’s.
Remember: You must be a business owner or have self-employed income and can’t have any employees who work 1,000+ hours a year to qualify.
What are the advantages of solo 401(k) plans vs. self-directed IRA’s?
In short, solo 401(k) plans are better for the self-employed. Self-directed IRA’s do not require self-employment. Solo 401(k) plans also have the following advantages/differences:
- A solo 401(k) allows for checkbook control from the outset. To gain checkbook control with a self-directed IRA, you must first set-up a limited liability company (Self Directed IRA LLC). “Checkbook Control” is the term used when a self-directed IRA owner has complete signing authority over an account that gives access to his/her retirement funds.
- A solo 401(k) allows for much higher annual contributions than a self-directed IRA. In 2018, the IRS allows those under 50 years old to make total contributions of $55,000 into their solo 401(k) plans. This contrasts with $5,500 for self-directed IRA’s- ten times the amount!
- This isn’t directly applicable for real estate investment, but solo 401(k) plans may invest in life insurance. Self-directed plans are not allowed to invest in life insurance products.
- The solo 401k business owner can serve as trustee of a solo 401k. The owner of a self-directed IRA cannot serve as a trustee of their plan. They must appoint a custodian or bank.
- A solo 401(k) allows for personal loans, which are rather unimaginatively called 401(k) loans. It is prohibited to borrow from self-directed IRA accounts.
- There are some differences with Roth accounts. Mainly, Roth solo 401(k) funds are subject to RMDs (requirement minimum distributions). Roth IRA funds are not subject to requirement minimum distributions. Therefore it might be advantageous to transfer Roth solo 401(k) funds to a Roth IRA before turning age 70 ½ in order to escape the Roth RMD requirement applicable to Roth 401k contributions.
- No surprise here: they use completely different tax forms. Why would the IRS make it easy?
So I want to purchase Madrid real estate through a solo 401 (k). What are the next steps?
Moving2Madrid has a client that is, to our knowledge, the first person to invest in Madrid real estate through a solo 401(k) plan. Our lawyers have helped her to learn how to do this, and we are now well-versed in the procedure. Please arrange a free consultation if you would like to speak to one of our property specialists about this process.
Step 1: Open a solo 401(k) account
This can be done through many online brokers. Make sure you have an Employee Identification Number (EIN) before you do this. We recommend going through a reputable broker such as TD Ameritrade, Merrill Edge, Fidelity, Vanguard or Charles Schwab. Here is a link to a reputable third-party blog that compares the different online brokers.
Step 2: Make sure your 401(k) plan documents allow you to invest in real estate
If they do not, you need to have your plan documents amended to invest in real estate. In our experience, it is easiest to get a plan company such as Broadband to do this for you.
Step 3: Determine if you want to set-up a US pass-through company (LLC or S-Corp, although an LLC is easier) to purchase the real estate, or if you want to do it yourself.
There is more paperwork involved if you do it through a US pass-through company, but we understand there is less risk of an IRS audit if you do it this way.
Step 4: Identify how to manage the future revenue stream for your Madrid property investment
This is an important point because neither you, nor your dependents, can live in a property purchased via a solo 401(k), or self-directed IRA. You also can’t rent it short-term. Our suggestion is to find a legal entity in Madrid to lease the apartment to on a yearly basis, let them manage the rental property for you and each month, send the proceeds to your solo 401(k). This is important because the IRS needs to see proceeds from the investment flowing back into your 401(k) each month.
To learn more about your rights as a landlord in Madrid, and the difference between long and short term leases, we suggest you read Renting property in Spain.
Step 5: Contact Moving2Madrid and start your apartment search
CONTACT US TODAY for a free consultation and to get your search started.
Step 6: Plan your apartment shopping visit to Madrid
Moving2Madrid will work with you, interactively, to develop a short-list of properties for you to see over the course of a couple of days. When this list has been established, you will need to buy a ticket and come to Madrid. To learn more about what your search will encompass, please read What to expect during your Madrid apartment shopping experience.
Step 7: Figure out how you will buy euros, set-up an account and fund it
Once you have determined your budget, you will need to set up a foreign exchange account and fund it. We recommend opening an exchange account with Currencies Direct as they provide excellent, personalized service. Using a dedicated exchange broker will save you 3+% versus letting your bank handle the foreign exchange.
Currencies Direct’s rates are, on paper, are a little more than the purely online Transferwise. However, we have a relationship with a currency broker from Currencies Direct who will match any rate quoted by Transferwise for Moving2Madrid customers.
When you come to Madrid and select your property, you will enter into a Contrato de Arras. This just means you place an initial offer on the apartment. When you do this you will need to put down at least 10% as a down payment. So it’s best to have purchased euros and be ready to make that deposit when you make the offer. This will save you a lot of stress. Moreover, if you take your time, you can wait to get a preferential exchange rate. This could save you tens of thousands of dollars, given the current volatility in global exchange rates.
Step 8: Select your property
Your personal property shopper will show you a number of properties. When you see them all, make a selection!
Step 9: Make an initial offer
As mentioned above, this is when you enter into a Contrato de Arras. When you enter into this offer, you will need to make a down payment of 10%.
Step 10: Set-up a Spanish company.
Your solo 401(k) or the US company you set-up to pass the transaction through (see Step 3 above) will purchase your property through this new Spanish company. Why create a Spanish company to purchase your property? Because it will save you up to 45% on Spanish real estate taxes.
Step 11: Sign the closing documents and get your keys!
Step 12: Plan your renovation
The best way to make money on your property investment is to buy a place that is in need of refurbishment. We at Moving2Madrid have found that every 1€ spent on refurbishment yields 1.5€ in return.
Moving2Madrid is dedicated to making your Madrid apartment shopping experience as smooth as possible. Moroever, we want to make it as tax efficient as possible. Contact us today to learn more about purchasing a Madrid investment property through your solo 401(k) plan.