Investing your retirement funds in real estate is a great way to diversify your portfolio for retirement. Sadly, not all investors have enough funds in their retirement accounts to purchase a real estate property outright. The Good news is that does not mean that you still can't purchase real estate through your retirement account.
While it is a bit more difficult you can still purchase real estate through your retirement account without having 100% of the money by using a non-recourse loan. What is a non-recourse loan? In terms of a real estate non-recourse loan a non-recourse loan means that the borrower is not personally liable. If the borrower defaults on his loan the lender/issuer (typically bank) can seize the collateral, but the lender's recovery is strictly limited to the collateral.
In general, a non-recourse loan is more difficult to come by. Only certain banks will allow for these types of loans and most lenders require a substantial down payment of around 30%-40%. The bank is taking on much more risk doing a non-recourse loan and thus requires the heftier down payment.
One important thing to note when doing a loan through your IRA is that payments are paid through your IRA cash balance. You need to make sure your IRA account has enough cash inside the account to be able to pay the monthly payments. If you have a rental property the money made on the rental goes back into the IRA account and that can be used as the funds to pay the monthly payment. You cannot use your own funds to pay off the monthly payment, again everything has to come from the IRA account.
While investing with an IRA may sound tricky it really isn't as long as you follow the rules to investing with a self directed IRA.
Another thing to be aware of when getting a loan with a bank or anyone through your IRA you are subject to Unrelated Debt Financed Income, also known as UDFI. It applies to any income that was generated by a property that was partially financed by debt. For example, if 60% of your initial purchase was financed than 60% of the earnings would be subject to UDFI taxes. This percent will continually change each year as you are paying down the percent that is financed by debt. The best advice would be the quicker you can pay off that loan the better because you then wouldn't be subject to UDFI. This also applies if you sell the real estate and make a profit and a percent was financed. Whatever your percent finnaced that same percent would be subject to UDFI.
These are just a few of the examples or reasons UDFI may need to be paid but there are also reasons it may not need to be paid. Because of this, and the fact that your situation is unique, it is very important to consult a tax or legal professional for help with your situation.
Contact us today for more information about investing with your IRA.
Author: Nick Barker