by William Bronchick, ESQ.

Most people think that an IRA cannot borrow money.  In fact, an IRA can borrow money so long as the debt is WITHOUT RECOURSE (i.e., contains language in the note limiting the recourse of the lender to the asset collateralized).  The IRA owner cannot personally guarantee the debt either, including a personal guaranty on a line of credit or credit card (read the language carefully when you get credit card offers to an IRA-LLC, discussed below).

To the extent you borrow money to purchase an asset such as real estate, the profits derived therefrom are taxable on your personal return.  This is called the “Unrelated Debt Financed Income” tax (UDFI).  Thus, if you buy a property using 50% cash from the IRA and 50% through a seller-financed loan, then when you resell the property, 50% of the profit would be taxable.  And the bad news is, you can’t use any of the profit earned by the IRA to pay the taxes!

The news is better, however for long-term buy and hold rental properties. Rental profits are also taxed under UDFI, but you get the depreciation deduction to offset and net income from rental activities.  And, when you sell the property, the UDFI tax is based on the amount financed when you sell, not when you started.  Thus, using the above example, if the property were held 20 years and the debt was paid off completely, a sale would probably result in no UDFI tax for the IRA owner.  NOTE: This is a complex area of the tax code that you should review with your attorney or CPA before proceeding.

Finally, you have to consider that you cannot pledge personal assets as collateral for the IRA loan. A simple example would be if a lender wanted to cross-collateralize a real estate loan with your principal residence, that transaction would not be kosher.  A more subtle example would be if you co-owned a house with your IRA and your IRA wanted to borrow money against the house.  In that case, your IRA could only pledge its portion of the house, not yours. Effectively, this would mean no loan, since a lender would not likely take a lien against half of the property as collateral. There are lenders in every market, however, that will finance a non-recourse loan using an entity, a trust or even your IRA. Be aware that you may have to put 25-30% or more down in such cases.

Knowing the rules and how to properly invest using IRA Funds is a matter of being educated!

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