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Many self-directed IRA owners invest in real estate with their retirement funds, but not all IRA owners have enough cash in their account to purchase a property outright. Luckily, this lack of cash doesn’t necessarily mean the end of a deal. Instead, self-directed IRA owners may apply for a non-recourse loan to finance the purchase of an investment property.

What is a non-recourse loan?

In general, there are two types of loans – recourse loans and non-recourse loans.

A recourse loan favors the lender and provides the lender with “recourse” if a borrower defaults on the loan. If money is still owed to the lender after the collateral is collected, a recourse lender may seize additional assets owned by the borrower, such as bank accounts.

A non-recourse loan works differently and favors the borrower. With a non-recourse loan, the lender can recoup only the loan’s underlying collateral in the event of a default, not the borrower’s additional assets.

When using a non-recourse loan to buy real estate with a self-directed IRA, the loan is taken out in the name of the IRA—not the IRA owner. If the IRA defaults on the loan, the lender can seize only the property in the IRA that was used as the loan’s collateral. A non-recourse lender cannot legally pursue additional assets owned by the account holder or the IRA. This is why non-recourse loans are attractive for IRA investors. 

What type of down payment is required with a non-recourse loan?

Given the risk involved with these loans, most lenders require a substantial down payment—often 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. 

Your lender will likely also want to ensure your IRA has a source of income, such as rental property income, to contribute to future loan payments.

How are non-recourse IRA loan payments made?

You must make loan payments from your IRA’s 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. 

Given this, you need to ensure your IRA has ample cash to cover not only your loan payments, but also any other costs related to the real estate investment, such as closing costs, property taxes, or ongoing maintenance. 

Are there tax implications when using a non-recourse loan to buy real estate in an IRA?

Debt-financed real estate transactions within your IRA trigger the possibility of Unrelated Debt Financed Income (UDFI), a sub-section of Unrelated Business Taxable Income (UBTI). If your IRA owes UDFI tax, you are responsible for ensuring your IRA files IRS Form 990-T and paying the taxes. At Pacific Premier Trust, we work with many clients whose IRAs file 990-T and pay taxes each year.

Because of the complexity of real estate investing and UDFI, we highly recommend that you consult a tax, legal, and/or investment professional to assess your unique situation.

Editor’s Note: This is an updated version of a post published in May 2017. We welcome new comments and questions below.

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.

Pacific Premier Trust (formerly 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. Pacific Premier Trust is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.

NOT FDIC-INSURED | NO BANK GUARANTEE | MAY LOSE VALUE