A Non-Recourse Loan vs. An Investment Partner For Real Estate Investment
Posted by Entrust Sacramento on Mon, Mar 08, 2010
Some of you may have considered a non-recourse loan for your
real estate investment, either because you are short on cash and/or want to use loaned monies as leverage for your investment. While it’s true a non-recourse loan is an option for real estate investment, there are other available options that prevent your IRA from being subjected to UDFI (Unrelated Debt-Financed Income) tax.
A non-recourse loan is a secured loan (debt) utilizing a pledge of collateral, typically real property, for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender's recovery is limited to the collateral. The UDFI tax is a subset of UBIT. Under IRC § 514, the IRS will assess a tax on any income that is derived from the use of, “acquisition indebtedness,” in passive
self-directed IRA investments. For example, if you use $30,000 of funds from your self-directed IRA and borrow $70,000, using a non-recourse note, to purchase a $100,000 rental property that generates $10,000 annual rent, the IRS would assess UDFI tax on about $7,000 of the profit. That is because 70% of the investment came from leverage. The tax rates for UDFI ranges from 15-38%. Solo/Individual 401k accounts and other qualified plans are exempt from UDFI. You can consult your CPA or tax professional for more details
An alternative option to a non-recourse loan is an investment partner. Below is a list of investment partners to consider:
• Self-Directed IRA Holder(s)
• Qualified Plans (i.e. 401K, 457, 403B, etc..) and IRA Holder(s)
• Private Investor(s)
Someone from this list can partner with you in a TIC (Tenants In Common) relationship, in which case your interest rate may be lower and the terms may be more flexible than a lender, without being subject to UFDI. You would still be employing the concept of using OPM (Other People’s Money), but without the added tax cutting into your profit. Relative to the percentage of ownership of the property among all parties, the profits and expenses must be split accordingly. For example, if you decide to partner with your spouse’s or other investors’ IRA and/or private funds to make a real estate purchase and the ownership between both parties is 50/50, all expenses, rents and profits must be split in accordance to these ownership percentages.
There are investors in your community and local investment clubs who are losing money in the stock market, have employers who are no longer matching their 401K’s and/or are not making a great return that are looking for alternative investment options.
The above listed information is NOT intended to be tax or legal advice as Entrust do not provide legal and/or tax advice. The variables are designed to educate investors and for you to factor in these variables when making your investment. For more information call me at (916) 509-7271 or come into our office for a free no-obligation consultation.
By Lamarr Baxter, Business Development Manager
lbaxter@theentrustgroup.com