Self-directed IRAs allow you to invest in a wide variety of alternative assets, including real estate. Ideally, when you purchase property through your IRA, you do so using the funds available. But what if you don’t have enough money saved to take advantage of a real estate investment opportunity? A self-directed IRA non-recourse loan may be the answer.

How Does a Non-Recourse Loan Work in an SDIRA?

A self-directed IRA non-recourse loan is a special type of financing that allows you to purchase property if you don’t have enough funds in your IRA. These loans leverage the property as collateral instead of your personal belongings, such as your primary residence, vehicle, or savings account. As such, they offer a limited liability solution that keeps your IRA investment separate from your personal assets.

When you’re ready to purchase a property, you must apply for a non-recourse loan with a lender specializing in this type of financing.

Self-directed IRA non-recourse loans present a greater risk to lenders and are often harder to obtain than traditional loans. If approved, the loan is issued to your IRA, not you.

How Do Non-Recourse Loans Differ from Conventional Loans?

The primary difference between a non-recourse loan and a conventional loan is what happens if you can’t meet your payment obligations.

If you fail to meet non-recourse loan repayment obligations, the lender’s only option is to seize the property for which the loan was issued. Since the lender issued the loan to the IRA, the lender can’t move to seize other assets owned by the IRA holder.

Suppose you fail to meet conventional loan repayment obligations, the most common type of mortgage in the United States. In that case, the lender can seize your personal assets and the property. For instance, if the property’s value exceeds the outstanding loan balance, the lender can take legal steps to garnish your wages.

Non-recourse IRA loans and conventional loans also differ in the following ways:

• Conventional loan eligibility relies heavily on your credit score, whereas non-recourse scores issued to an IRA do not depend on the account holder’s credit score.
• Therefore, requirements are typically stricter for non-recourse loans, with some lenders requiring between 30% to 50% or more of the property value.
• Non-recourse loans have strict eligibility requirements regarding the property. For instance, the property must have been constructed after 1940 and cannot share a roof with another property.
• Because non-recourse loans carry more risk for the lender, they generally have higher interest rates than conventional loans.

Benefits of a Non-Recourse IRA Loan for Real Estate

Real estate can present a promising opportunity if you’re looking to bolster your retirement savings.

• It makes investing in property easier even if your IRA funds can’t fully cover the investment. When you purchase property with your IRA, you cannot leverage personal funds to complete the transaction. IRA non-recourse loans help bridge the gap between your investment account balance and the purchase of a real estate property.
• Allow you to grow your self-directed IRA account. A non-recourse loan can jump-start your saving efforts because you don’t have to wait for your IRA to hold enough funds to purchase a property outright. For instance, if you are buying a property using a non-recourse loan, you can later flip the property, pay off the loan, and deposit the remaining earnings into your IRA account, where they will grow tax-free.
• Provides asset protection. An SDIRA non-recourse loan is tied to your IRA and the property for which it was issued. If you fail to repay the loan, the lender’s only recourse is to seize the property. They cannot go after your personal assets.

Avoiding UBIT and UDFI

Despite the benefits of an SDIRA non-recourse loan, two minor drawbacks can occur: unrelated business income tax (UBIT) and unrelated debt-financed income (UDFI).

In many cases, UBIT is not applied to real estate earnings held in an SDIRA. However, UBIT frequently comes into play when unrelated debt-financed income comes into play. If you use a non-recourse loan to purchase property, you’ll owe UBIT on a portion of the earnings relative to the portion you financed.

If you want to invest in real estate but avoid UBIT, there are a few options to consider:

• Roll funds from other investment accounts into your SDIRA. If you have another retirement, such as a 401(k), consider rolling some available funds into your SDIRA to avoid a non-recourse loan.
• Partner with another SDIRA holder. If you can find another SDIRA holder to invest with, you can avoid getting a non-recourse loan and thus avoid debt-financed income from the property.
• Consider loans and liens before investing directly in property. Loans and liens allow you to invest in real estate without making the upfront investment required to purchase property. The earnings from these assets can then be used to buy property in the future.
• Use other IRA investments to quickly paydown the non-recourse loan, thus decreasing or eliminating the amount or duration of UBIT.

How to Get Started with a non-recourse IRA Loan

If you want to leverage a non-recourse loan to purchase property, these steps can help you get started:

1. Open a self-directed IRA. A standard IRA does not allow you to invest in real estate. Only SDIRAs allow you to invest in alternative assets, including real estate, mortgage notes, and liens.
2. Find a property to invest in. SDIRAs can hold several types of property, including residential and commercial properties and raw land.
3. Research lenders that offer recourse loans. Not all lenders provide non-recourse loans, and some lenders have different requirements, including down payment requirements.
4. Apply for the loan. Review all lender requirements to improve your approval changes and ensure the loan process happens as quickly as possible.
5. Work with your custodian to complete the process. Your custodian can help you complete the purchase process or, if you have checkbook control, answer any questions you may have about the process.

FAQs

Are there any limitations on the types of properties I can purchase with a non-recourse loan?

In general, a non-recourse loan can be used to purchase residential and commercial properties and land; however, some lenders may restrict the type of property for which they will issue a non-recourse loan.

Non-recourse loan restriction can be based on the type of property as well as the condition of the property. For instance, a lender may not issue a non-recourse loan for a property that is a certain number of years old, in poor condition, or is not a standalone structure.

Always check with your lender to determine property restrictions related to a non-recourse loan.

How does the repayment process work for non-recourse loans?

When you take out a non-recourse loan, your lender will stimulate the repayment terms, including interest, repayment period, and repayment schedule. Like a conventional loan, payments include principal and interest. However, non-recourse loans generally have shorter loan terms, though terms will vary by lender.

What happens if I default on a non-recourse loan?

If you default on a non-recourse loan, the lender can seize the property. They can then sell the property and use the proceeds to recoup their losses. Because a non-recourse loan is secured by the property and issued to the IRA, the lender cannot go after your personal assets.