Financed Investment with IRA Non-Recourse Loan

Case Study: How to Invest with a Self-Directed IRA Non-Recourse Loan

The following case study shows how one of Advanta IRA’s clients financed the purchase of their investment property. A self-directed IRA non-recourse loan was used to finance an investment when the IRA did not have enough funds to invest on its own.

Rachel wants to invest in a $100,000 rental property in her IRA. She only has about half of that amount in her account to make the investment. She decides her IRA can make a 40 percent down payment on the rental property and obtain a non-recourse loan to finance 60 percent of the purchase price.

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Rachel’s IRA takes out the non-recourse loan, which means she is not personally responsible for paying this note; her IRA must. However, her IRA will owe unrelated debt-financed income (UDFI) tax based on the percentage of the investment that was financed by this loan. In Rachel’s, case, 40 percent of that investment income reverts to her IRA with no tax consequence since that portion was purchased with IRA funds. The remaining 60 percent of income is subject to UDFI tax since it was financed by her IRA’s non-recourse loan. So, if her IRA receives $1,000/month in rent, $600 of that income is subject to UDFI.

On the flip side, when an IRA is subject to UDFI tax, the IRA can take certain deductions to limit the impact of the tax. Rachel’s IRA can offset deduct 60 percent of certain expenses (property taxes, mortgage interest, repairs, etc.) and depreciation from the total income. The IRA only pays tax on the net income.

Rachel’s IRA pays the mortgage loan each year and the property value increases. The ratio of her IRA’s debt-to-equity decreases, which means the percentage of investment income subject to UDFI decreases. If Rachel decides to sell the property, her IRA receives the proceeds from the sale and owes UDFI tax on a portion of the profits. If the non-recourse loan is paid off by the time she sells, no UDFI applies.