Most investors know you can use a Self-Directed IRA to buy real estate. What surprises many is that your IRA does not always have to pay all cash. Under the right circumstances, your IRA can borrow money to acquire property, which opens the door to larger or more lucrative deals.
Here’s what you need to know about financing real estate inside an IRA.
Your IRA Can Borrow with a Non-Recourse Loan
An IRA is legally a trust, and like other legal entities, it can borrow money. The key difference is that your IRA cannot pledge your personal credit or guarantee the debt. That is where a non-recourse loan comes in.
With a non-recourse loan, the lender’s only recourse in the event of default is to take back the property itself. They cannot pursue your personal assets or other funds in the IRA. This protects you, but it also means these loans are more specialized and often require larger down payments.
Why Use Financing in an IRA
Using financing allows your IRA to increase purchasing power and acquire properties that might otherwise be out of reach. It can also help magnify returns when property values or rental income rise. Another benefit is diversification, since borrowing may allow your IRA to buy more than one property and spread risk across different assets.
Understanding UDFI Taxes
When your IRA uses borrowed money to buy property, part of the income may be subject to a tax called Unrelated Debt-Financed Income, or UDFI.
The portion of the income that comes from borrowed funds is taxable, even inside the IRA. For example, if your IRA purchased a rental property with 50 percent financing, roughly half of the net rental income could be subject to UDFI. This tax is reported on IRS Form 990-T and must be paid directly from the IRA.
Although this adds complexity, many investors find that the overall return potential still outweighs the tax cost.
What Lenders Consider
Since you cannot personally guarantee the loan, non-recourse lenders place greater emphasis on the property itself and the IRA’s financial position. They will look at the property’s income potential, the size of the down payment, and the IRA’s liquidity and reserves. Typically, down payments of 30 to 40 percent are required.
Practical Example
Suppose your IRA has $100,000 in cash. You find a $200,000 rental property that generates steady income. With a 50 percent down payment and a non-recourse loan for the balance, your IRA can now control an asset worth twice what it could have purchased with cash alone. This may potentially double long-term growth.
Key Takeaways
Your IRA can borrow using non-recourse financing, but never with your personal credit. Expect higher down payments, plan for UDFI taxes, and work with professionals who understand the rules. Financing inside an IRA can be powerful, but it adds complexity, so careful planning is essential.
The Bottom Line
Financing real estate through a Self-Directed IRA is not for everyone, but it can be a powerful tool when used wisely. By combining retirement funds with a non-recourse loan, your IRA may be able to access bigger opportunities, diversify holdings, and potentially accelerate growth while keeping investments in an area you know and understand best: real estate.