Financing Property? Try a Solo 401(k)
By Jordan Sheppherd
Financing property within a retirement account can be a great thing. Using someone else’s money to make money is always a good thing.
Most of you are probably familiar with some of the rules relating to loans to a retirement account. Because of the self-dealing provisions, any loan to a retirement account has to be non-recourse, which just means you cannot personally guarantee the loan. The loan has to be made in a non-recourse fashion, so that if the loan has defaulted, the property itself is the only asset that the lender can take back.
It surprises a lot of people to learn that they will trigger tax if they finance property through a self-directed IRA or IRA LLC. Something called the Unrelated Debt Financed Income (UDFI) tax applies to profits realized from any leveraged transaction within an IRA. Specifically, the portion of the profits that are made with the financed money is subject to tax.
For example, if you were to finance a property 70% by way of a non-recourse loan, then 70% of the net profits from that deal are going to be subject to the UDFI tax. As a result, the IRA would have to file a 990-T tax return and pay any tax that’s due.
If you are thinking of financing some property within a retirement structure, you might consider doing it through a Solo 401(k), instead of an IRA related structure.
401(k)s’ are exempt from taxation on profits realized from leveraged real estate transactions. Using the example above, if a Solo 401(k) finances a property at 70%, no tax will be due at all, because the 401(k) enjoys an exemption, whereas an IRA does not.
Another reason to favor the Solo 401(k) structure over an IRA LLC.
If an IRA owned “C” corp leverages a property, will that “C” corp still pay UDFI tax IN ADDITION to the regular corp income tax rate…………….or does the payment of regular corp income tax eliminate the UDFI tax?
Hi Mickey,
Good question. Because the C-Corp files its own tax return and pays its own taxes, UDFI would not apply to the C-Corp. The Corp would file and pay its taxes, and any dividends would come back to the IRA tax-free.
You do have to worry about UDFI flowing through an entity if it’s a flow-through entity like a partnership or a single-member LLC. The C-Corp estops the UDFI from flowing through, because the C-Corp pay its own tax. Hope that helps.
Great article as always Jordan. Non-Recourse loans are not easy to find. I did eventually use NASB which has worked out well, however if you have any other lenders you are aware of that offer these loans at a reasonable rate please do advise.