Non-Recourse Loans in a Self-Directed IRA to Buy Real Estate
As a result of my upcoming wedding, I’ve been meeting a lot of soon-to-be in-laws who are interested in what I do. After overcoming the initial surprise that it’s possible to invest in alternative assets such as real estate and private companies with your IRA, their next question often is whether your IRA can purchase real estate with a mortgage. The short answer is, yes; the longer answer requires further explanation.
Not quite. An investor might be able to use a non-recourse loan to finance the purchase of investment property in their IRA. After making a down payment for the investment property from your IRA, your IRA might be able to borrow the balance of the purchase price using a non-recourse loan (NRL) from a non-recourse loan lender. With an NRL, the bank can only recoup the underlying property in the event of a default, and not the assets of the IRA itself.
An NRL is paid down with payments made from your IRA cash balance. At your direction, your IRA custodian will pay down the principal and interest according to the terms of the loan, decreasing the amount of the liability in your IRA account as the principal decreases.
There are a few considerations to be aware of regarding an investment strategy like this: First, most lenders might require a substantial down payment (30%-40% in many cases). For example, a $100,000 property might require a $40,000 down payment from the IRA, with the non-recourse lender loaning the remaining $60,000. Also, your IRA will need to have additional income (e.g., property rental income) or contributions to make future payments on the NRL.
Something else to consider with these debt-financed real estate transactions is the possibility of Unrelated Debt Financed Income (UDFI), a sub-section of Unrelated Business Taxable Income (UBTI). If UDFI tax is owed, you are responsible for paying the taxes and ensuring your IRA files IRS Form 990-T. PENSCO works with many clients whose IRAs file 990-T and pay taxes each year.
PENSCO strongly encourages working with tax, legal or investment professionals to determine whether such a strategy as this fits your circumstances. Download our guide for more information about holding real estate in your IRA.
This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.
PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. PENSCO is indirectly affiliated with a registered broker dealer and with a licensed small business investment company through Opus Bank (“Opus Affiliates”). Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.
Editor’s Note: This is an updated version of a post we originally published in September 2014. We welcome new comments and questions below.