Financing with non-recourse loans in an IRA
Non-recourse loans are used and required by the IRS when your IRA uses financing to invest in real estate. A non-recourse loan is typically secured by collateral (real property) and neither the IRA nor the account owner personally guarantees repayment of the loan. If there is a default, the lender’s only option would be to foreclose on the underlying collateral.
Non-recourse loans are used because IRS Section 4975 prohibits you from obtaining financing for your IRA by using your personal credit for the benefit of the IRA. This prohibition extends to any disqualified individuals as well. Many lenders shy away from this type of lending, but there are a few national lenders that work with IRAs in this situation.
Understanding UDFI Tax
If your real estate IRA acquires non-recourse loans to help purchase investments, it’s important to understand the account may be subject to unrelated debt-financed income (UDFI) tax, per IRC 514. This tax applies to any financed asset held in the IRA, even if the IRA is not the entity applying for the financing. If your IRA invests through an LLC or partnership that owns financed real estate, your IRA may still subject to UDFI tax on any income it receives.
Note: Qualified plans, like the individual 401(k) plan, do not pay UBIT or UDFI.