How Your IRA Can Get A Loan To Buy Real Estate
You may be familiar with the fact that your IRA (while keeping its tax advantages), can buy and sell real estate to create earnings by investing in real estate with your IRA, but you may feel like your account doesn’t have enough money in it to make a purchase. Don’t worry… learn how to build a real estate portfolio and how your account can get a loan to purchase that real estate. That’s right! The IRS allows your IRA to make money using other people’s money!
An IRA as a borrower – what you need to know
An IRA is actually a legal and financial entity that is separate you’re your personal finances. You make the decisions for the account, but because the IRA has different tax status than your personal finances, it invests separately from you personally. When your IRA borrows money for a real estate purchase, you (and other disqualified persons) may not pledge your personal assets as collateral for the loan. Therefore, loans to IRAs are often termed “non-recourse” loans in that, should your IRA default on the loan, the lender cannot come after your personal assets for remuneration. In most loan scenarios, this means that the lender will ask for a higher down payment than a loan that has recourse to your personal assets. Thirty to forty percent down is not unusual; however, the IRS does not regulate this type of loan. Terms are negotiated between the IRA holder and the lender and those terms can vary widely. It is a good idea to shop and compare.
For example, let’s say your IRA wants to purchase a $100,000 property, and let’s say that a lender will loan your IRA $60,000 on that property. Your IRA would need to come up with $40,000 cash for the closing. Once the closing has taken place, your IRA owns the property and is entitled to the entire cash flow from rent as well as all proceeds from sale! Now, your IRA (the owner of the property and the borrower of $60,000) does need to pay debt service. Typically, rent gets paid to your IRA cash position, and, out of that cash flow, the debt service is paid. In fact, your IRA operates just like any other real estate investor taking in rent and paying out for expenses, except that it has the tax advantages of the account type.
Is this type of IRA investing a good deal?
Taking on debt is often cited as a way to increase buying power and “cash on cash” return. And keep in mind that if you are not taking distributions from the account (often the case for someone under the age of 59.5), you may not care about cash flow in the short run. This may allow you to be more aggressive leveraging the amount that you do have in your IRA. A chat with your CPA and/or financial team may help determine your strategy.
UBIT (Unrelated Business Income Tax)
When calculating your ROI on an IRA investment like this, remember that UBIT may come into play. UBIT is a tax that your IRA (not you personally) pays to the IRS on the net profit associated with the outstanding debt percentage. It is a cost of doing business when your IRA is earning returns from borrowed money. There are specific rules related to UBIT that can help you pay less; so, do familiarize yourself with the particulars.
Don’t feel left out if your IRA doesn’t have the full purchase price of a property! Your account may very well be able to borrow the balance and start creating returns for your retirement savings today.