Non Recourse Financing
by Peter Rizzo
With the increased real estate values across the country, many clients are asking about taking out loans to buy real estate with their Solo 401k’s or Check Book IRA’s. The one rule is it must be a non-recourse loan and here is some information regarding that.
What a Non-Recourse Loan Is
Typically, when a borrower takes out a loan, the lender requires collateral pledged as security against the possibility of non-payment. If the loan isn’t repaid, the lender can seize the collateral.
Collateral can include the asset purchased with the borrowed money, other assets, and/or bank accounts owned by the borrower.
A non-recourse loan is a type of debt that is secured only by the asset the loan finances. The lender has no other recourse, or ability to seize other assets if the borrower defaults on payments.
IRA holders and Solo 401k trustees cannot extend their personal credit to their IRAs or Solo K’s. Thus, prospective investments must have sufficient income potential to convince a lender to fund a non-recourse loan. Most lenders will only fund multi-family real estate to mitigate risk, but now many will also extend the non-recourse loan to any type of real estate.
Benefits of Using Non-Recourse Loans
Non-recourse loans can be a great option if you want to take advantage of an investment opportunity, but don’t quite have the funds to finance it. A non-recourse loan can provide the additional funds you need without putting additional collateral at risk. Asset protection is the most significant benefit of a non-recourse loan, as the loan shields unrelated assets if you default.
This is especially important for investors who use non-recourse loans to purchase real estate. For example, your IRA takes out a non-recourse loan to purchase a duplex that you intend to rent out. A hurricane damages the duplex. Rather than undertaking very expensive repairs, you decide to let the bank foreclose on the loan. The bank can seize only the duplex. It cannot go after the funds in your IRA.
If your SDIRA purchases a property using a non-recourse loan, the debt financing transaction will subject the IRA to unrelated debt-financed income (UDFI). Unrelated business income tax (UBIT) is the tax associated with income earned by the percentage of the asset that is unpaid or still subject to the loan agreement. Solo 401k’s do not have the UDFI tax which makes them even more advantageous.
Below are examples of some non-recourse lenders, but if you have a good relationship with your local bank don’t be afraid to try them also.