solo 401k - pay cash or finance real estate

[JC Conchas]

BP, I'm in the process of setting up a solo 401k. Does it make sense to pay cash for small 6 unit MF rental, or should I get a commercial loan? After speaking with some lenders, most commercial loosens are max of 60% LTV, because they must be non-recourse loans. Since the property will be in a solo 401k, I don't have any benefit of using mortgage interest or depreciation for that matter, on my taxes. Should I pay cash for a property, thus maximising the account growth, because most of the rental income will grow the account faster? no loan to pay back. if I finance the purchase I could buy two or three properties, but lower cash flow, since I'll have loans to pay... I'm stuck. can't decide one way or the other. I feel the analysis paralysis closing in on me... JC

[Brian Eastman]

@JC Conchas

The use of leverage in a Solo 401(k) can, if well deployed, be a path to building wealth faster.  As with all things investing, however, it is a matter of risk vs reward.

With an all cash purchase, there is less risk, as there is no mortgage to pay each month.

With a mortgage, the Solo 401(k) has the obligation to pay the mortgage whether there is a tenant paying rent or not. As such, you should retain a reasonable amount of 401(k) capital in reserves in some form of cash or semi-liquid investment.

The use of mortgage financing, however, should allow for a higher cash-on-cash return.  You may not see it directly in immediate cash flow, but the income will be purchasing additional equity in the properties as you pay down principal on the note(s).

Here is a basic Investopedia article on the topic of leverage:

https://www.investopedia.com/articles/mortgages-re...

While your statement is correct that the 401(k) will not have the benefits of deductions like depreciation, that is because the rental income is not being taxed in the first place since it is fully tax-deferred within the plan.  No taxes = no need for write-offs.