If your retirement fund is on the small side, do not despair! All investors have to start somewhere. When looking to purchase investment property that costs more than the cash available in your retirement account, your Midland IRA has two key options. Your IRA can partner funds or take out a non-recourse loan.
Option #1: Partnering Funds
Your IRA can partner with anyone, such as a spouse’s retirement fund, or even your own personal funds to purchase investment property. In the partnership, each party has to pay their fair share of the bills, and in return, gets to collect their share of all the income. On the deed, each partner is listed with his/her percent of ownership.
For example: “John Smith as to an Undivided 40% Interest and Midland IRA Inc. FBO John Smith IRA #12345 as to an Undivided 60% Interest.” In this example, John has enough cash in his IRA to purchase 60% of the property. As his IRA is short on cash, he uses enough of his own savings to purchase 40% of the property personally. This means ownership of the property is split 60-40 between his IRA and John personally. His IRA account must pay 60% of all bills, but gets to collect 60% of all the income (such as rental income and the sales proceeds when the property is eventually sold). John pays his 40% of all the bills but gets to pocket 40% of all the income personally.
Many people like the partnering funds option when they want the ability to touch some of the profits now and also earn tax-sheltered income in their IRA for use in their retirement years.
Option #2: Non-Recourse Loan
If you are not interested in splitting ownership and want your IRA to own 100% of the property, you can look at borrowing. In this option, your IRA has enough cash for a down payment and gets a mortgage to finance the rest. The IRA is both the buyer and the borrower. The IRA will collect 100% of all the income, but will pay 100% of all the bills such as property taxes, and the mortgage. The loan must be a non-recourse loan, which means you, as the IRA holder, cannot offer a personal guarantee.
The IRS will only allow a non-recourse loan in an IRA account as IRS rules prohibit individuals from using their personal credit for the benefit of their retirement plans. As there is no personal guarantee, these types of loans are harder to find.
Midland IRA keeps a list of all non-recourse lenders that have assisted our clients in the past. We can provide that to any investor who wants to research borrowing money in their IRA to finance an investment. When using financing with your IRA, the account may incur yearly, unrelated business income tax (UBIT). Consult with your financial professional or CPA to make this determination and proper payment to avoid complications with the IRS. Many times the tax bill is minimal as the investor gets to deduct depreciation and interest. In addition, the first $1,000 of net income is not taxable. Lastly, only the portion of income generated from debt is subject to UBIT. If 60% of the purchase was financed, only 60% of the income is possibly taxable.
Borrowing via non-recourse loans is a way to leverage a small amount of retirement savings for large real estate purchases. When an IRA is low on cash, borrowing can be the answer for some investors looking to make purchases that surpass the IRA’s cash balance.
To learn more about partnering funds or using non-recourse loans to purchase investment property, please contact Midland IRA. We serve clients across the nation who hold over $1 billion in assets in their self-directed plans. Self-directed IRAs allow account owners to choose their own assets to build tax-sheltered income for retirement.