What Is a Self-Directed IRA Loan and How Does It Work?

Summary: A self directed IRA loan enables IRA holders to diversify their assets into a high-value real estate market.

 

A self directed IRA loan is a financing tool for purchasing investment properties. The objective of the loan is to enable IRA holders to invest in the booming real estate market. The advantage of a private loan is it allows asset diversification with minimum risk to the IRA. Retirees can take it as an opportunity to make a quick profit with minimum investment.

 

How it works:

 

When an IRA account wants to purchase an investment property with borrowed funds, the loan must comply with IRS regulations that prohibit IRA holders from personally guaranteeing loans made to their IRS accounts. Since private property loans are approved on investment properties, they don’t come under the purview of IRS regulations.

 

With a non recourse IRA real estate loan, the only recourse the lender has in the event of loan default is the property itself. The structure of an IRA loan protects the personal assets of the account holder. The lender can claim the financed property if the borrower fails to repay the loan. Other than the property, the borrower won’t face any losses to his assets or integrity.

 

Highlights of an IRA loan

 

1. No Personal Guarantee

 

The law doesn’t authorize the borrower to co-sign or guarantee the loan. However, the lender reserves the right to claim the property for loan recovery, if the borrower fails to keep their promise or wants to foreclose the loan.

 

2. Property Must Cash Flow

 

Lenders give real estate investment loans only for high-value properties. They evaluate and market value of each property before financing. They want to ensure a high return on investment. For this reason, private lenders are often choosey in financing investment properties.

 

3. Down Payment Requirements

 

IRA holders looking for real estate financing should be ready to pay a heavy down payment of up to 30-40% of the property value. Private lenders ask for a high down payment to minimize their risk. The upfront amount is deducted from the IRA account. If you have limited IRA funds, you could end up paying your entire savings in a down payment.

 

4. Unrelated Business Income Tax (UBIT)

 

IRA holders should know that income generated by leveraged real estate investment could attract UBIT. The tax deductions could reduce your profit margin. If you are planning to borrow a self directed IRA loan, you should weigh all the options and go through the pros and cons of real estate investment.