How To Use a Loan With Your Self-Directed IRA To Make Investments

Hey, you may or may not know this already. But your Self-Directed IRA is the ultimate retirement solution. A whole world of profitable investment opportunities is just waiting for you.

Think of your Self-Directed IRA as a "retirement investment vehicle" that allows you to invest your retirement funds in almost anything, even real estate. The best part? This is all tax free, and you don't need a custodian. That means you don't have to pay those costly custodian fees.

Why Would You Need a Loan in the First Place?

Most investors using retirement funds to make an investment will use cash to make their investment. Whether the investment is in the form of stocks or real estate, most investors will not borrow any funds to make an investment.

One significant reason why retirement account investors will generally not borrow money (also called debt or leverage) as part of an investment of real estate acquisition is the IRS. (Surprised?)

Internal Revenue Code Section 4975 prohibits the IRA holder (you) from personally guaranteeing a loan made to your IRA.

What about self-directed ira real estate loans? So in the case of a Self-Directed IRA, you could not use a standard loan or mortgage loan as part of an IRA transaction since this would trigger a prohibited transaction pursuant to Code Section 4975. (Which is bad.)

What it comes down to is this.:You can't get a "normal'" loan with Self-Directed IRA. This leaves you, the empowered Self-Directed IRA investor, with only one financing option...a non-recourse loan.

What Is a Non-Recourse Loan?

A non-recourse loan is a loan that is not guaranteed by anyone. Sounds crazy right? Basically the lender is securing the loan by the underlying asset or property that the loan will be used for.

So if you, the borrower, are unable to repay the loan, the lender’s only recourse is against the underlying asset (i.e. the real estate) not you. Hence the term "non-recourse".

Non-recourse loans are  more difficult to secure than a traditional loan or mortgage. There are a number of reputable non-recourse lenders. However, the rate on a non-recourse loan is less slightly higher than a traditional loan.

What Are The IRS's Rules For Non-Recourse Loans?

The IRS allows IRA and 401k plans to use non-recourse loans for financing only. The rules covering the use of non-recourse financing by an IRA can be found in Internal Revenue Code Section 514.

Section 514 requires debt-financed income to be included in unrelated business taxable income (UBTI or UBIT), which generally triggers close to a 40% tax for 2017.

If non-recourse debt financing is used, the portion of the income or gains generated by the debt-financed asset will be subject to the UBTI tax, which is generally 40% for 2017.

For example, if an individual invests 70% IRA funds and borrows 30% on a non-recourse basis, 30% of the income or gains generated by the debt financed investment would be subject to the UBTI tax.

Which means if a Self-Directed IRA investor such as yourself invests $70,000 and borrows $30,000 on a non-recourse basis and the IRA investment generates $1,000 of income annually, 30% of the income or $300 would be subject to the UBTI tax.

Note: There are ways to reduce the $300 base tax.

How to "Escape" UBTI/UBIT Tax

Here's another great reason why the Solo 401k Plan is such an attractive investment vehicle.

If you use non-recourse financing to invest in real estate through your Solo 401k Plan, you will "escape" UBTI/UBIT tax due to an exception. This exception can be found in the Unrelated Debt Financed Income (UDFI) rules found under IRC 514(c)(9).


Last Updated: 
October 22, 2017

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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