Leveraging is a valuable tool to increase the buying power of an IRA. Leveraging means borrowing funds to increase purchase power and acquire a property that would otherwise be unaffordable. Surprisingly, many people aren't aware that their IRA or 401k funds can be leveraged and utilized as a down payment for a real estate IRA investment.
In order to use leverage, a non-recourse loan is required. The IRS restricts an IRA holder from personally guaranteeing the account or its assets. Consequently, lenders usually offer borrowers non-recourse loans with slightly different terms and loan-to-value requirements.
Key concepts for non-recourse loans
- An IRA is its own legal entity, separate from the IRA holder’s personal finances.
- Loan documents must be titled in the name of the IRA (i.e. NDIRA, Inc. FBO Client Name, IRA).
- The personal finances of the IRA holder or other disqualified person can’t guarantee the loan.
- The lender must be a non-disqualified person or entity.
- Unrelated Business Income Tax (UBIT) on profits derived from the debt-leveraged percentage may be incurred by the IRA.
- Terms of the loan are determined by the IRA holder and the lender.
The lender and non-recourse loans
The non-recourse lender determines the criteria that they wish to use to qualify an IRA (borrower) and the terms that they are willing to offer that IRA. It is common for the terms of a non-recourse loan to an IRA to be different from the terms that a lender would offer to an individual whose personal assets are available in the case of default. For example, non-recourse lenders may require 30 to 40 percent down or more.
The non-recourse lender may offer a percentage rate that is higher than they might offer for a personally secured loan. The IRS does not dictate to the lender which IRAs qualify for a loan, nor do they prescribe any terms of the loan except the concept noted above that disqualified persons cannot guarantee the loan.
The IRA provider and non-recourse loans
The IRA provider does not negotiate the loan for the IRA. It is also not the role of the provider to evaluate or approve the loan. Even though the loan is negotiated between the lender and the IRA holder, all legal documents associated with the loan are signed by the IRA provider, not the IRA holder.
