Investing your retirement funds in real estate is a great way to diversify your portfolio for retirement. Sadly, not all investors have enough funds to purchase a real estate property outright in their retirement accounts. This does not mean you still can’t buy real estate through your retirement account.
What is a non-recourse loan?
While it is a bit more complicated, you can still purchase real estate through your retirement account without having 100% of the money through a non-recourse loan. This makes it possible for those who are looking at financing real estate with self-directed IRA but don’t have all the capital.
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 a 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 an investment property, the money made on the rental goes back into the IRA account, which can be used as the funds to pay the monthly payment. You cannot use your funds to pay off the monthly payment. Everything has to come from the IRA account.
Get more in-depth information about non-recourse loans with your IRA.
Non-recourse Loan Rules with your IRA
While investing with an IRA may sound tricky, it isn’t as long as you follow the rules of investing with a self-directed IRA.
Another thing to be aware of when getting a loan with a bank or anyone through your IRA is that 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 you invested 60% of your initial purchase, then 60% of the earnings would be subject to UDFI taxes. This percent will continually change each year as you pay down the percent financed by debt.
The best advice would be that the quicker you can pay off that loan, the better because you wouldn’t be subject to UDFI. This also applies if you sell the real estate, make a profit, and finance a percentage of the purchase. Whatever your percent is financed, that same percent would be subject to UDFI.
These are just a few examples of reasons UDFI may need to be paid, but there are also reasons you won’t need to pay it. Because of this and your unique situation, it is essential to consult a tax or legal professional for help with your situation.
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