Can your IRA/LLC use debt to leverage a real estate investment? Yes, but it must be a non-recourse loan.

What is meant by non-recourse loan?

With a non-recourse loan, if the borrower defaults, the lender’s only recourse (or method of recompense) is to foreclose and take back the property. In a non-recourse loan, the lender may not seek debt repayment directly from the IRA owner or the IRA/LLC. The loan qualifications may not be based on the individual’s creditworthiness, but solely on the asset (property) itself.

This keeps the loan in compliance with IRS rules, which prohibit the IRA investor from guaranteeing a loan or obtaining a loan personally for the IRA’s investments. But it also limits the options when it comes to finding an investor, since not all banks or local lenders specialize in this type of loan.

Because they cannot seek recourse for nonpayment beyond repossessing the property, these lenders typically require a large down payment (30% to 40%). For example, on a $100,000 property, your IRA might have to put $30,000 to $40,000 down, with the lender fronting the remainder.

Terms also can be expensive for the borrower. In addition, many non-recourse loans are short-duration (less than five years) and in some states cannot be used to purchase raw land. Loan-to-value requirements can be strict.

Tax implications

There are a number of things to be aware of when obtaining a non-recourse loan, not the least of which is the tax implications.

While the IRA’s funding of the real estate is tax-sheltered, a non-recourse loan is not. Therefore, any income generated through the use of the non-recourse loan—known as Unrelated Debt Financed Income—is subject to Unrelated Business Taxable Income (UBTI) rules. There are exceptions, however.

Sound confusing? Yes, indeed, which is why you should always seek guidance from your tax, financial or legal adviser who knows your specific circumstances.