Self-Directed IRA for Real Estate

If you have enough funds in your Self-Directed IRA to cover the entire real estate purchase (including closing costs, taxes, fees, insurance, etc.) you may make the purchase outright using your Self-Directed IRA. The real estate investment can made via a full-service self-directed IRA or a self-directed IRA LLC. All income or gains relating to your real estate investment must return to your Self-Directed IRA.

Learn More: What is a Self-Directed IRA LLC?

If you don’t have sufficient funds in your Self-Directed IRA to make a real estate purchase outright, your Self-Directed IRA can purchase an interest in the property along with a family member who is a non-disqualified person. You can also purchase with a friend, or colleague. The investment will not be made into an entity owned by the IRA owner. Instead, it’s invested directly into the property.

For example, your Self-Directed IRA can partner with a non-disqualified family member, friend, or colleague to purchase a piece of property for $150,000. Your Self-Directed IRA can purchase an interest in the property (for example, 50% for $75,000) and your family member, friend, or colleague can purchase the remaining interest (50% for $75,000).

All income or gain from the property will allocate to the parties in relation to their percentage of ownership in the property. Likewise, all property expenses must be paid in relation to the parties’ percentage of ownership in the property.

Based on the above example, for a $2,000 property tax bill, the Self-Directed IRA will be responsible for 50% of the bill ($1,000). The family member, friend, or colleague is then responsible for the remaining $1,000 (50%).

Nonrecourse Loan

One question we are frequently asked is, “Can an IRA get a mortgage or loan?” A real estate IRA or Self-Directed IRA can absolutely get a loan. The process of qualifying for a loan inside an IRA is called non-recourse financing.

A nonrecourse loan is a loan that is not personally guaranteed by the borrower.  In the case of a self-directed IRA, IRC 4975(c) does not allow an IRA owner to personally guaranty an obligation of an IRA, This is the reason why an IRA can only use a nonrecourse loan to acquire real estate.

Because a nonrecourse loan does not include a personal guaranty, the lender is essentially taking on a greater level of risk.  The only recourse the lender would have for a default in payment is to take back the underlying property since there is no personal guaranty.  Hence, most nonrecourse lenders will require a higher level of equity, technically at least 30%.  In addition, the interest on the loan is typically higher on a nonrecourse loan.

UBIT

In general, when it comes to using a retirement account to make investments most investments are exempt from federal income tax. This is because a retirement account is exempt from tax pursuant to IRC Sections 401 and 408.  IRC Section 512 of the Internal Revenue Codes exempt most forms of investment income generated by an IRA from taxation. Some examples of exempt type of income include interest from loans, dividends, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate. Whereas the type of income that generally could subject a retirement account to UBTI is income generated from the following sources:

• Income from the operations of an active trade or business – i.e. a restaurant, gas station, store, etc.
• Business income generated via a passthrough entity, such as an LLC or partnership
• Using a nonrecourse loan to purchase a property (in the case of an IRA)
• Using margin on a stock purchase

When a debt-financed asset is sold, a special rule applies for the purpose of calculating the taxable gain. In general, the IRA would be subject to a UBIT tax of up to 37% on the debt financed portion of the income or gains attributable the loan above $1000. The UBIT taxed is paid by the IRA on form 990-T.  IRA financial will assist the IRA owner in completing and filing IRS Form 990-T.

Note – there are several ways to reduce the impact of the UB IT tax, such as a C Corporation blocker.  IRA Financial has significant experience in structuring self-directed IRA real estate transactions that minimize the application of the UBIT tax.