It’s a stubborn myth that you can’t borrow money within your IRA. The fact is that there is nothing in the law that makes it illegal to lend or borrow money using a Self-Directed IRA or any other type of IRA or retirement account. Many of our clients have successfully taken out mortgages to buy real estate within their Self-Directed IRAs for many years.
So relax. You can use your IRA to borrow money for investments within your Self-Directed IRA account. However, there are rules you should be aware of. Read this over before you sign any kind of note!
- You cannot borrow money from yourself. As the IRA owner, you cannot sell to or lend to your IRA directly. Nor can you lend to it or buy assets from it. By extension, the same applies to any entities (corporations, LLCs, trusts, etc.) that you control. This would create a conflict of interest for your IRA, which was created to provide for your financial security in retirement, not to be a cash flow device for you, or be a financial plaything, before you reach retirement age. Congress specifically wrote in laws prohibiting these kinds of conflicts of interest.
- Understand prohibited counterparties. Just as your IRA cannot transact with you or any entities you control, it also cannot transact business directly with your spouse, nor your descendants or ascendants, or those of your spouse. The same applies to any entities they control. This means that your IRA may not borrow directly from these persons. However, the law does not currently restrict your IRA from transacting with siblings, aunts, uncles, nieces and nephews.
- The loan must be in your IRA’s name. The check from the lender should be made out to the IRA itself, not to you, personally. If it’s a wire transfer, the wire transfer should go directly to the IRA, via American IRA, LLC. If you have questions about structuring the transaction, call us immediately at 866-7500-IRA before going forward with it. If you don’t do this properly, you could be facing significant taxes and penalties.
- You can’t sign a personal guarantee. No matter what an overeager mortgage lender may tell you, you cannot sign a personal guarantee of any loan to your Self-Directed IRA. You also may not pledge any collateral from outside your IRA. Generally, the loan must be against the property being purchased.
- You can’t pay off the loan with personal funds. All mortgage payments must come from within your IRA, and not from your personal bank account. Be sure to maintain enough liquidity within your IRA that you are able to make the mortgage payments.
- The debt must be non-recourse. This means that in the event of default, the lender cannot come after you, personally, to make good on the debt. Any collateral or security must come entirely from within the IRA.
In practice, this makes your own personal income and credit history irrelevant for the purposes of IRA lending. The loan is based on the security of the asset being purchased, not your future income.
This also means that lenders will expect you to have more skin in the game than they would on loans underwritten based on your income. Only a few major lenders are active in the Self-Directed IRA market. Most of them will finance about 65 percent of a purchase, maximum. For condominium investments, they will usually only finance a maximum of about half of the investment.
Rates are higher. Expect to pay about 1 to 2 percent more for mortgages on IRA investments than you might pay on them outside of your IRA, though this varies.
Understand Unrelated Debt-Financed Income Tax. In Self-Directed IRAs, income and capital gains tax on assets bough with your own money are typically deferred until you begin taking withdrawals in retirement. This doesn’t apply, however, to assets you own via other peoples’ money. Expect to pay capital gains or income tax, as applicable, on any gains or income attributable to debt. For example, if your IRA owns 50 percent of a given property and you still owe 50 percent of the value of the property to a mortgage company, you can expect to pay tax on 50 percent of the net income you realize from the property that year.
However, if you establish a self-directed solo 401(k), and own the real estate within your 401(k) instead of an IRA, you may be able to legally avoid the unrelated debt financed income tax. Speak with your tax professional for statistics.
Contact American IRA, LLC to learn more.
American IRA is among the country’s leading experts on the ownership of real estate within Self-Directed IRA accounts and real estate IRA strategies. Founder and CEO Jim Hitt has been investing in real estate and other alternative asset classes within his own IRA since the early 80s.
We can’t provide specific tax advice to your personal situation (we’re third party administrators of Self-Directed IRA accounts, not tax experts), we can help you ensure that your loan and purchase are properly structured to be compliant with the law and with IRS regulations.